The role of green finance on the European path to ecological transition

Article
Domenico Salerno

The ambitious programme of the European Union towards climate neutrality by 2050 requires a huge use of economic resources. In the last 10 years, global investments in the low-carbon energy transition have more than doubled to exceed $ 500 billion, however, all the major decarbonisation scenarios developed recently demand much larger volumes of resources. The IEA report “Net Zero by 2050: A Roadmap for the Global Energy Sector” quantified US $ 5 trillion per year by 2030 as the investment needed for the energy transition, about 4.5% of global GDP. After 2030, an additional $ 4.5 trillion per year of investments will be required to achieve the zero-climate impact goal by 2050. Therefore, the ecological transition cannot only be sustained by public resources but must necessarily be the result of a collaboration with private financiers, with the international financial sector playing a leading role in providing credit and support for projects linked to the green revolution.

In 2020, global investments in the low-carbon energy transition amounted to $ 501.3 billion, up from $ 458.6 billion last year and from just $ 235.4 billion in 2010. The first sector for investments has been renewable energy ($ 303.5 bln), up by 2% compared to 2019 despite some delays due the Covid-19 pandemic. Following, we find electric transport with $ 139 billion being invested in new vehicles and charging infrastructures (+ 28%) and electric heating with $ 50.8 billion in investments (+ 12%), while hydrogen and CCS are marginal (1.5 bln and 3 bln, respectively), but expected to grow, however, in the future.

Europe and China are currently competing for the most active markets in energy transition investments. In 2020, European countries allocated a large part of the increase in investments in this area. Growth for Europe is +67% compared to 2019, for a total value of $ 166.2 billion, higher than China and the US.

THE ROLE OF GREEN BONDS

In the broader framework of sustainable finance, an essential factor is green bonds. These are bonds that, on the one hand, offer financial returns on a par with any other bond and, on the other, guarantee returns in environmental terms as they finance activities and projects with positive effects on the environment. Green bonds help bridge the gap between providers of capital and green goods, helping governments raise money for projects that aim to achieve climate goals and enabling investors to achieve sustainability goals.

The green bond market emerged about a decade ago and has experienced rapid growth since then, particularly in recent years. According to data released by the Climate Bonds Initiative, one of the main international organisations engaged in mobilising and orienting the capital market towards solutions to combat climate change, 2019 was the first year since 2016 in which all regions of the world recorded an increase in green bonds issued, also with considerable variations. Europe recorded the largest increase, with $ 50 billion more than in 2018, accounting for as much as 57% of global expansion. In 2020, after a first quarter of strong growth, green bond issuance clearly suffered from the pandemic in the second quarter, but a record third quarter ensured a good overall result. Europe at the end of 2020 recorded a growth of 28% with an overall increase of $ 34.5 billion even higher than the world average (+ $ 23.2 bln), which was instead affected by the decline recorded in the Asia-Pacific area (-$ 12 bln) and by supranational organisations (-$ 4 bln). This trend strengthens European leadership, with an overall volume, in the 2014-2020 period of approximately $ 465 billion, almost double that of North America and the Asia-Pacific area.

In July 2021, a proposal was published to create a European Green Bond Standard (EUGBS). This would be a standard to be applied on a voluntary basis to bonds that finance green investments. This action aims to provide companies and institutions with a single European standard to support projects that meet sustainability criteria, foreseeing an increase in the volumes of the green bond market.

THE ROLE OF THE NEXT GENERATION EU PLAN

Green finance is also an important element of the European exit plan from the Covid-19 crisis. The Commission is aiming to raise 30% of the € 750 billion of resources needed to finance Next Generation EU on the markets through the issuance of green bonds. The first issue recorded a demand for more than € 135 billion, compared to the € 12 billion of securities issued. The high demand allows the EU to place the bonds (with a duration of 15 years) at a lower yield than initially expected, thus saving on interest. Furthermore, any projects and investments financed with the Recovery Fund cannot compromise the achievement of sustainability and environmental protection objectives. Regulation 2021/241, which establishes the Recovery and Resilience instrument, provides for Recovery Fund resources being only used to finance projects that fully respect climate and environmental standards and comply with the principle of not causing any important harm (“Do no significant harm”, DNSH).

EU TAXONOMY AND THE NATURAL GAS AND NUCLEAR ISSUES

EU Taxonomy is a robust, science-based tool which classifies the main economic sectors on the basis of their ability to mitigate or adapt to climate change. These are divided into three types: those already environmentally sustainable, defined as low carbon; those that pollute, but which cannot be done without and which are asked to do everything possible to shift towards a zero-emission economy but which still cannot be defined as zero carbon, defined as transition; those that are useful to the other two categories which, therefore, allow other activities to have low carbon performance or present a considerable reduction in emissions, defined as enabling.

This tool is important to offer transparency for businesses and investors. The first of the delegated acts of the EU Taxonomy, approved by Commissioners on 21 April, introduces a series of technical screening criteria to define the activities mainly contributing to two of the environmental objectives envisaged by the taxonomy regulation – the adaptation to climate change and climate change mitigation. A second delegated act covering the remaining targets will be published this year.

Two of the main issues in the EU Taxonomy discussion are the possibility of including investments in natural gas and nuclear power. The decision on these two energy sources, which play a crucial role in the EU (two main sources of the EU electricity generation mix), had been postponed to the end of the year. In October 2021, the Ministers of Economy and Energy of Bulgaria, Croatia, the Czech Republic, Finland, France, Hungary, Poland, Romania, Slovakia and Slovenia jointly declared that the inclusion of nuclear energy in the European classification is “absolutely necessary”, as it is a “reliable resource for a low-carbon future”. However, there is a large group of countries firmly opposed to the introduction of nuclear power in the taxonomy, including Austria (ready to appeal against a possible favourable decision of the Commission), Germany (according to the statements made a few days ago by the Minister of the Environment Steffi Lemke, the German government has reached an internal agreement and will say “a clear no” to the proposal), Belgium, Spain, Luxembourg, Portugal and Denmark. On December 31, the European Commission released to the Member States a draft of the delegated act that sets the conditions to allow the two energies to achieve the “green” label. The deadline for any objections had been set for 12 January, but the complexity of the decision meant that the deadline has been postponed to 21 January. After receiving and examining the comments from the Member States, the Commission will consider possible amendments to the draft delegated act.

CONCLUSIONS

Until now, a sectoral criterion has prevailed to classify an investment as sustainable (e.g. exclusion of sectors such as arms and tobacco). However, this model does not allow for evaluating the real environmental impact of an investment and favours incorrect practices such as Green Washing, or not guaranteeing the achievement of environmental sustainability objectives. Therefore, the creation of a shared taxonomy for energy investments is essential to provide the lender with a useful tool to make an informed choice. This could spur growth in the green bond market globally. These tools are important for bridging the gap between providers of capital and green goods, helping large private companies and governments to raise economic resources for projects that aim to achieve climate goals and enabling investors to reach sustainability targets. However, a problem linked to the use of green bonds is linked to the impossibility for small and medium-sized companies to access these forms of financing. Thus, it would be useful to make practical tools available to support companies that have difficulty in making direct deposits on the market.

To attract capital to green stocks, it would also be opportune to provide incentives that allow investors to find such investments attractive. Furthermore, the European institutions must continue along the path of defining consistent and common standards, metrics and certifications, as well as the introduction of disclosure obligations so that the European financial and business system becomes more sustainable.