July 22, 2021—For decades, the European Union (EU) has led the world in pursuing sustainable finance policies, particularly in carbon reduction. Within Europe, sustainability objectives enjoy broad support across the left, right, and center. Last year, the European Commission ratcheted up these efforts by incorporating its “European Green Deal” into its massive multi-year budget program, alongside efforts to boost European competitiveness in the digital space. The surprisingly large multi-year budget, as well as its focus on green and digital technology coupled with the European Central Bank’s (ECB) COVID-related monetary support has underpinned our positive view of European equity markets.
In this Wilmington Wire, we explore a parallel effort by the European Commission to formally integrate sustainability objectives into the EU’s capital markets directives. This regulatory initiative is top of mind for many European asset managers and institutional investors but is less well-known among U.S. counterparts. Of course, many listed European companies are responsive to their European stakeholders and have already started pursuing sustainability objectives. Likewise, many European investment managers have encountered strong demand for sustainable strategies from European institutional investors and have already integrated sustainability into their investment processes, regardless of how their products are branded. We anticipate that as economic actors in Europe become progressively more responsive to sustainability objectives, reallocating capital from value-destroying legacy industries to value-creating emergent ones, the better the likely outcomes will be for the EU’s long-term economic growth.
EU’s capital markets union: work-in-progress
Over the last 15 years, the EU has been building its capital markets regulatory system, crediting a capital markets union (CMU) to facilitate free flow of capital across national borders, much like the single market encourages free flow of goods and services. The EU wants stock and bond financing to be more widely accessible to European firms, which have traditionally relied on commercial banks for their corporate financing needs. The EU has been making steady progress in developing regulations, particularly regarding disclosures and conflicts of interest, significantly strengthening the authority of the European Securities Markets Agency (ESMA), the EU’s equivalent of the SEC in the U.S.
The EU is advancing its “EU Green Deal” by integrating sustainability-related disclosure requirements into its regulatory framework. These requirements aim to encourage private investment capital to flow toward firms with demonstrably sustainable characteristics. They also seek to make “greenwashing” (overstating sustainability credentials in order to attract more investment capital) an illegal practice.
The heart of the European Commission’s work is EU Taxonomy, which provides disclosure requirements for large public firms doing business within the EU. Per the taxonomy, a firm can describe itself in its corporate reporting as pursuing one or more sustainable activities provided it pursues any one of the six objectives noted in Figure 1, does no significant harm (DNSH) to any of the other six, and adheres to both the Organisation for Economic Co-operation and Development (OECD) Guidelines for Multinational Enterprises and U.N. Guiding Principles for Business and Human Rights.