From legislation to consolidation: navigating the future of green finance

Earlier this month (March 2024), Natixis CIB hosted its fourth consecutive annual Sustainable FIG conference. The event, a close collaboration between Natixis CIB’s DCM teams and its Green & Sustainable Hub, addressed sustainability challenges across the financial landscape and explored how financial institutions can best prepare for the road ahead.

Thomas Girard, Head of Green & Sustainable Syndicate at Natixis CIB, kicked off the event by outlining the current landscape, highlighting the growing focus on climate as ESG regulation moves further up the agenda. Notably, this has led to an increased focus on transparency and disclosure amongst market participants – particularly as greenwashing concerns become more prominent.

To dive deeper into the current landscape, Thomas Garnier, Sustainable Finance Advisory at Natixis CIB was joined by Nigel Fletcher, ESG Analyst at Amundi; Petra Mellor, Head of Bank Debt at Nordea; Nelson Ribeirinho, Portfolio Manager at Mirova; Bodo Winkler-Viti, Head of Funding & IR at Berlin Hyp and Dorota Wojnar, Head of ESG Risks Unit at the European Banking Authority (EBA).

Aligning banking operations for a greener future

An important indicator of a corporate’s commitment to the sustainability agenda is the strength of its ESG profile. The panel began by highlighting the key areas that financial institutions should focus on when it comes to ensuring best practices are achieved and upheld.

A bank's climate strategy must present a clear plan for reaching net-zero, and its practices must demonstrate progress towards this goal. Banks should factor in all relevant financing activities, including investments, lending and capital market activity. In addition to its own operations, banks should also consider off-balance sheet activities and facilitated emissions – especially counterparty scope three emissions that are material for the sector.

Financial institutions should also look to have their emissions reductions targets independently validated by an industry body, such as the Science Based Targets initiative (SBTi), as well as ensuring that financing tools, such as green bonds, are aligned with the relevant principles or taxonomy.

Demonstrating a strong commitment to phasing out thermal coal from portfolios is also fundamental to a strong transition strategy. Financial institutions must seek to reduce their coal exposure in accordance with global governing bodies' guidelines, as well as explicitly excluding coal developers from their financing activities. Importantly, banks should make sure that they are accurately reporting on the full scope of their activities to ensure alignment with disclosure requirements and promote transparency.

Steering the legislative journey towards implementation

The panel also highlighted the importance of regulatory consolidation. While much work has gone into establishing regulatory frameworks, ESG is a complicated area and there are still a number of elements that require fine-tuning – for instance, regarding capital requirements and transparency – particularly as the focus shifts towards implementation and monitoring.

With larger banks well acquainted with the current landscape, governing bodies are now turning their attention to smaller financial institutions, with a focus on ensuring legislation is tailored to support their needs when it comes to reporting and transparency. Indeed, where large institutions often have dedicated teams of specialists to handle complex reporting requirements, their smaller counterparts lack the same capacity and therefore must be supported to ensure they are able to comply with the current legal requirements.

As legislation continues to evolve, its focus will expand to include a wider range of sustainability concerns. Currently, the primary focus has been on developing climate risk-based standards. While these issues are critical, particularly for those operating in the Western world, moving forward, more attention will be paid to factors such as biodiversity, as well as social and governance concerns.

Reconciling green loan instruments

Green loans are growing in prominence as financing instruments. However, the panel noted that these are still marginal when considering the wider financing landscape. In Europe, for instance, green loans account for just 4.5% of all loans issued. For corporate portfolios, this figure drops to 2.5%, while for retail SMEs it is close to zero.

What’s more, the criteria used to classify whether a loan can be considered green varies drastically from institution to institution. Some banks, for instance, rely on the 'do not significant harm' clause of the Sustainable Finance Disclosure Regulation (SFDR), which states that an investment is considered sustainable if, at the very least, it does not actively harm a social or environmental objective set out by the SFDR. While this clause serves as good basis for ensuring investments do not cause active damage, it is typically insufficient to determine whether a loan is truly green.

Green mortgages, which make up the majority of green loans issued in Europe, are usually easier to assess in terms of environmental impact due to product harmonisation. However, there is still a lack of consistency with bank labelling, with some institutions focusing on the energy efficiency of a building and others on loan proceeds. To overcome these issues, greater consistency is required, and banks should not rely solely on internal standards to classify green financing. 

Making use of the EU taxonomy

The EU taxonomy for sustainable activities was established to clarify which economic activities are environmentally sustainable. Despite the fact that its stated purpose is to increase industry standardisation, so far, banks have rarely used it.

The panel acknowledged that the application of the taxonomy is difficult, but maintained that standardisation is critical to progress. The European Banking Association (EBA) has proposed the creation of a voluntary label for green loans in order to clarify definitions. And, to promote comparability and transparency, it has proposed defining green mortgages. The forthcoming review of the Mortgage Credit Directive – an effort toward an EU-wide mortgage credit market with an emphasis on consumer protection – provides an excellent opportunity to accomplish this.

The EU taxonomy should not be used as a risk management tool, but provides a vital benchmark for transparency. It can also serve as a useful starting point for the assessment of certain risks, such as greenwashing. And, while ultimately, the model does not protect against high credit risk on certain investments, financial institutions need to become more aware of its value.

Adapting to the green finance landscape

As the regulatory landscape continues to evolve, the way in which financial institutions respond to various requirements is critical. They must create their own environmental frameworks to ensure that their practices align with the most up-to-date expectations.

Compartmentalisation is important for distinguishing environmental and social bond products, with panel members advocating for the use of separate portfolios. Updating portfolios annually to keep up with changing regulations is a difficult but necessary step towards ensuring that ESG frameworks remain aligned with the changing landscape.

Fund managers, for instance, can divide green portfolios into subcategories to differentiate between different regions and financial instruments. This would provide investors with a high level of transparency, allowing them to understand which assets are used when issuing various formats and currencies. This transparency also helps with reporting when funds produce quarterly breakdowns.

The path ahead

When considering the broader landscape, an enormous amount of work has already been done to develop viable sustainable finance models. An encouraging amount of legislation has already been passed, and banks are making strong progress when it comes to establishing their ESG frameworks.

To consolidate this progress, moving forward, governing bodies must strengthen existing legislation and financial institutions must tailor their operations to meet these global environmental goals. Standardised reporting models, clear compartmentalisation of green loan instruments and well-developed internal ESG frameworks will all be tantamount to the financial sector having a meaningful, long-term impact on the journey to net-zero.

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