Regulatory landscape

Principles of setting fees for greenhouse gas emissions, the European Green Deal, Climate Law, emission reduction plans and reporting on climate issues and other global and European regulations are basic knowledge that members and members of Supervisory Boards should have.

Worldwide

Carbon Pricing

The World Bank defines Carbon Pricing as an „instrument that captures the external costs of greenhouse gas (GHG) emissions  [such as rising healthcare costs due to heatwaves or loss of property due to flooding] and ties them to their sources through a price, usually in the form of a price on the carbon dioxide (CO2) emitted”[1]. Placing a price on carbon utilizes market forces and mechanisms to influence emission intensive economic activity, with the ultimate goal of mitigating climate change. This effect manifests through price signals which raise costs for emission intensive industries and create monetary incentives for reducing emissions (where otherwise they would stay an externality borne by the public).

The two key forms of carbon pricing are carbon taxes and emissions trading schemes. Carbon taxes place explicit tax rates on GHG emissions (i.e. a price per tCO2e), however set no defined limit on emissions. Conversely, emissions trading schemes (also referred to as „Cap and Trade”) define a target volume of emissions and distribute an equivalent amount of tradeable permits (for free or by auction) to emission intensive industries, allowing the market to ultimately determine the price of carbon. Emissions exceeding permitted volumes face high penalties. Trading schemes allow regulated entities to comply with emission targets in the most efficient way – whether through internal abatement or permit purchase.

64 initiatives have been implemented (or scheduled for implementation) worldwide, covering 22% of global emissions, and providing a market-based mechanism for the mitigation of climate change through caps on emissions from emission intensive sectors[2].

Existing, emerging and potential carbon pricing instruments (ETS, tax)
Existing, emerging and potential carbon pricing instruments (ETS, tax)

Source: Carbon Brief

European Union

European Green Deal

The European Green Deal is a package of measures which seeks to revitalize European economies in a sustainable way, with measures including cutting greenhouse gas emissions, preserving the natural environment, and supporting innovation. The Green Deal will mobilize the financial sector for this purpose, expecting it to play a key role in financing sustainable growth.

In seeking to transform the EU’s economies for a sustainable future, the Green Deal encompasses the following elements:

  • Increasing the EU’s climate ambition for 2030 and 2050;
  • Supplying clean, affordable and secure energy;
  • Mobilizing industry for a clean and circular economy;
  • Building and renovating in an energy and resource efficient way;
  • A zero pollution ambition;
  • Preserving and restoring ecosystems and biodiversity;
  • The „Farm to Fork” initiative for fair, healthy, and environmentally friendly food systems;
  • Accelerating the shift to sustainable and smart mobility;
  • Ensuring a Just Transition;
  • Financing the transition.

The first initiatives under the Green Deal include the European Climate Law, the European Climate Pact, and the 2030 Climate Target Plan.

EU Climate Law

In accordance with goals set by the European Green Deal, the Commission proposed the first European Climate Law, which seeks to make the European economy climate neutral by 2050 through a binding target of net zero emissions. The European Climate Law seeks to create a predictable business environment for industry and investors by clearly mapping future measures and rates for emission reductions.  The law is expected to be finalized in 2021, and has four key objectives: shaping long-term trajectory for meeting 2050 climate neutrality objectives, creating a system for monitoring progress, providing predictability for investors, and ensuring the transition to climate neutrality is irreversible. Progress is to be reviewed every 5 years in line with Paris agreement stocktaking.

New EU emissions targets

As a step to achieving the 2050 target, the Commission proposed a new target for 2030, whereby greenhouse gases are to be reduced by 55% compared to 1990 levels.  The European Parliament adopted the position of a 60% reduction by 2030.

EC Action plan on financing sustainable growth

Taxonomy – providing general-use definitions for sustainable investment: The Action Plan underlines that for multilateral action to be effective, shared understanding of key terminology is essential. An „unified EU classification system – or taxonomy – will provide clarity on which activities can be considered ‚sustainable’ ”[3], and is considered to be an essential first step in the Action Plan. This taxonomy would be „gradually” integrated into legislation with the aim of providing greater certainty for investors and market actors, undoubtedly serving to also benefit sustainability disclosure and reporting frameworks (which in the past have been criticized as difficult to compare). The taxonomy will cover not only climate but also wider environmental and social aspects (whilst making sure that no single aspect of sustainability serves to the detriment of other objectives), making for a complex and technical system which will inevitably need time perfect and complete. Building on the taxonomy, the Action Plan notes standards and labels for sustainable financial products as a logical next step, protecting the integrity of the sustainable financial market.

Green bonds – the taxonomy would serve to support uptake in green bond markets. Although green bonds have seen growing interest and expansion in recent years, they still account for less than 1% of total bonds worldwide. An EU standard accessible to market participants could facilitate growth in green investments and might form a basis for developing reliable labelling of financial products. Such labelling would be of great benefit to both institutional and  retail investors who are increasingly interested in sustainable activities (but may be dissuaded by disparate labelling and terminology which obstructs market understanding and comparison).

Climate benchmarks and benchmarks’ ESG disclosures – benchmarks play an important role in price formation of financial instruments, and are useful for investors looking to track performance and allocate assets accordingly. Traditional benchmarks only reflect sustainability goals to a limited degree, and while index providers have developed benchmarks which account for ESG and sustainability goals, the lack of transparency has been alleged to negatively affect their reliability. The Action Plan declares the Commission’s intention to increase transparency in sustainable indices’ methodologies (in compatibility with the Paris Agreement), which may „improve the performance assessment of low-carbon funds”.

Disclosure of climate-related information – as part of the Commission’s Sustainable Finance Action Plan, the European Commission published new guidelines in 2019, incorporating the TCFD recommendations into the Non-Financial Reporting Directive 2014/95/EU.

In response to concerns that accounting rules were not conducive to sustainable investment decision-making, the Action Plan also sought to address a need to strike an appropriate balance between „flexibility and the standardization of disclosure necessary to generate the data needed for investment decisions”. As part of the measures designed to strengthen sustainability disclosure, asset managers and institutional investors would be requested to disclose how they consider sustainability factors in their strategy and investment decision-making process – particularly as relating to their exposure to climate risks. The Action Plan also determined it would strengthen guidelines for reporting non-financial information, building on metrics developed by the EC technical expert group on sustainable finance, and in line with the Financial Stability Board’s (the “FSB”) TCFD.

Task Force on Climate-related Disclosures (TCFD)

The Financial Stability Board  was tasked to review how businesses worldwide were able to take into account climate-related issues in their disclosures. FSB initiated the TCFD, which released its final report (“TCFD Recommendations”) in 2017. While remaining voluntary, the TCFD Recommendations are globally acknowledged as a key benchmark for investors, lenders and insurance underwriters to help assess companies’ integration of climate relating issues into its governance, strategy and financial planning. In the UK, all listed companies and large asset owners are expected to report information in line with the TCFD by 2022. The Recommendation will also become mandatory for members of the UN Principles for Responsible Investment (UN PRI, the largest responsible investment body globally) starting from 2020.

It is currently supported by over 1700 companies from 77 counties, including over 500 financial firms, responsible for assets of $138 trillion.[4]

The text is an expert study of publicly available materials for non-executive directors from sectors other than financial services.

[1] World Bank, What is Carbon Pricing? | Carbon Pricing Dashboard (worldbank.org)

[2] The World Bank, https://carbonpricingdashboard.worldbank.org/map_data (access: 1.02.2021)

[3] European Commission, EUR-Lex – 52018DC0097 – EN – EUR-Lex (europa.eu)

[4] TCFD Knowledge Hub, https://www.fsb-tcfd.org/support-tcfd/, (access: 1.02.2021)

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