FINANCING A

SUSTAINABLE
EUROPEAN ECONOMY

Interim Report, July 2017

By the High-Level Expert Group on Sustainable Finance
Secretariat provided by the European Commission
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Foreword by

Valdis Dombrovskis, Vice-President for the Euro and Social Dialogue, also in charge of
Financial Stability, Financial Services and Capital Markets Union

Jyrki Katainen, Vice-President for Jobs, Growth, Investment and Competitiveness

Two years ago, the nations of the world chose a more sustainable path for our planet and
our economy, with the adoption of the Paris Agreement on climate change and the UN 2030
Agenda for Sustainable Development. Following the US decision to withdraw from the Paris
Agreement, the EU has pledged to take the lead in implementing this historic agreement and
delivering the transition to a low-carbon, more resource efficient, and more circular economy.

Over the next two decades, Europe needs about 180 billion in additional yearly investment,
notably in clean energy, to keep the increase in global temperatures to well below 2 degrees
Celsius. This is a major challenge, but also an opportunity. By reorienting public and private
financial flows towards green and sustainable efforts, we can help mitigate the risks posed
by climate change, and create new jobs and sustainable economic growth in the process. As
Article 2 of the Paris Agreement also makes clear, the financial sector is key to enabling this
transition.

With the European Fund for Strategic Investments (EFSI), the EU is already working to
accelerate funding for investments in renewable energy and energy efficiency, and other
environment and resource efficiency projects. EFSI aims to unlock up to 315 billion of
investment in combination with private funds, and in the future, our goal is to have at least 40%
of EFSI funds contributing towards COP21 goals.

The commitment to hardwiring sustainability into EU policies and cross-cutting initiatives

is already ingrained in the Mid-Term Review of the Capital Markets Union Action Plan. But a
deeper re-engineering of the financial system is necessary for it to become truly sustainable
from an economic, social and environmental perspective.

To develop the overall vision of sustainable finance that this requires, the Commission decided
last year to appoint a High-Level Expert Group under the chairmanship of Christian Thimann.
The work of this remarkable group of experts will ensure that our approach to sustainable
finance is ambitious and at the forefront of innovation.

The expert group recommends reforming the EUs rules and financial policies to facilitate green
and sustainable investment. We need to make sure that capital flows towards sustainable
projects and serves our long-term goals. For this, as the first priority, we need to work on
changing the investment culture and behaviour of all market participants. This includes
providing more financial and other incentives to choose and offer green products.

The Interim Report provides a set of recommendations for action, which we welcome. In
particular, we believe that suggestions for a classification system for sustainable assets and
a European standard and label for green bonds have great potential. They should be explored
further, as a step towards our long-term goal of establishing EU labels and quality standards
for all sustainable assets. These labels will provide the confidence and trust in sustainable and
green products needed for investors to fund the transition to the low-carbon economy.

Urgent action is needed. We very much look forward to the final recommendations, which will
be elaborated by the expert group at the end of 2017. And we reiterate our commitment to act
on these findings as soon as possible and by the first quarter of 2018 at the latest, as set out
in the Capital Markets Union Mid-Term Review. Through a continued push from both policy-
makers and the private sector on a global scale, we can ensure our financial system plays its
part to keep us on the path towards a more sustainable and prosperous future.

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Foreword by

Christian Thimann, Chair of the High-Level Expert Group

Sustainable finance is about two imperatives. The first is to improve the contribution of
finance to sustainable and inclusive growth, in particular funding societys long-term needs
for innovation and infrastructure, and accelerating the shift to a low-carbon and resource-
efficient economy. The second is to strengthen financial stability and asset pricing, notably by
improving the assessment and management of long-term material risks and intangible drivers
of value creation including those related to environmental, social and governance (ESG)
factors.

In short, sustainable finance means better development and better finance development
that is sustainable in each of its economic, social and environmental dimensions; and a
financial system that is focused on the longer term as well as material ESG factors.

Progress on sustainable finance starts not with finance itself; the first step is to describe the
desired economic model of sustainability. The European Union has developed this model:
a low-carbon, resource-efficient and increasingly circular economy characterised by high
employment, technological innovation and sustainable growth.

The second step is to see how finance needs to change to move the economy towards the
desired model. This implies adjustments in policy and financial regulation, as well as changes
in financial market practices, norms and behaviour. To guide this second step, the European
Commission has launched the High-Level Expert Group on Sustainable Finance.

The central challenges for the Group are three-fold. First, to identify more precisely the core
areas of sustainability: this Report outlines an initial framework on sustainability taxonomy,
standards and labels. Second, to foster longer-term orientation in finance and the wider
economy: this Report explores ways to attenuate impatience in finance and avoid decision-
making, in particular regarding investments, based on too short horizons. Third, to integrate
ESG factors into financial decision-making: this Report examines key elements across the
investment and lending chain.

Repositioning financial regulation towards sustainability cannot be done with one stroke of
a pen. But neither does it require rewriting the whole system of financial regulation. Rather, it
means identifying the key areas where adjustments are needed and developing specific and
targeted proposals for change.

The High-Level Expert Group on Sustainable Finance has not started from scratch. It has built
its considerations on a broad range of existing initiatives. The unique feature of the Group is
that it is working with the EUs main financial regulator: the European Commission is providing
the Secretariat to the Group and, though the Group works independently, supports the Group
through its expertise.

The High-Level Expert Group has benefitted from invaluable support by the Commission. This
includes exchanges on the overall policy context with officials, notably Valdis Dombrovskis,
Jyrki Katainen and Olivier Guersent as well as the cabinets; it also includes a Secretariat team
overseen by Niall Bohan and coordinated by Martin Koch and Michelle Kosmidis as project
leaders. The Secretariat team has not only successfully coordinated the work of the group, but
also ensured systematic linkages with current and evolving EU regulation. The Group would like
to thank the European Commission, the Secretariat team, the Groups observers and the many
experts that have provided guidance and feedback.

We hope that this Interim Report will help to stimulate debate on sustainable finance and
create the basis for engagement by a wide range of stakeholders to inform the Groups final
report due in December.

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Table of contents

Executive Summary 5

I. Introduction 8

II. Towards a sustainable financial system 11

1. The scale of the sustainable finance challenge
2. Progress towards sustainable finance
3. Identifying barriers
4. A vision of sustainable finance

III. Sustainability and the processes, incentives and culture of the financial 18
system
1. Mismatched time horizons and objectives across the investment and
lending chain
2. Disclosure
3. Fiduciary duty and related concepts
4. Investor governance and corporate governance
5. Corporate reporting: frequency and contents
6. Market indices and benchmarks
7. Accounting frameworks

IV. Sustainability and the participants and facilitators of the financial system 31
1. Banks
2. Insurance companies
3. Pension funds
4. Asset managers
5. Credit rating agencies
6. Stock exchanges
7. Green financial centres

V. Mobilising capital for a sustainable economy 42

1. Developing a coherent EU strategy to mobilise investments
2. Agreeing a classification system for sustainable finance
3. Developing sustainable financial products

VI. Financing a sustainable European economy: early recommendations and 54

policy areas for further discussion
1. Early recommendations
2. Policy areas for further discussion

VII. Next steps 64

The High-Level Expert Group 65

Acknowledgements 66

List of acronyms and abbreviations 68

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Executive Summary

In the aftermath of the financial and sovereign debt crises, sustainable finance could provide
the best opportunity for the European Union to reorient its financial system from short-term
stabilisation to long-term impact. The EU has been leading on the global sustainability agenda,
which seeks to combine economic prosperity with environmental and social sustainability. The
EU also recognises that the goal of sustainability must be supported by a financial system that
promotes growth in a way that is sustainable over the longer term.

The EU must now develop a clear strategy that unifies this ambition with one of its key
achievements in terms of financial policy and regulation, and which also funds the path
towards a low-carbon, resource-efficient and environmentally protective economy. To that
end, in December 2016, the European Commission established a High-Level Expert Group
(HLEG) on sustainable finance. The HLEGs objective is to help to develop an overarching and
comprehensive EU strategy on sustainable finance to integrate sustainability into EU financial
policy. It brings together experts with diverse profiles representing different approaches to this
complex topic.

While EU reforms following the financial crisis managed to stabilise the financial system, the
challenge is now to improved its contribution to sustainable development. The functioning of
the financial system thus needs to be refreshed in the dual context of stimulating job creation,
investment and prosperity in Europe, as well as making the transition to a sustainable model
of development. Responding to the challenge of long-term sustainable development is also a
powerful way for financial institutions to reclaim the positive role they can play in society.

This Interim Report of the HLEG identifies two imperatives for Europes financial system.
The first is to strengthen financial stability and asset pricing, by improving the assessment
and management of long-term material risks and intangible factors of value creation, including
those related to environmental, social and governance (ESG) issues. The second is to improve
the contribution of the financial sector to sustainable and inclusive growth, notably by financing
long-term needs such as innovation and infrastructure, and accelerating the shift to a low
carbon and resource-efficient economy.

1. PROCESSES AND PARTICIPANTS IN THE

FINANCIAL SYSTEM
Fiduciary duty and related concepts: The responsibility of directors and investors to manage
long-term sustainability risks should be enshrined in their relevant duties, whether it is through
fiduciary duty in common law or its equivalent in other legal systems. Updates should make
clear that managing ESG risks is integral to fulfilling these duties. Policy and regulatory
interventions will also have to promote the advancement of market-based tools essential to
investment decision-making, such as benchmarks and credit ratings.

Disclosures: Clear, comprehensive and comparable disclosure of information on sustainability

are essential to success. Better financial and ESG reporting by firms and financial institutions
is urgently needed to reflect a truer picture. Developing broadly accepted standards for
measuring performance, impacts on carbon, health and safety, and human capital would
support better-informed decision-making. Investors should provide forward-looking analysis
of how their portfolios are aligned with the energy and environmental transition, potentially via
mechanisms comparable to Frances recent Energy Transition Law, Article 173.

Putting sustainability at the heart of the financial system: To deliver systemic change,
ESG factors and long-term sustainability risks and opportunities will be needed in corporate

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governance, core indices, accounting standards and credit ratings. They will also need to be
reflected in the role played by the European supervisory agencies (ESAs), such as through
common guidelines and, subsequently, supervisory convergence on ESG disclosure.

The role of banks: As the largest asset pool, banks have an essential role in the transition
towards a sustainable financial system. To date, however, their potential contribution to
sustainable development has not reached its full potential. Green-supportive factors or brown-
penalising factors could be investigated; the appropriateness of the capital framework for
project finance and specialised lending should be assessed; while Pillars II and III of prudential
regulation could be strengthened with regard to sustainability.

Insurance companies and pension funds: Prudential regulation for institutional investors will
also have to be reviewed. For example, consideration of adjusting Solvency II to enable greater
investment by insurance companies in sustainable equity and long-term assets should be
explored.

Asset managers: As the last stage of the investment and lending chain before capital enters
the markets, asset managers are uniquely placed to help capital flow towards more sustainable
investments. Embedding sustainability into stewardship codes and asset management
agreements, and requiring asset managers to disclose how they integrate ESG factors into
their strategy and vote on ESG issues, are all part of the measures that could be pursued to
strengthen the ownership chain.

Credit rating agencies and stock exchanges: It is time for long-term sustainability risks and
opportunities to move from an add-on consideration to a built-in feature in ratings. While
EU stock exchanges are global leaders when it comes to disclosure of ESG factors, much
more can be done to promote sustainability. Exchanges could also support the integrity and
growth of the green bond market by encouraging the development and application of robust
standards.

Global financial centres: Given European expertise on sustainability, the EU is in an ideal

position to take the international lead among such global financial centres. It could establish
a network of EU sustainable financial centres to exchange best practices, align standards and
achieve market scale.

2. MOBILISING CAPITAL FOR A SUSTAINABLE

ECONOMY
Mobilising capital for a sustainable economy requires action on two fronts: the first is shifting
the current capital allocation from an unsustainable pathway to a sustainable one; the second
is filling the investment gap to ensure that objectives are achieved on time.

Clarity on policy plans: A coherent policy strategy is urgently needed to translate sustainable
development ambitions into investment opportunities. Member states need to provide a plan
indicating to investors how they intend to mobilise the capital needed to meet their 2030 goals
and the long-term climate and energy obligations of the Energy Union and the Paris Agreement.

Sustainability taxonomy: Agreeing an EU classification system of sustainable assets would

boost investor confidence and give firms a better understanding of which assets qualify as
sustainable investments. Establishing a common language also requires appropriation of
the EU classification by market participants through its integration into process guidelines
and assessment (product and process) standards. A European standard for green bonds, in
particular, would help the EU green bond market reach its full potential.

Product standards and labels: The EU should encourage the development of sustainable
financial products. This could be pursued by considering new political risk guarantees for
sustainable infrastructure, and support for the development of green and social bond markets,
as well as that of new sustainable financial products and services that use technology to
deliver sustainable outcomes.

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Fostering infrastructure: To support and facilitate these investments, the EU could create
Infrastructure Europe, a dedicated organisation responsible for developing and structuring
infrastructure projects and matching them with investors. This new entity would be responsible
for match-making infrastructure projects with investors, focusing on sustainability projects in
particular, and help countries in their efforts to access capital markets to finance their capital-
raising plans.

Wider society: Last but by no means least, enabling greater engagement of society by
increasing literacy on sustainable finance issues, which will stimulate informed demand. The
EU should support the creation of a set of publicly available corporate sustainability league
tables, ranking firms on their performance against the Sustainable Development Goals. We
also recommend the creation of sustainable investment standards at the retail level as a
simple way for citizens to demand sustainable investment with impact.

In summary, the early recommendations of the HLEG are to:

Develop a classification system for sustainable assets

Establish a European standard and label for green bonds and other sustainable assets
Clarify that fiduciary duty encompasses sustainability
Strengthen ESG reporting requirements
Introduce a sustainability test for EU financial legislation
Create Sustainable Infrastructure Europe to channel finance into sustainable projects
Enhance the role of the ESAs in assessing ESG-related risks
Unlock investments in energy efficiency through relevant accounting rules

3. NEXT STEPS
This Interim Report is intended to provide the basis for fruitful and constructive consultations
as the HLEG engages in the next phase of its work. The HLEG welcomes comments, questions
and discussions during the process of preparing its final report for publication in December
2017.

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I. Introduction

1. CONTEXT AND POLICY AMBITION

Sustainability is the model for Europes future development and finance is an essential
lever for achieving ambitious goals for economic prosperity, social inclusion and
environmental regeneration. The origins of the European Union (EU) can be traced to the
establishment of the European Coal and Steel Community in 1951 a community focused
on ensuring a smooth transition of member states economies from coal to what was then
the more modern fuel: oil. Now, more than six decades later, the Paris Agreement and the
2030 Agenda with its 17 Sustainable Development Goals (SDGs) provide the foundations for
Europes next transition. The EU has the opportunity to be the global champion of sustainable
finance in support of that transition: action taken at the European level could help to deliver
sustainable finance at scale across the world.

For the financial system, sustainability has a dual imperative. The first is to ensure that
environmental, social and governance (ESG) factors are at the heart of financial decision-
making. The second is to mobilise capital to help solve societys key challenges that require
long-term finance: creating jobs, especially for young people, improving education and
retirement finance, tackling inequality, and accelerating the shift to a decarbonised and
resource-efficient economy. A sustainable European economy must be characterised not only
by better protection of natural resources but also by higher employment levels and greater
financial and economic stability.

The transition to a sustainable financial system has started, but urgent and transformational
action is now required. The financial sector represents over 100 trillion of assets, or more
than six times the EUs annual GDP. It provides services to Europes households, firms and
governments, safeguarding savings and deploying investments as well as protecting people
and property from a range of risks. Positive steps have been taken, but they are clearly
insufficient. For example, there is an annual funding gap of close to 180 billion just to deliver
Europes decarbonisation efforts, let alone other priorities for sustainable development.

In the aftermath of the financial and sovereign debt crises, sustainable finance could provide
the best opportunity for the EU to reorient its financial system from short-term stabilisation
to long-term impact. Indeed, the sustainability and stability of the financial system can be
seen as two interrelated objectives. European policy-makers recognise that what is needed is a
financial system that is not just momentarily stable but that is helping to deal with Europes key
strategic challenges: employment, education, technology, retirement funding, infrastructure
all of which now have a sustainability dimension.

Much has been done to strengthen the financial system following the crisis, but it still does
not function as effectively as it should. Sustainability requires a long-term perspective both
in terms of providing long-term funding for critical infrastructure and responding to long-term
threats. If the financial system can address the long-term yet pressing risks and opportunities
related to climate change, it will have developed processes, approaches and thinking that can
be drawn on to deal with other long-term sustainability challenges.

Incorporation of climate risks into financial decisions is therefore the litmus test for finance,
a priority highlighted in the Financial Stability Boards Task Force on Climate-related
Financial Disclosures. Ultimately, this would deliver a financial system that gains resilience,
strength and stability by promoting a social and economic model that is sustainable in itself.

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 2. THE EU AGENDA
The EU has been leading on this agenda, taking ambitious steps towards decarbonisation
and the transition to a sustainable European economy. Looking just at climate change, a fifth
of the EU budget for 2014-2020 has been earmarked for this priority; the next phase of the
European Fund for Strategic Investments (EFSI) is expected to have at least 40% of its funds
allocated to climate action. Moreover, between 2007 and 2015, issuance of Climate Awareness
Bonds for renewable energy and energy efficiency projects has grown from 600 million to
42.4 billion1. The EU is also defining its overall 2050 decarbonisation goal, which will build
on the existing 2030 climate and energy package. And there is an ambitious new Circular
Economy Package to help European households and firms to make the transition to a stronger
and more circular economy where resources are used in a more sustainable way.

The EU has taken sustainability concerns into account in its financial policies since 2013.
Related flagship directives comprise the Non-Financial Reporting Directive and its related
guidelines, which were adopted in June 2017; the Institutions for Occupational Retirement
Provision (IORP II) Directive; the Shareholders Rights Directive II; and the political agreement
achieved on securitisation to include ESG requirements in the legal text. In addition, the EU
promotes the integration of climate policies and instruments such as the emissions trading
system (ETS), the Adaptation Strategy and the 2030 climate and energy package into financing
decisions through relevant procedures and practices2.

But what has been missing is an overarching strategy for delivering innovative solutions
that respond to the scale of the task. For a long time, discussions between climate and
energy transition experts and experts in financial regulation have taken place in silos. While
the G20 and other bodies have made significant progress on green and sustainable finance,
the international context has become more uncertain. This requires Europe to develop a clear
strategy that unifies its long-term economic, environmental and social ambitions with one of its
key achievements in terms of financial regulation.

The European Commission has recognised the need to develop and strengthen an economic
and finance strategy oriented towards long-term sustainable and climate-resilient
development. For example, the Mid-term review of the Capital Markets Union (CMU) highlights
that deep re-engineering of the financial system is necessary for investments to become more
sustainable and for the system to promote truly sustainable development from an economic,
social and environmental perspective.

3. THE HIGH-LEVEL EXPERT GROUP

The European Commission decided to establish a High-Level Expert Group (HLEG) on
sustainable finance in September 2016. The objective is to provide a roadmap towards a
sustainable financial system that fosters sustainability in economic, social and environmental
developments. The group will provide recommendations on how to hardwire sustainability
into the EUs regulatory and financial policy framework and how to mobilise more capital flows
towards sustainable investment and lending.

The HLEG has been given the task of setting out the scale of the challenges and
opportunities of sustainable finance, as well as recommending a comprehensive programme
of reforms to the EU policy framework. The HLEGs focus is on informing and guiding
the numerous regulatory and financial policy initiatives of the European Commission and
related institutions as part of a broader retuning of financial policy for long-term economic
prosperity, building on existing best practice, learning from experience and incorporating

1 UNEP, Connecting Financial System and Sustainable Development: Market Leadership Paper, Inquiry: Design of a Sustainable Financial System, Input paper to The
Financial system we need From Momentum to Transformation, 2016
2 European Investment Bank, Mobilizing finance for the transition to a low-carbon economy and climate-resilient economy, EIB Climate Strategy, 2016

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the latest analysis and evidence. Specifically, the HLEG is charged with delivering policy
recommendations that aim to:

Provide a vision for sustainable finance.

Integrate sustainability into the EUs regulatory and financial policy framework.
Mobilise capital for a sustainable economy.

The group was formed by bringing together experts with diverse profiles and expertise
representing different approaches to this broad and complex topic. The group was asked in
the first place to have particular regard for harnessing financial markets in response to climate
and environmental challenges. Members were selected by the European Commission from
the finance, business, civil society and academic communities on the basis of their personal
expertise, their contribution to the field of sustainable finance and the prominence of their
affiliation in this area.

4. INTERIM REPORT
This is the Interim Report (Phase I) of the HLEG, with the Final Report to be provided by
December 2017 (Phase II). The Interim Report outlines key areas where European policy-
makers could further align financial practices with sustainable policy objectives. The report
presents the initial analysis, options, dilemmas and trade-offs that the HLEG has identified. It is
structured as follows:

- Chapter II provides an overall vision for a sustainable financial system, key barriers that
will need to be addressed to achieve it, critical success factors and the opportunity ahead.
- Chapter III then explores ways of integrating sustainability into the EUs regulatory and
financial policy framework, covering issues such as disclosure, accounting, fiduciary duty,
corporate reporting and benchmarks.
- Chapter IV focuses on market participants (banks, insurance companies, pension funds
and asset managers) and market facilitators (including credit rating agencies and stock
exchanges).
- Chapter V focuses on measures to mobilise more capital flows towards sustainability,
in terms of both public and private finance. It also addresses the issue of sustainability
taxonomies, standards and labels.
- Chapter VI presents the initial set of recommendations and policy areas for consideration.

This report is aimed at readers in Europe and beyond, who are concerned about issues of
sustainability, financial markets and the wider challenges for society. Beyond the European
Commission and legislators and regulators in EU member states, including a global investor
audience, non-governmental organisations, cities and regional governments, but also leaders in
civil society, business and investment, as well as issuers, the corporate sector and advisers in
the financial sector.

The hope with this report is to provide the basis for fruitful and constructive consultations as
the HLEG engages in the next phase of its work.

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II. Towards a sustainable financial
system
The fundamental purpose of a sustainable financial system is to serve the economy and
wider society. The activities and resources of the financial system are there to underpin
balanced prosperity and competitiveness, as well as to promote innovation that generates
social inclusion, respects the environment, protects the climate and delivers on objectives for
human rights.

In strategic terms, a sustainable financial system supports sustainable development by

meeting the needs of the present without compromising the ability of future generations
to meet their own needs. It enables households, firms and governments to store and access
their incomes and assets reliably for present and future use. It ensures capital is available to
support productive and sustainable financing, investment, innovation and consumption. And
it is transparent and accountable, providing lenders, investors and society with information on
both how their capital is being used and how to hold firms and asset managers to account.

The EU has historically pioneered a number of key sustainable finance practices thanks
to market and regulatory innovations, and early adoptions by issuers, investors and
intermediaries. The first ever green bond was issued by the European Investment Bank (EIB) in
2007; between 2010 and 2014, as the largest climate financier globally, the EIB provided more
than 90 billion for climate action projects, 13.8 billion financing for energy infrastructures
and energy security in 2015 and over 150 billion since 2005 in the transport sector3. The
allocation to climate-related issues in the European Strategic Investment Plan was recently
raised to 40% and the most recent pension fund regulation strongly fosters consideration and
disclosure of environmental, social and governance (ESG) impacts on investment strategies
and risk management frameworks.

Important questions about the role and functioning of the financial system and Europes
economic model remain. While reforms following the financial crisis managed to stabilise the
financial system, they did not improve its contribution to the significant challenges of youth
unemployment, funding for retirement, education, technological innovation, environmental
protection and climate change. The functioning of the financial system thus needs to be
refreshed in the dual context of stimulating job creation, investment and prosperity in the
European economy and society, while simultaneously making the transition to a sustainable
model of development and a stable model of financing. Indeed, responding to the challenge
of long-term sustainable economic and social development is a powerful way for financial
institutions to reclaim the positive role they can play in society.

This creates two imperatives for Europes financial system. The first is to integrate ESG
factors fully into financial decision-making to manage risks and seize investment and lending
opportunities. This is key to delivering better finance finance that is more long-term, more
attuned to emerging risks and more efficient at delivering returns for the economy and
wider society. The second, complementary imperative is for finance to contribute to better
development thus supporting the creation of good quality jobs, tackling inequality, delivering
inclusive growth and accelerating the shift to a decarbonised and resource-efficient economy
(see also Box 1).

3 European Investment Bank, Better infrastructure, better economy, 2017

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 Three definitions of sustainable finance

n Bro
itio ad
es
efin t
d de
w fin
rro

iti
Na

on
A financial system that is
stable and tackles long-term
Integrating Finance fostering education, economic, social,
environmental, sustainable economic, environment issues, including
social and governance social and sustainable employment, retirement
(ESG) factors in environmental development financing, technological innovation,
financial decisions
infrastructure construction and
climate change mitigation

1. THE SCALE OF THE SUSTAINABLE FINANCE

CHALLENGE
The scale of the sustainable finance challenge in terms of investment needs is undoubtedly
very large. For the energy transition alone, additional investments of 177 billion per year have
been estimated to be required to meet the EUs 2030 climate and energy targets (Box 2).

Box 1: Green finance: a subset of the sustainable finance agenda

Sustainable finance is a comprehensive approach that brings together different strategies

for improving the social, economic and environmental performance of the financial system.
Green finance can be seen as a subset of the more strategic sustainable finance agenda.
China has popularised the term green finance in its domestic work and within the G20;
this refers to finance that generates explicit environmental benefits, which are specified
beforehand. Sustainable finance is a more comprehensive concept, incorporating ESG
factors.

Sustainable
development

Environmental Social Economic Governance

Climate change Climate change Other

mitigation adaptation environmental

Low-carbon

Climate

Green

Socioenvironmental

Sustainable

A simplified schema for understanding broad terms - UNEP Inquiry, Definitions and Concepts: Background Note,
2016

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 It is essential to recognise that a large proportion of this represents productive investments,
not costs and may yield substantial returns in terms of jobs and new markets due to the
development of new technologies and business models. Those that move fastest to seize
these opportunities will be at an advantage in the new world economy. This argues for early
action by the EU to secure a competitive advantage.

In the context of Europes financial system, these levels of investment are ambitious but not
excessive. The average investment required to meet the EUs 2030 climate and energy goals,
for example, represents 2.5% of projected levels of annual capital formation over the same
period.

Investment estimates for other sustainability priorities are available, but not always
comparable. This is in part because they use different base years, timelines and methods of
calculation. As such, they are only illustrative. Research by the Ellen MacArthur Foundation, for
example, estimates the investment needs for the circular economy in the EU to be around 320
billion between now and 20254.

Box 2: Climate and energy investment needs to 2030

Currently, the EU is not on track to deliver the 11.2 trillion required to meet its 2030
energy policy targets. The latest estimates put the annual investment gap at around 177
billion between 2021 and 2030, totalling 1.77 trillion.

The biggest gaps relate to investment in energy efficiency in buildings (74%) and
transport (17%). Geographically, the biggest gaps are in central and eastern Europe.
Investment needs for climate adaptation and resilience are generally not available.
This is largely because most member states have not set out their climate adaptation
requirements, and where they have, the quality of current national/regional adaptation plans
vary considerably.

Closing the investment gap will bring significant benefits, including clean energy and
reduced greenhouse gas emissions; it will also create new jobs in Europe, reduce energy
poverty and improve air quality. Given the scale of the gap, unlocking energy efficiency
investment in buildings must be the top priority. One key solution is for EUROSTAT to issue
guidance to national statistical authorities on classifying energy performance contracts as
services or as buy-and-leaseback contracts. This would enable governments to contract
and finance energy efficiency investment programmes to the private sector off balance
sheet. Along with reforms of state aid, this would be a significant step forward in boosting
investment where it is most needed5.

While energy-related investments are mostly direct investment opportunities and attractive
for private investors, other environmental goods and services might be difficult to finance.
Where policy can be used to create a market price for some air pollutants, water and waste
a direct investment case can be created. For other environmental goods and services, such
as biodiversity or ecosystem services, it is less obvious who pays? beyond taxpayers since
these are public goods and non-paying users cannot be prevented from accessing them. Two
sectors that particularly require investments as well as strong policy guidance are sustainable
fisheries and sustainable agriculture. Attempts have been made to develop innovative thinking
on business models for these sectors and on financing non-excludable goods; further progress
is strongly encouraged.

4 This is likely to be an upper bound as the studys definition of a circular economy goes well beyond the EUs. (Ellen MacArthur Foundation, Achieving Growth
Within, 2017)
5 Buildings owned and/or managed by the public sector make up more than 10% of the overall EU building stock with an annual energy bill of 47 billion and a
large cost-effective energy saving potential that remains untapped. Other public installations, as street lighting, are also significant as inefficient systems can
account for 30-50% of their total municipal electricity consumption.

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 This has important implications for mobilising capital towards a sustainable economy. For
policy-makers, it points to the key role of setting stable, predictable and supportive framework
conditions for investments that can deliver many environmental outcomes. For example, use of
blended public/private finance for development policy objectives by the European Commission
has increased in the last seven years (1.6 billion of EU grants financing more than 240
blended projects).

Since many environmental effects are interlinked and have a social dimension, addressing
one area of concern will have positive spillovers between policy objectives. For example, air
quality affects climate change and health, and water quality affects biodiversity. This suggests
that artificially dividing objectives into silos of investment needs is counter-productive.
Investors can also take lessons from this since it argues for a wider view of value for the users
and providers of capital. It also argues for stronger engagement by investors with firms to raise
environmental standards to deliver long-term value.

Improved tracking of the EUs sustainable investment needs and financial flows is urgently
needed. This would link government spending, bank lending, corporate investment and
asset level data on capital investments. Progress has been made in some member states on
mapping climate finance landscapes, which track sources and financial instruments directing
capital towards investments with climate mitigation or adaptation outcomes6. This could be
extended across the EU and broadened to include all sustainable development priorities, the
potential result being a fully functional and coherent EU sustainable finance statistical system.

The EU could also create a common framework for strengthening sustainable finance
tracking at the member state level, starting with climate change. The support, dissemination
and uptake by financial institutions of European labels for climate, green or sustainable
projects would facilitate this process. While ownership of this process by the member states
is key, a coordination effort at the EU level through creating a new observatory function
could be useful for developing a common language on methods and tools, to aggregate the
data, to inform collective decision-making and to help to target further policy interventions
(including public finance) in relation to climate change mitigation and adaptation that may be
required.

This European Observatory could start with climate change, support member states by
helping to monitor progress against policy objectives and provide recommendations to
EU decision-makers on the risks of under-investment. This body could operate as a cross-
agency collaboration staffed by experts from within existing institutions, or it could be a new
body altogether.

2. PROGRESS TOWARDS SUSTAINABLE FINANCE

As the largest asset pool in the EU, banks play a key role, but the overall levels of sustainable
lending are unclear. Banks remain the main source of external finance for European
households and small and medium-sized enterprises (SMEs), as well as roughly 80% of green
infrastructure finance7. The EU has a diversity of banking models, including public, shareholder-
owned as well as stakeholder banks and a small group of sustainable banks. But better tagging
and tracking of lending to green assets is still required. Likewise, a clear transition away from
lending that damages natural capital is urgently needed.

Institutional investors in Europe are increasingly active in sustainable finance. As a

group, they account for nearly half of the global PRI (Principles for Responsible Investment)
membership. But while Europes investors have been leading the decarbonisation of investment
portfolios, the combined exposure of their equity portfolio to carbon-intensive sectors remains
large (45-47%)8. In fact, as the G20s Green Finance synthesis report notes, less than 1% of the
holding by global institutional investors are green infrastructure assets9.

6 Institute for Climate Economics (I4CE), The landscape of climate finance in France, 2016
7 OECD, Investing in Climate, Investing in Growth, 2017
8 Battiston, A climate stress-test of the financial system, Nature Climate Change, 2017
9 G20 Green Finance Study Group, G20 Green Finance Synthesis Report, 2016

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 The EU was one of the pioneers in the issuance of green bonds, although its global share has
fallen in the past year. Until 2014, the EU accounted for over 45% of all green bond issuance.
Since then, issuance in other regions notably China has significantly increased, bringing
the EU down to around 30% in 2016 (Climate Bonds Initiative). The EU remains still far from
its market potential, however, estimated at US$74.6 billion of annual green bond issuance
by 202010 (vs. ~US$20 billion issued as of mid-2016). Several studies and market specialists
indicate that the use of green bonds could lead to at least US$100-140 billion per year of
additional investments in clean and efficient energy systems alone11.

The EUs public equity markets have made progress in disclosure: capital-raising for firms
with green revenues is the next priority. Stock exchanges in the EU are among the worlds
leaders in sustainability disclosure, comprising seven of the top 10 exchanges globally in 2016,
according to Corporate Knights12. EU firms also report comparatively well on ESG factors with
a clear edge on environmental disclosure. According to Novethic, as of 2016, most of the 120
international investors (with a total of 8.8 trillion in assets) that had signed the Montral
Carbon Pledge are in Europe. Half of the signatories come from asset managers. Among
them are 11 insurance companies, which account for more than 20% of assets held by the
Montral Carbon Pledge. Yet both North America and Asia Pacific outpace the EU in terms
of proportions of firms with green revenues and a compound annual growth rate of green
industries (both at 11% relative to the EU at 5%)13.

3. IDENTIFYING BARRIERS
As the European Commission rightly notes in its Mid-term review of the Capital Markets
Union of June 2017, a deep re-engineering of the financial system is necessary for
investments to become more sustainable and for the system to promote truly sustainable
development from an economic, social and environmental perspective. This will include
updating its regulations, norms, incentives and responsibilities as well as its overall policy
framework. It will also require overcoming barriers, of which the following are particularly
noteworthy.

1. Europes sustainability ambitions need to be translated into effective policy signals

that mobilise the financial system. The EUs long-term policy objectives for sustainable
development and climate action need to be translated into robust policy signals that provide
incentives for the allocation of capital to sustainable investments. The persistence of external
environmental and social costs that are not reflected in market prices and valuations means
that sustainability is often not considered to be material now. This results in an insufficient
supply of sustainable assets with attractive risk/reward characteristics and in missed
opportunities to invest in job creation, innovation and environmental improvement.

2. The financial system has become more stable, but is not fully connected with a real
economy in transition. The system has been stabilised after the crisis, but is not yet
fully effective at funding the real economy, society, new technologies and much-needed
infrastructure and inclusive growth. Policy frameworks and market behaviour continue to
favour a focus on liquid assets, short-term financial returns and instruments, as well low-
yielding debt in times of low interest rates. By contrast, investment and lending in infrastructure
(equity and debt), small-cap indices, SMEs, securitisation, private equity and real assets is
more limited. Yet these assets are often the most critical for the transition to sustainable
development.

3. The assessment and management of financial risks needs to integrate sustainability

factors more effectively. The financial system and policy framework is focused on securing

10 UNEP Inquiry, Analysing Potential Bond Contributions in a Low-carbon transition, 2016

11 Climate Bonds Market Roundup, 2016
12 World Stock Exchanges Report, 2016
13 Climate Bonds Market Roundup, 2016

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 risk-adjusted returns, but the understanding of value often remains constrained to conventional
elements rather than considering powerful intangible factors, including the ESG dimensions of
performance and impact. Yet these factors are real and increasingly impinge on the financial
risks facing individual assets as well as the system as a whole. They constitute a shadow
materiality generating the prospect of stranded assets and wasted capital. Equally, most
prudential rules and operations by policy authorities within the financial system have not been
designed with sustainability in mind.

4. The financial sectors toolkit for sustainability remains incomplete. A range of practical
issues within financial institutions and markets are holding back progress. There remains a
lack of common definitions and metrics. The levels and quality of disclosure are insufficient to
enable informed decision-making and oversight. Financial incentives and the business models
of intermediaries are not yet fully aligned with sustainable development. Alongside this,
financial institutions need to understand better the sustainability expectations of individual
savers and investors. In addition, levels of sustainability literacy and expertise along the
investment and lending chain are often inadequate14.

5. The financial system and policy framework risks succumbing to the tragedy of the
horizon. This arises when the financial outlook is too short to factor in the issues at hand
for example, climate change, demographics or technology, benefits of long-term investment
thus blinding financial institutions and policy-makers to their implications. Many firms
and financial institutions that wish to invest in long-term value creation are often subject to
short-term market and regulatory pressures and so under-invest in human, technological and
natural capital. The result is maturity mismatches between long-term projects, long-term risk
materialisation and their short-term market liabilities.

4. A VISION OF SUSTAINABLE FINANCE

The rapid evolution of the sustainable finance agenda could provide the best opportunity
for the EU to reorient its financial system from short-term stabilisation to long-term impact.
In a narrow sense, sustainable finance means integrating the ESG criteria into financial
investment decisions. In a broader sense, sustainable finance refers to a financial system that
is promoting sustainable economic development rather than boom and bust; sustainable social
development rather than inequality and exclusion; and sustainable environmental development
rather than damaging the endowments of nature. Achieving this requires a clear vision one
that can be understood, implemented and measured in practice.

Box 3. A financial system that serves the sustainable development of the EU is one that:

1. Considers the full value of financial assets, incorporating sustainability factors into
valuation and product design.
2. Is productive, serving its users in their projects and needs, notably households, firms
and governments.
3. Is resilient, withstanding and recovering from a wide range of both external and
internally generated shocks.
4. Demonstrates alignment between the sustainability preferences of its users and the
outcomes of the decision-making process, ensuring accountability and transparency.
5. Takes a long-term perspective and overcomes the tragedy of the horizon.

14 E3G, Missing in Action: The lack of ESG capacity at leading investors, 2017

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Transformational change is clearly needed to realise this vision, yet many of the elements
are already emerging. The five dimensions listed above frame the architecture of a sustainable
financial system (Box 3). The task of delivering this can seem immense. But many of the
changes can already be observed today. The challenge is to identify what can be scaled up,
where fresh innovation is required and which special coordinated efforts are required at the
European level to achieve the change required.

The development of a sustainability test that measures the performance of EU legislation

against sustainability criteria is key. Measurement is essential for understanding
performance, the progress being made and the distance still to be travelled. Much work is
being done to understand the sustainability of financial investments. What is lacking, however,
is a more comprehensive sustainability test that would provide a practical tool to measure
performance at various levels of legislation, including rules on specific financial products or
rules that affect the decisions of financial institutions. In addition, the sustainability test could
be formally applied to any EU legislation. As part of its Better Regulation Agenda, the European
Commission carries out impact assessments for new legislative proposals with significant
impacts. The sustainability test could be put forward as part of future reviews of the Better
Regulation guidelines; it could also be applied to ex-post evaluations of existing legislation.

The construction of a sustainable financial system in Europe is the natural next step in the
EUs current financial policy priorities, notably the CMU and the Investment Plan for Europe.
It is also a foundational element in the realisation of the EUs plans to build an Energy Union in
harmony with the Paris Agreement. Of critical importance, therefore, is a detailed definition by
2018 of the EU and its member states plans to reach 2030 and 2050 climate and energy goals
and a clear articulation of the role that financial market reform is expected to play in meeting
those objectives.

A sustainable financial system for Europe would promote the role of a well-functioning
market and reconnect finance with society. Such a system would take ESG issues into
account, it would continuously assess the most up-to-date, relevant and material information,
and it would use performance indicators to track and communicate success. More importantly,
it would enable individuals to know where their money is going and how it is being invested
to contribute to sustainable development. It would provide them with the engagement tools
necessary to ensure that they can hold firms and fund managers to account with respect to
sustainability performance. The result would be a financial system that is both a catalyst for
change and an alarm signal for misguided actions of issuers thus exerting a disciplinary
function that regulation can never achieve.

The building of a sustainable financial system would also enable the EU to take a leading
role in shaping international frameworks. With a strong domestic platform, the EU would be
able to support the expansion of sustainable finance within both the G7 and the G20, as well
as within key international standard-setting bodies such as the BIS, the Basel Committee, the
FSB, the IAIS, the IMF, IOSCO, the OECD and the World Bank. This would also enable the EU to
strengthen bilateral relations with key partners across the world, to develop shared approaches
and to encourage cross-border flows of sustainable financial services, particularly with
developing countries.

The current international geopolitical context is extremely propitious for such a move and
sustainable finance thus represents a strategic opportunity for the EU to assert global
leadership. As the European Political Strategy Centre notes, the EU now has a unique
window of opportunity to take the global lead on sustainable finance and position itself as
the investment destination for low-carbon technologies, securing a substantial competitive
advantage.

Capturing the window of opportunity requires a dual strategy that simultaneously seeks to
mobilise capital for specific sustainability priorities while integrating sustainability factors
across the financial system. Details of how these twin goals can be achieved are laid out in the
following chapters.

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III. Sustainability and the processes,
incentives and culture of the financial
system
A key function of the financial system is to match the supply of capital with demand in order
to create sustainable value in the economy. Capital flows to and from the three main users
of finance in the real economy households, firms and governments pass through a range
of intermediaries in the investment and lending chain. Returns and accountability for the
management of these funds then flow back to the ultimate beneficiaries.

The responsibilities, norms, incentives and regulations governing financial intermediaries

in the investment and lending chain profoundly influence the direction of capital towards
productive and sustainable investments. Influencing these governing characteristics is a
fundamental lever for ensuring that the financial system is stable and productive in a social
sense.

There are two misalignments at the heart of the sustainability challenge: one concerns
the appropriate time horizon; the other concerns the appropriate conception of risk. Key
objectives such as job creation, environmental protection, retirement financing and climate
transition require a focus on the longer term and a broad perspective on potential risks to
society. Yet much of the financial system is biased towards the short term and a relatively
narrow view of financial risk.

These misalignments pose a challenge for the investors and firms entrusted with capital,
conferring on them a duty to consider long-term sustainability risks. Taking account of
sustainability risks should be enshrined in the duties of investors, whether it is through
fiduciary duty in common law or its equivalent in other legal systems. These duties should be
cascaded onto the other participants across the investment and lending chain.

From such duties, it follows that both the governance of financial institutions and the
agencies that supervise them have to be developed simultaneously. In parallel, policy and
regulatory interventions will have to go hand in hand with the advancement of market-based
tools essential to investment decision-making, such as benchmarks and credit ratings.

Underpinning this objective are better financial and ESG disclosures by firms, which should
converge over time eventually to reflect a truer picture of their performance. Developing
broadly accepted standards for accounting for performance on measures of carbon, health
and safety, and human capital would support better-informed decision-making.

This chapter and the next one explore how the current regulatory and financial policy
framework can be adjusted to address the misalignments of time and risk. They set out
a range of regulatory, financial policy and market changes that could make capital more
productive through integrating ESG factors into day-to-day operations across the investment
and lending chain. This, in turn, would help deliver more socially productive investment and
make sustainability a core part of Europes financial system.

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 1. MISMATCHED TIME HORIZONS ACROSS THE
INVESTMENT AND LENDING CHAIN
The central problem of sustainability is a double compression: a compression of time
and a compression of risk. The time horizon in finance is typically much shorter than the
time horizon needed to address societys pressing challenges; and the conception of risk in
finance is typically much narrower than one that effectively captures economic, social and
environmental sustainability.

The policy priorities should therefore be to lengthen the time horizon and broaden the
conception of risk. The most pressing economic, social and environmental challenges are
long-term, with their impact and financial relevance stretching over years if not decades. But
the financial system is structured around shorter-term frameworks affecting the time horizons
of firms that depend on funding and continuous assessment by financial institutions to sustain
their activities.

The mismatch of time horizons is deeply embedded in the financial system. In theory,
investor patience is rewarded: investors with long-term liabilities can invest in illiquid and
more risky assets and wait until it is the right time in the business cycle to sell them, leading to
better returns than short-term strategies15. Yet research suggests that the relatively long-term
investment horizon of end-beneficiaries with long-term liabilities (pension fund beneficiaries,
household savers, sovereign wealth funds, etc.) is not reflected across the investment and
lending chain, due to principal-agent concerns, as well as inadequate performance metrics and
incentives16. As a consequence, there is insufficient demand for long-term risk analysis.

The mismatch of time horizons makes certain social and environmental issues such
as resource depletion, which are likely to materialise only in the long term become
externalities. They are deemed not material for financial markets and are thus not
sufficiently accounted for by asset owners and managers. But they do have financial
consequences in the real economy and for end-beneficiaries.

The mismatch of time horizons means that when short-term performance is the priority,
there are weaker incentives to address long-term opportunities and risks. Risks that are
non-cyclical (past trends do not provide sufficient indication of future behaviour), non-linear
(extrapolation of current trends is therefore misleading) and only likely to materialise after
five years (that is, not material in a one- to three-year window) are likely to be missed by risk
analysis that is focused on the short term. Past examples include the impact of the energy
transition on German utilities and automakers defeat device practices for pollution tests.

The double compression of time and risk drives a mismatch of investment objectives. The
willingness of some beneficiaries to vote with their money in favour of better social and
environmental outcomes is often not translated into investment decisions at the other end
of the chain. The failure to recognise beneficiaries interests increases the misalignment of
financial decisions with public policy goals and commitments, which require capital allocation
and investments in climate transition and long-term opportunities. While there are notable
exceptions among some pension funds, which consult with and express their beneficiaries
preferences in their investment policy and management, these are not yet the norm.

Europe has been actively working to promote sustainable finance in policy frameworks
and financial practice. In November 2016, the European Commission expressed its full
commitment to implementing the 2030 Agenda and the SDGs17. The EU started mapping

15 New Zealand Superannuation Fund, White Paper: The Advantages of Being a Long-term Investor, 2014
16 2 Investing Initiatives, All swans are black in the dark: how the short-term focus of financial analysis not shed light on long term risks, 2017
17 Communication from the European Commission, Next steps for a sustainable European future, 2016

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 European policies to the SDGs, in particular through the following commitments: Investment
Plan for Europe18, Towards a circular economy19, Energy Union, Capital Markets Union20 and the
EU budget Multi-Financial Framework (MFF)21.

Action within the EU and its member states has been focused in specific areas, notably on
investment and securities, where actions on disclosure feature prominently. Recently, there
has been an increase in system-level action, including assessments of how environmental risks
(such as climate change) could affect the health of financial sectors and systems. Over the last
two years, several actions have been taken in different member states, including Sweden and
elsewhere22.

Policy direction
There is no single parameter that could switch off short-termism and move finance to
the long term, aligning it with all the major economic challenges that demand a long-term
perspective. Nevertheless, progress can be made through, first, continued emphasis by
policy-makers that what is needed in particular is long-term finance; second, a review of
regulation and market practices to foster long-term decision-making (outlined below); and
third, protection of those who take long-term investment decisions in the face of short-term
pressures from financial markets.

2. DISCLOSURE
Disclosure is an essential instrument in helping the financial system steer firms towards a
sustainable economy. This disclosure would include information on performance, position,
risks opportunities and impact, as well as appropriate metrics of sustainability. The market
economy and the financial system operate on the basis of transparent prices and risks.
These essential signals influence economic activity, investment decisions and the use of
scarce resources of all kinds. But there is clearly a problem if some longer-term risks are not
transparent and thus not taken into account: improved sustainability metrics and disclosure
offer a potential solution. Greater transparency is expected to make firms and financial
institutions more resilient and perform better, both in financial and non-financial terms.
Over time, this will lead to more robust growth and employment and increased trust among
stakeholders, including investors and consumers.

A significant challenge with sustainability-related information and metrics is their breadth.

They often encompass both economic and ESG criteria, which can be difficult to delineate and
measure. The question of whether a given indicator is relevant for economic and investment
decisions depends on the type of activities considered. It can vary across sectors, locations
and other contexts. Compared with financial information, sustainability metrics may also
be harder to summarise in a single indicator. But while material information related to
sustainability might be difficult to express in monetary terms, it is nevertheless of essential
financial relevance.

Another challenge is the time dimension. As sustainability is intrinsically linked to longer-

term developments, relevant metrics should be forward-looking and take account of long-term
horizons. This places an additional layer of difficulty and uncertainty on information relevant
to sustainability. Forward-looking information, whether relating to financial or sustainability
dimensions, is exposed to the criticism of being insufficiently objective. New types of
disclosure may be needed to give sustainability-relevant information, including on long-term
risks and opportunities, robustness, comprehensiveness, coherence and comparability.
Scenario analysis, laying out a series of alternative business projections along some broadly
established trajectories of variables, may be valuable for some themes and sectors
(for example, climate change-related disclosures in the energy or extractive sectors).

18 Communication from the European Commission, Investment Plan for Europe: evaluations give evidence to support its reinforcement, 2016
19 Report from the European Commission, Report on the implementation of the Circular Economy Action Plan, 2017
20 Communication from the European Commission, Action Plan on Building a Capital Markets Union, 2015
21 European Commission, Multiannual Financial Framework adjusted for 2018 (EC website)
22 France introduced the worlds first mandatory climate disclosure requirements for institutional investors.

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 Many EU firms are global leaders on sustainability-relevant transparency in their respective
sectors. Building on this, but also recognising the need for further improvement, in 2014, the
EU adopted the Non-Financial Reporting Directive23. This directive requires certain large firms
(approximately 6,000) to disclose as of 2018 relevant information on environmental and social
aspects, including respect for human rights and action against corruption and bribery. On
26 June 2017, the Commission adopted guidelines on non-financial reporting to help firms
disclose environmental and social information.

The work of the Task force on Climate-related Financial Disclosures (TCFD), established
by the Financial Stability Board (FSB), is a major international development. The TCFD has
developed a framework for voluntary disclosures of climate-related financial information,
including risks and opportunities, in the annual reports of firms and financial institutions. This
climate-specific framework, published in June 2017, recommends disclosures on governance,
strategy, risk management and metrics. One of the innovations in the TCFD framework is to
propose scenario analysis to provide forward-looking disclosures that are particularly relevant
to guide investments, seem both from within firms and by outside investors.

The question arises of how the EU should take account of the TCFD framework.
Although some argue that disclosures such as those proposed by TCFD may translate into
administrative burdens, business risks and potential legal risks, the HLEG considers that
enhanced transparency provides on balance significant advantages and a competitive edge,
including better steering of business decisions based on a comprehensive and forward-looking
scenario analysis. The European Commissions guidelines on non-financial information reflect
the TCFD recommendations and the solutions proposed by other relevant national, EU-based
and international frameworks. The political signal by the EU to stick to the Paris Agreement
despite the withdrawal of the United States is very welcome. In the implementation of the TCFD
recommendation, however, the EU should ensure that including vis--vis US firms European
firms are not disadvantaged in terms of reporting burden and commercial risks. Moreover, care
should be taken to avoid undermining the level playing field.

While the quality and quantity of sustainability disclosure is improving over time, overall
reporting remains inadequate. For example, it is estimated that across 6,300 large firms
worldwide, only 45% provide quantitative information on carbon emissions24. While this
represents progress, much of the information provided is insufficiently robust or forward-
looking, and managers and investors may have difficulties when trying to incorporate it within
valuation models, business strategies and decision-making.

The lack of relevant disclosure by firms and financial institutions makes it difficult for
managers, investors and other stakeholders to analyse ESG risks and opportunities. Clear
reporting of indicators, encompassing a broader definition of performance may also allow
asset owners to fulfil their fiduciary duty more effectively, helping them to encourage asset
managers to generate sustainable returns over the short, medium and longer term. This, in
turn, would help capital flow towards sustainable solutions. Key considerations include how
an entitys business model may be contributing to a sustainability objective, and assessing the
ESG risks to its strategy.

Financial institutions should also disclose more systematically how they factor ESG risks
and opportunities into their investment and lending strategies. This transparency is key for
accountability and enabling clients and beneficiaries to make informed choices. This includes
reporting on sustainability risks and opportunities at portfolio level and, more broadly, how
financial institutions are contributing to sustainable development through their investments.
Impact-oriented metrics and other targets are also needed from financial institutions to reflect
fully their overall contribution to sustainable development. The objective is that financial
institutions including asset owners and asset managers in particular align themselves
with the long-term oriented decision-making required for financing sustainable economies and
societies.

23 Directive 2014/95/EU amending Directive 2013/34/EU as regards disclosure of non-financial and diversity information by certain large undertakings and groups,
2014
24 Trucost, Environmental Disclosure: The Second Major Review of Environmental Reporting in the Annual Report & Accounts of the FTSE All-share, 2017

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Policy direction
Strengthen disclosure on all sustainability dimensions by financial and non-financial firms to
inform management, employees, lenders, investors and supervisors and other stakeholders
about the considerations of such risks and opportunities. Integrate the TCFD recommendations
in a way that advances EU leadership on these areas, while avoiding possible commercial risks
and maintaining a level playing field globally.

Disclosure for retail financial products

The Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation requires
manufacturers and distributors of packaged retail investment and insurance products
respectively to draw up and provide retail investors with key information documents (KIDs).

The PRIIPs Regulation is applicable to a wide range of products, but not to non-retail collective
investment funds, non-life insurance products or direct investments. The PRIIPs Regulation
states that the KID should include where applicable, specific environmental or social objectives
targeted by the product. The Regulation contains a provision empowering the Commission to
adopt delegated acts detailing the procedures to be used to establish whether a PRIIP targets
specific environmental or social objectives (Art. 8(4)). The empowerment, however, does not
foresee the specification of criteria for the label.

Furthermore, the PRIIPs Regulation states that its review (by the end of 2018), should
include a survey of the practical application of rules herein laid down, taking due account
of developments in the market for retail investment products and the feasibility, costs and
possible benefits of introducing a label for social and environmental investments (Art. 33(1)).

Should the PRIIPs Regulation be amended, it could be envisaged to include in the description
of the investment strategy pursued by the PRIIP product how it is incorporating sustainability
factors. Criteria for sustainability integration would have to be either described in a separate
regulation or included in the product specific governance rules. In addition, the PRIIPs
KID could be used to promote a potential European label for retail investment products
(funds, structured products and insurance wrappers) that target ESG objectives by explicitly
referencing to this label.

The collection of information on the application of this Regulation could only start as of
January 2018 when the regulation enters into application. Furthermore, to cover all retail
investment products (including those such as occupational pension products which are
outside the scope of PRIIPs), the same disclosure standards and requirements for product
governance should be introduced in other relevant legal texts.

Policy direction
References to sustainability factors should be incorporated into the Key Information
Documents.

3. FIDUCIARY DUTY AND RELATED CONCEPTS

There is a growing consensus that financial intermediaries, which manage money on behalf
of others or give advice, have an obligation to include considerations of sustainability as
part of their duty to their beneficiaries and clients. The interpretation of fiduciary duty has
profound implications for the consideration of sustainability factors across the investment and
lending chain. But bringing this approach into the mainstream requires a number of important
legal, conceptual and practical clarifications.

Fiduciary duty sets out the responsibilities that financial institutions owe to their
beneficiaries and clients. Although fiduciary duty is originally a common law concept, its
underlying principles of loyalty and prudence are prevalent in both EU and national policies and
regulations, including avoidance of misrepresentation and conflicts of interests, disclosure
requirements, transparency, best execution and duty of care. The central expectation is to be
loyal to beneficiary interests, prudent in handling money with care and transparent in dealing
with conflicts.

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 At the EU level, the duties of loyalty and prudence are partly codified in a number of
directives, but standards differ greatly. Some offer possibilities for departures from acting
in the best interests of clients in a way that is sometimes fuzzy and inconsistent across
jurisdictions. Notions of fiduciary duty or related concepts are enshrined in Solvency II
(insurance), IORP II (occupational pensions), MiFID (investment firms), UCITS (mutual funds)
and AIFMD (alternative investment funds). Even though existing investment regulations
allow material ESG factors to be incorporated into decision-making, the degree to which
such considerations are mandatory and how potential conflicts with other considerations are
resolved are unclear25.

The central problem relates to the lack of appropriate standards in some instances as well as
a lack of clarity of legal rules on the overarching investment objective in case of trade-offs
and potential conflicts of interest. Such trade-offs and conflicts can occur across beneficiaries
or between beneficiaries and third parties, including the fiduciary institution itself. And even
where there is no legal conflict, evidence suggests that some investors, directors and pension
trustees still misinterpret their obligations.

A further challenge is the pursuit of financial returns in the presence of market failures. This
often leads to fiduciaries taking actions that avoid weaker short-term returns or losses while
ignoring the long-term consequences or the directly or indirectly expressed preferences of their
beneficiaries.

Many people, when asked, say that they do not want to exploit their fellow citizens or the
planet in an unsustainable way26. But fiduciaries currently tend to ignore these interests,
and few beneficiaries are asked about their preferences at the time of investing. This leads
to capital allocation that exacerbates market failures and undermines societys collective
interests and, over time, the economy itself.

Among ESG risks, climate change and its related risks have become a crucial issue in
fiduciaries decision-making process. The FSB recently recognised the materiality of these
risks (physical, transition and liability risks) whether in the short or long term. Among those
risks, the liability (or litigation) risk can be considered as a piece of soft law that places an
obligation on fiduciaries to consider climate-related risks as part of their fiduciary duty. Failure
to do so could potentially lead to claims for damages by beneficiaries and clients of financial
institutions who may not have acted in their best interests. transition and liability risks) whether
in the short or long term. Among those risks, the liability (or litigation) risk can be considered
as a piece of soft law that places an obligation on fiduciaries to consider climate-related risks
as part of their fiduciary duty. Failure to do so could potentially lead to claims for damages by
beneficiaries and clients of financial institutions who may not have acted in their best interests.

Some actions have already been taken by financial institutions and EU regulatory authorities
to incorporate sustainability factors into the operation of fiduciary duty. Several member
states require pension funds to disclose if and how they consider sustainability factors in
investment decision-making (see section on pension funds). Leadership is also being displayed
by the private sector, with pension funds such as the UK Environment Agency Pension Fund
and Dutch asset owners ABP and PFZW taking an active role in promoting a vision of fiduciary
duty with sustainability at its core. This includes active dialogue with beneficiaries on their
responsible investment preferences.

A harmonised approach across EU financial regulation would be ideal so that high fiduciary
standards can be applied across the investment and lending chain and the full array of
financial instruments. Building on the existing principles already found in relevant EU legal
texts will help in that regard, including improving the duty of loyalty, where necessary, and
extending the definition of the prudent person principle, namely that Fiduciaries should
throughout their decision-making process consider the broad range of long-term interests of
their beneficiaries. In doing so, it should be made clear to financial actors that the long-term

25 European Commission DG ENV, Resource Efficiency and Fiduciary Duties of Investors, 2014
26 In a survey of 1,500 UK employees with direct contribution pension funds, nearly half expressed the desire to have their pension invested in organisation
reflecting their social and environmental values. (Big Society Capital & ComRes, Pensions with Purpose: an opportunity to drive deeper engagement with DC
savers, 2014)

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 interests of beneficiaries include not despoiling the planet and exploiting their fellow human
beings. It should clarify that the obligation is also to include material ESG considerations
and encourage engagement with the client and ensure their concerns are integrated into the
investment decision-making process.

This common framework could then be applied to the EUs legislative framework and the
activities of the European supervisory agencies (ESAs). Implementing the clarification of
fiduciary duty and sustainability would involve a review of provisions in key directives such as
IORP II, the Shareholders Rights Directive II and MiFID, as well as Solvency II, UCITS, AIFMD,
EuVECA and EuSEF. In addition, it would involve the establishment of EU best practice in
relation to corporate governance and long-term sustainable value creation, as well as the
inclusion of sustainability in stewardship codes, thereby promoting convergence across the EU.

The new legal principles would be based on a common concept covering all the key
participants in the investment and lending chain, according to their specificities. In addition
to changes in the legal framework, as with any new legal principle, guidance would have to
be provided to ensure the new concept does not stifle investments in the short term. Such
guidance could build on existing rules and specify that fiduciaries should:

Act with due care, skill and diligence, in line with professional norms and standards of behaviour.
Act in good faith in the best interests of beneficiaries and clients, including preventing conflicts
of interest across different classes of beneficiaries. Where such conflicts are unavoidable,
balance such conflicts in a way that does not undermine long-term performance and
sustainability objectives in favour of short-term returns.
Fiduciaries must not act in their interest or in the interest of a third party to the detriment of the
interests of their client or, if such conflict is unavoidable, they must not act without the informed
and explicit consent of the client.
Factor in ESG considerations in their investment processes and decision-making, encourage
high standards of ESG performance in the firms or other entities in which they are invested, and
support the stability and resilience of the financial system.

A further step would be to embed sustainability within the mandates, investment policies
and risk management frameworks of institutional investors. Mandates are the central
legal document specifying how asset owners want asset managers to run their money. The
International Corporate Governance Network has produced pioneering guidance for asset
owners, covering the time horizon; the risk management framework; the integration of ESG
into the investment process, the alignment of interests through fees; and the pay structure and
culture. All of this seeks to ensure that the highest standard of stewardship is conducted on
clients behalf, with good standards of transparency that enable all this work to be scrutinised.

The EU could provide global leadership by promoting a common interpretation of fiduciary

duty at the international level. A powerful way to do so would be to champion the idea of an
OECD convention27. The OECDs secretary-general has noted that if we want to get serious
about unlocking green investment, we need to get serious about systematically integrating
climate risks into our understanding of fiduciary duty. The convention could supplement
guidance at the national and EU level.

Establishing an international convention would give domestic regulators the confidence to

improve the quality of regulatory drafting, which currently leaves much of the interpretation
to the fiduciaries. It would also help to increase ESG integration and reduce liability risk a
win-win for sustainability. Finally, it would make clear to all involved that managing ESG risks
is integral to fulfilling fiduciary duty.

27 Principles for Responsible Investment, UNEP Finance Initiative, United Nations Global Compact, Fiduciary Duty in the 21st Century, Inquiry: Design of a
Sustainable Financial System, 2015

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 Investors need to become more engaged to ensure that sustainable investments are
available. Many investors have lamented the lack of deal flow for green assets; actively
engaging with governments so they develop adequate (sustainable) infrastructure plans can
help to develop this pipeline. Ensuring that national capital-raising plans for climate change
action are delivered consistently with what investors are seeking to put in their portfolios is
key. Investors have an opportunity to act collectively on this issue through platforms such as
the Principles for Responsible Investment (PRI), the Institutional Investor Group on Climate
Change and the Green Infrastructure Investment Coalition (a joint project of the PRI, UNEP and
the Climate Bonds Initiative, among others).

Policy direction
Establishing a single set of principles of fiduciary duty and all its related concepts that
can then feed into the respective relevant laws according to the specificities of market
participants. The regulatory authorities need to make clear to all involved in the investment
and lending chain that managing ESG risks is integral to fulfilling fiduciary duty, acting loyally
to beneficiaries and acting in a prudent manner.

4. INVESTOR GOVERNANCE AND CORPORATE

GOVERNANCE
The interplay between corporate governance and sustainability is key to ensuring that those
who lead institutions become fluent in sustainability risks and opportunities. Therefore,
improving investor and lender governance is central to aligning financial markets with
sustainability outcomes. Investors and lenders need to understand both the risks associated
with unsustainable business practices, as well as the interests of their clients in taking account
of sustainability considerations and adopting a long-term approach to investment.

It is important to build the governance skills necessary to anticipate and address

long-term sustainability value drivers. To do so, the EU should actively encourage
professional accreditation bodies to incorporate sustainability, and embed it as part of the
requirements for continuous learning for directors and other investment professionals.

Research suggests that beneficiaries are better off when they are involved in the
decision-making process of institutional investors. The study28 shows a positive link between
pension schemes performance and their size, business model and governance arrangements,
as well as their adoption of leading practices for responsible investment.

Well-governed schemes exhibit the following characteristics29: All beneficiaries are

consulted on their ESG preferences and have a voice in the investment process; board or
trustee members have suitable skills, knowledge and resources; and board decision-making
is transparent and accountable. The findings also suggest that the funds that have moved
furthest in their integration of sustainability considerations into their strategy have explicit
sustainability expertise in their governing bodies.

In consultant/intermediary-led markets, the governance arrangements of pension funds

can be a barrier. Since the members of governing bodies are often not financial specialists,
reliance is placed on specialist financial advisers and outsourced investment managers. There
is a question over the relevant competencies of investment consultants field staff, which may
be very separate and disconnected from responsible investment specialists at the consultant.
These governance arrangements often limit the ability of pension funds to deal with emerging
risks, and especially long-term sustainability risks.

28 F. Stewart and J. Yermo, Pension Fund Governance: challenges and potential solutions, OECD Working Papers on Insurance and Private Pensions No. 18, 2008
29 Shareaction, Realigning interests, reducing regulation: a vision for reforming UK workplace pensions, 2015

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 On this note, the HLEG supports the recommendation that advisers to institutional investors
should have a duty conferred on them to raise ESG issues pro-actively within the advice that
they provide30. This requirement would have to be established by the supervisory authorities,
based on an extended definition of advisers duties. More broadly, responsible investment,
active ownership and the promotion of sustainable business practices should be a routine part
of all investment arrangements, rather than an optional add-on.

Active responsible ownership is being exercised by growing numbers of investors, but

much more could be done. A more explicit reference to sustainability issues in corporate
governance and stewardship codes, for example, would help to increase the positive influence
of the investment community. This has been addressed in some corporate governance codes,
including in France, Germany and the Netherlands, and should be encouraged further. In
addition, the EU could support the adoption of stewardship codes that are designed to make
shareholders more effective in holding firms to account.

The dynamic relationship between firms and their investors could also be enhanced through
the development of European principles for both corporate governance and stewardship. As
providers of capital to public and private firms, investors have both the right and responsibility
to hold firms to account and to call for change where needed.
In line with actions that some investors have already adopted to promote a long-term
perspective in the boardroom, European corporate governance principles could enshrine
recommendations such as:

Explicit board responsibility for sustainability, including capacity to determine long-term

materiality from a wider perspective in terms of both stakeholders and non-financial
aspects31.
A board sustainability committee in certain industries or for firms above a certain size.
Clear links between executive remuneration and key indicators of performance on
sustainability measures.

Policy direction
Developing and promulgating a set of principles of corporate governance and stewardship that
incorporate long-term value creation and improving investor governance should be central
objectives at the European level. Sustainability needs to be embedded in the objectives and
oversight of board directors and investment institutions/funds and their advisers.

5. CORPORATE REPORTING: FREQUENCY AND

CONTENTS
The growing pressure on firms for reporting on both their financial and non-financial
performance could leave some executives feeling torn between satisfying demands for
long-term investments and financial market demands for short-term profits. Some
executives describe this situation as having two speeches in their pocket: one for market
analysts focused on financial performance in the current quarter; the other for presentations at
employee receptions, meetings with policy-makers and conferences like the World Economic
Forum to discuss value creation and the firms contribution to education, society and the
planet. In a world of fully sustainable finance, there would be no disconnect between these two
speeches.

Firms typically report on their financial performance quarterly, which requires continuous
attention to short-term indicators, potentially at the expense of a longer-term focus. When
this happens, it is clearly an obstacle to promoting sustainable, long-term investments. At the

30 UNEP Asset Management Working Group, Fiduciary responsibility Legal and practical aspects of integrating environmental, social and governance issues into
institutional investment, 2009
31 R. Eccles and T. Youmans, Materiality in Corporate Governance: The Statement of Significant Audiences and Materiality, Harvard Business School, 2015

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 same time, investors demand for information is legitimate to oversee and steer the allocation
of scarce resources. An important development in that regard is the establishment of the
International Integrated Reporting Council, which seek to promote integration of financial and
non-financial issues in reports and accounts as a way of identifying and communicating the
ability of an organisation to create value over time.

The European Commission is also mindful of this challenge and that reporting regulation
might influence the short-term behaviour of firms and investors. One response has been the
2013 amendment to the Transparency Directive, which removed the obligation from issuers of
listed securities to publish financial information on a quarterly basis. It is now a member state
option to require more frequent reporting: only Austria, Bulgaria, Croatia and Poland have used
this clause to require quarterly information.

Market practices that continue to expect high frequency reporting by firms are an issue.
Such reporting at higher frequency than annual or half-yearly might relate only to a few key
business indicators. Nevertheless, anecdotal evidence suggests that given the time needed
to prepare reports on large and complex corporate groups, many managers feel that they are
trapped in a constant cycle of reporting.

Another challenge for corporate reporting relates to the time horizon of what is requested.
While a small share of investors (executives typically mention 5%) are asking about long-term
and ESG matters, the overwhelming amount of questions and probing of investors focus on
the current year and financial metrics, such as sales and income trajectories, costs, cash flows,
return on investment and current year dividends. This stands in contrast to other stakeholders
who are interested in innovation, technology innovation, value creation to society, contribution
to youth education, infrastructure and climate change.

In the context of sustainable finance, it would be valuable to analyse whether the removal of
mandatory quarterly reporting has changed the actual frequency of reporting and the time
dimension of issues asked. Empirical evidence of a positive impact would suggest a reduction
in the executives dilemma, while a negative impact would indicate the opposite. The European
Commission could ask ESMA to investigate this matter and provide relevant evidence and
examples. Reporting frequency and time horizon of issues demanded in reporting practices are
after all very important in a context of sustainability.

Policy direction
Examine firms current practices on corporate reporting since the possibility of imposing
mandatory quarterly reporting was dropped. Collect empirical evidence and examples
regarding the assessment of corporate reporting frequency by corporate management, lenders
and investors, by sector and nature of activity.

6. MARKET INDICES AND BENCHMARKS

Indices and benchmarks are cornerstones of global capital markets. They play a central
role in defining the reference points in terms of performance and in determining sector
allocations for a large number of market participants. Both institutional and retail funds are
not only benchmarked against indices but they are also structured as passive funds that
directly replicate or track the index. The benchmark indices are reference points for portfolio
performance and help to determine sector and geographical allocations.

The leading indices are typically weighted by market capitalisation and only reflect ESG risks
to the extent that the listed equity or bond market does so more generally. It is important
to note that given the international nature of most firms, a domestic benchmark covering
securities listed in that countrys stock market will usually not reflect the average exposure
of the domestic economy as it will include only listed firms, including many large global firms
but not smaller or non-listed ones32. For example, the share of the oil and gas sector in the

32 Based on ICB super sector classification. See also 2 Investing Initiative, Optimal diversification and the energy transition, 2016.

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 FTSE 100 is 14% (as of April 2017), whereas it represents less than 3% of the UK economy33.
This is because multinationals like BP may be listed in one country, in this case the UK, but
have global operations with only a minority of their operations and revenue coming from their
country of listing.

Requirements by supervisors that institutional investors use common benchmarks can

discourage investors, either explicitly or implicitly, from taking portfolio positions that
deviate much from the index. This can run counter to portfolios built on sustainability
convictions. As a starting point, therefore, supervisors and asset owners could encourage the
use of multiple reference points by active managers and enhance their own ESG capacity.

The number of indices aligned with sustainability has increased, but their significance in
overall portfolio allocation is still minimal. A growing number of alternative indices are being
developed by all the major index and benchmark providers but, until recently, the uptake of low-
carbon and ESG indices as benchmarks has been marginal, even for sustainable investment
funds34. Nevertheless, it appears that demand is now growing, especially for bespoke as
opposed to standard sustainability benchmarks. There is a growing range of options
available on both a standard and custom basis that enables different climate and sustainability
parameters to be built into passive investment strategies. Moreover, some large asset owners
are starting to integrate climate considerations into their core benchmarks (for example, the
Norwegian Pension Fund and HSBCs UK Pension Fund).

Misalignment of standard market benchmarks with key ESG and sustainability objectives
persists. Because the standard market benchmarks only reflect ESG issues and risks to the
extent that the listed equity market (on average) more generally does, investment strategies
based on them will follow the status quo.

Policy direction
The HLEG will review in greater depth the interplay between market benchmarks, indices and
sustainability investment.

7. ACCOUNTING FRAMEWORKS
The accounting frameworks used to assess firms financial position and performance have
an important impact on investment decisions and on the extent to which managers and
investors consider sustainability issues. There are two overarching considerations: first,
the need to integrate sustainability more effectively into accounting standards as a way of
tracking, for example, the economic reality of externalities; and second, the need to ensure that
accounting standards (combined, in some cases, with prudential standards) do not present an
obstacle to sustainability and long-term investment.

The EU has decided to adopt the International Financial Reporting Standards (IFRS)
developed by the International Accounting Standards Board (IASB) for mandatory use by
listed firms. The IFRS, which have been adopted in a large number of countries, treat investors
(rather than managers) as the prime users of financial reporting. For multinationals and firms
raising capital on financial markets, consistent and comparable corporate financial reporting
across international jurisdictions is particularly relevant for investors and conducive to the
allocational efficiency of capital markets.

Better integration of sustainability into accounting standards is critical. Information about

sustainability is increasingly relevant in the decisions of investors, lenders and managers.
Integrating it will be essential to help them make proper investment decisions. There are two
dimensions to this integration: one is whether standards should require a proper reflection of
sustainability risks in accounting valuations; the other is whether standards should require
more disclosure of relevant non-financial information on sustainability. With some exceptions,

33 Oil&Gasuk, Business Outlook 2017, 2017

34 R. Briand, L. Lee, S. Lieblich, V. Menou and A. Singh, Beyond divestment: using low carbon indexes, MSCI, 2015

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 information on sustainability is not yet subject to the same standardisation and assurance of
rigour as financial information, even though leading firms are starting to include such data in
their reporting and have its quality assured.

While there are numerous initiatives on sustainability reporting, the ultimate ambition has
to be the convergence of financial and sustainability information, supported by a more
comprehensive set of accounting standards. Integrated reporting supports this convergence
qualitatively through reporting that links sustainability factors with firms strategy. Accounting
standards can help advance the quantitative element.

The IASB has partnered with the International Integrated Reporting Council (IIRC) and
issued a Management Statement akin to an Integrated Report of financial and non-financial
information. Accounting for Sustainability (A4S), a CFO-network, has issued a guide to
accounting for human capital35. To make further progress in the convergence of financial
and non-financial reporting, the European Commission could invite the European Financial
Reporting Advisory Group (EFRAG) formally to ask the IIRC to work on how sustainability
factors can be captured in dedicated accounting standards, in addition to those for financial
reporting.

There is a perception in some quarters that certain accounting standards are making
sustainability investment more difficult for sectors with a longer-term focus such as energy
and insurance. These implications arise because of the difficulties in designing an accounting
system that is used for yearly or even quarterly reporting which captures the long-term nature
of certain businesses.

More specifically, IFRS 9 may have an impact on long-term finance, including both
investment and lending. In its future work, the HLEG will explore evidence on the impact of this
standard on the financing of ESG projects. This is with a view to ensuring that there will be no
undue consequences from the adoption of IFRS 9 for the financing of ESG projects.

For the energy sector, the difficulty can arise, for example, when firms have to make large
provisions related to the winding down of nuclear operations as part of the energy transition.
From a business perspective, this may involve long-term investments in equity instruments
that would be preferable over debt, given the favourable long-term risk-return profile of equities.
But IFRS norms, strongly favoured by securities investors, require mark-to-market valuations,
which creates short-term fluctuations and a reporting maturity mismatch. The HLEG may
look into whether or not this issue represents a material difficulty for the sector in the energy
transition.

Similarly, the insurance sector, which due to the long-term nature of many of its liabilities,
could well invest more in equities. But it is obliged through IFRS to report the current market
value of its equity investments or to consider depending on the accounting classification,
the equity as impaired in case of a substantial downward movement. These features,
combined with regulatory requirements under Solvency II, are seen by several practitioners as
having contributed to the decline in the share invested in equities among European insurance
companies, which is particularly striking compared with US insurers, which are under a
different prudential and accounting regime. For the banking sector, preliminary evidence
suggests that the issue may be more relevant for complex lending structures often entailed in
infrastructure financing than for standard unsecured loans.

The European Commissions Mid-term review of the CMU recognises these challenges. The
review calls for an assessment of the drivers of equity investments by insurance companies
and pension funds as well as a report on whether the accounting treatment of equity
instruments in IFRS 9 is sufficiently conducive to long-term financing. The HLEG believes
that further research should be conducted to determine whether IFRS norms create barriers
to sustainable finance in some sectors, including the energy sector, which is so central for
addressing climate change.

35 The Princes Accounting for Sustainability Project (A4S), Essential guide to social and human capital accounting, 2017

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Refinements of the present guidance on accounting consequences of energy performance
contracts are also important for unlocking investment for energy efficiency, as discussed in
Chapter IV. Here, the EU is looking at Eurostat in relation to public sector accounting on energy
efficiency investment.

Policy direction
Integrate sustainability into accounting standards to foster the convergence of financial and
non-financial reporting. Undertake analysis and seek practitioner feedback as to whether
accounting treatment can hamper long-term orientation and equity investments in some
sectors, and whether adjustments might be desirable as a result.

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IV. Sustainability and the participants
and facilitators of the financial
system
This chapter turns to the main institutions and facilitators of the financial system and
analyses the extent to which policy measures should be contemplated on sustainable finance,
particularly to encourage greater long-term lending and investment. The chapter also considers
issues of positive or negative sustainability risks and the stability of the system as a whole.

1. BANKS
Financing the transition to a low-carbon sustainable economic model will require the full
engagement of the banking sector, as banks are the backbone of the EUs financial system
and the largest source of external finance for the economy. Early feedback suggests that
by and large banks are keen on new lending activities and can see their role in the economy
expanding. The reason is that they are in search of good assets, with abundant liquidity and
capital not being a major issue as long as the current capital and liquidity requirements are not
tightened further.

To date, banks potential contribution to sustainable development has been underplayed.

Some policy-makers think of banks as engaged only in shorter-term business and are
concerned that sustainable lending means sector-specific (green) lending that could resemble
unwarranted political steering. Banks themselves mostly seem to see ESG factors as a matter
of reputational risk rather than financial risk, with considerations of sustainability not normally
embedded in business decisions and governance. Therefore, a number of questions need to be
addressed to develop the banking sectors potential contribution and attention to sustainability
with benefits for the sector and the economy36.

1. How to foster long-term lending and project financing

Banks primacy among lenders in assessing the credit risk of individual loans makes them
particularly important in financing the origination of sustainable assets, such as
longer-term infrastructure. This is especially true for the period when there is no income
stream yet37. Often, such lending does not remain on a banks balance sheet, but is securitised
or refinanced in capital markets directly. Ideally, capital and liquidity regulations would be
supportive of the part played by banks in originating longer-term finance and encouraging of
the securitisation of good quality long-term assets.

Yet there is the perception among banks that the current capital framework charges some
lending operations and long-term exposures more than is warranted by risk considerations.
Uncertainty about potential future changes to the capital framework might further discourage
longer-term exposures. The most recent analysis from the European Commission suggests
that an increase in target capital ratios can significantly constrain lending dynamics at the
current economic juncture38.

36 A recent legislation passed in Italy allows banks that meet certain requirements to be granted tax exemption to promote their capitalisation. This entails further
recognition of the social enterprise sector and increased possibilities of catering for the different financial needs of society.
37 T. Ehlers, Understanding the Challenges for Infrastructure Finance, Bank for International Settlements Working Paper 454, 2014
38 D.P. Monteiro and R. Priftis, Bank Lending Constraints in the Euro Area, European Commission Discussion Paper 043, 2017

- 31 -
 There is also a perception that calibrations on project financing and specialised lending
are high. Feedback from banks with a long history of project financing suggests that
regulatory capital requirements far exceed economic capital calculations. The regulation is
prudent because data points on defaults are rare. This situation resembles the calibration
of infrastructure debt for insurance companies, which was initially very high due to few data
points but eventually the Commission became convinced to lower it because higher intrinsic
recovery values of infrastructure compared with corporate debt. There may be a case for
reviewing whether the current capital framework properly assesses the risks of these activities.
Such an assessment should also feed into the Basel Committees continuing refinements of
the international capital regime. In this context, it is important to recall that EU banks play a far
more important role in project financing than, for example, in the United States.

Two factors seem to have a negative influence on long-term bank financing. The first is
uncertainty about capital requirements, in particular the combination of high requirements
for project finance type structures and the risk of an upward revision of capital weights in
the future. The second is the history of some European governments withdrawing financial
or regulatory support during the life of transactions that are only viable in a subsidised or
protected competitive position (discussed in Chapter V). To maximise bank participation in a
sustainable economy, the authorities need to maintain a stable regime of both financial and
non-financial regulation and support.

2. A green adjustment of minimum capital requirements?

It is sometimes suggested that there should be lower minimum capital requirements for
asset classes such as green bonds and green loans.

The arguments in support of this idea refer to the economic desirability of green projects,
the need to integrate positive externalities and the fact that green projects could be seen
by construction as less risky than other bonds, ceteris paribus, given that they contribute to
more sustainable economic development. But most supporters acknowledge that the risk
associated with a green loan/bond is only marginally lower than that of a non-green loan/
bond. Nevertheless, they consider that the lowering of capital requirements (which might
be larger than the risk differential) would represent an important policy signal to foster the
green sector.
The arguments against such a green-supportive factor refer to the blurring of risk and
policy considerations. A politically motivated supportive factor would be ignored by most
banks, which would stick to their economic capital calculation, while a few banks could
focus on such assets, which are then underpriced for the real risk they carry. Overall, it
would weaken the link between risk and capital requirements and potentially reduce trust
in the banking system. Moreover, there is as yet no well-identified sustainable assets
class to which different capital charges could be applied39. Finally, there may be more
effective ways to support a green sector than trying to steer capital flows through capital
requirements.
In any event, it would be useful to collect data for specific green assets to gain more
information on their risk profile. For example, initiatives such as the European Mortgage
Federation/European Covered Bond Councils Energy Efficiency Mortgage Action Plan40
could be one way forward.
A brown-penalising factor, raising capital requirements towards sectors with strong
sustainability risks, would yield a constellation in which risk and policy considerations go
in the same direction. Moreover, it would be more focused and easier to rationalise as
capturing the risk of sudden value losses due to stranded assets.

39 Pillar I capital weights have been difficult to agree internationally, even for well-established assets and risks. An intense debate recently dealt with whether internal
risk models should be allowed at all, and if so, for which asset classes. (Bank for International Settlements, Reducing variation in credit risk-weighted assets
constraints on the use of internal model approaches, Consultative document, 2016)
40 European Mortgage Federation & European Covered Bond Council, Energy Efficient Mortgages Action Plan, 2016

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 3. Sustainability risks and the supervisory process

A number of European authorities are exploring how to incorporate sustainability factors into
the supervisory review process (Pillar II). The aim of Pillar II is to enhance the link between
an institutions risk profile and its risk management systems. It is also used by supervisors
to encourage continuous improvement in banks internal procedures for assessing their
institution-specific risk situation and the adequacy of their capital.

Supervisors have numerous potentials tools at their disposal. Of particular relevance is their
ability to set extra capital requirements dictated by forward-looking considerations or because
of failings in risk management and/or governance. This could include stress tests that are
extended to risks relating to sustainability41. The Bank of England, for example, is taking steps
to look at sustainability issues through the risk lens (Prudential Regulatory Authority, 2015). An
advantage of a Pillar II approach over Pillar I is that as long as sustainability risks are deemed
significant, they should require no changes to legislation.

4. Disclosures (Pillar III)

Improving the transparency and disclosure by banks of sustainability factors and how
these influence their risk profile is perhaps the most advanced consideration, but further
regulatory action is needed. Pillar III of the prudential framework is designed to stimulate
market discipline through the disclosure of information. Voluntary and regulatory initiatives
have generated increasing disclosure of sustainability factors. To date, however, there has
been limited focus in these disclosures in linking them to the financial risks that face banks
or the systemic risks they generate for the wider financial system. To be useful, disclosures
need to be standardised across banks, to be reported consistently across time and to be
sufficiently forward-looking.

Policy direction
Detailed analysis is required of whether long-term lending by banks and specialised/project
finance is charged in terms of capital requirements over and above what is warranted by a risk
perspective. Green-supportive factors or brown-penalising factors could be investigated, while
Pillar II and Pillar III could be strengthened further with regard to sustainability.

2. INSURANCE COMPANIES
The business model of the insurance sector is particularly suited to supporting
sustainability. Insurance products enable households and firms to focus on the longer term,
knowing that they have financial protection against possible short-term misfortunes. Globally,
the insurance sector plays a significant role in investments across different classes of assets
amounting to a total of US$29 trillion in assets under management42.

The insurance sector is also the largest institutional investor in Europe, accounting for nearly
10 trillion in assets, or about 60% of EU GDP. At the portfolio level, most sector liabilities are
predictable and long-term. If regulation and accounting frameworks were to avoid creating
disincentives, insurance companies could hold considerable assets in the real economy and
act as stabilisers over the economic and financial cycle.

Insurance is regulated by Solvency II, which is probably the worlds most advanced,
comprehensive and complex framework for risk management. The move to a harmonised
risk-based regime, combined with strengthened internal risk governance, has many positive
points. But in the context of sustainable and long-term finance more broadly, the question

41 The European Systemic Rick Boards Advisory Scientific Committee has suggested that there should be options for increasing the requirements for high-risk
assets if a prudential threat is revealed through forward-looking stress tests. (Joint task force of ESRB and ECB Committees, Macroprudential policy issue arising
from low interest rate and structural changes in the EU financial system, 2016)
42 UNEP, Insurance 2030 Harnessing insurance for Sustainable Development, Inquiry: Design for a Sustainable Financial System, Inquiry Working Paper 15/01, 2015

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arises whether the approach leads to excessive penalisation of long-term investments and/or
illiquid assets.

Solvency II is based on a market-consistent valuation of assets and liabilities, which is

equivalent to an assumption that all the assets and liabilities of an insurance company should
be available for trading at any time. This market-consistent approach is strongly supported by
the community of global securities investors. But many insurance sector practitioners believe
that that the implementation of the market consistency principle in Solvency II discourages
long-term investments due to the associated volatility in the balance sheet because it fails to
recognise fully and appropriately the link between an insurers assets and its liabilities.

The reason is that while the insurance business model is inherently long-term, the current
approach exaggerates the valuation of liabilities and capital requirements for investment
assets. They also lead to artificial fluctuations in the measure of both available and required
capital by over-estimating the sensitivity of insurance companies to short-term changes
in asset prices. These implications create pro-cyclicality and are particularly adverse for
portfolios with long-term assets and liabilities. The so-called long-term guarantee package
in Solvency II aims at attenuating such volatility and pro-cyclicality, but questions about its
effectiveness remain.

As regards the notion of sustainability, the prudential regulatory regime for insurance
companies set out in Solvency II does not as yet explicitly require sustainability issues to
be addressed by firms or supervisors. Recognising sustainability issues more explicitly could
facilitate investment in (green) infrastructure projects.

Sustainability factors could be incorporated into each of the three pillars of the prudential
framework for insurance. Prudential frameworks could recognise more explicitly the long-
term nature of insurance companies liabilities and their long-term investment horizon. The
amendment to Solvency II in 2016 to lower capital requirements for certain infrastructure
investments is an important step, but it tackled only a specific part of the broader issue.
One possibility would be to consider expanding this further, but it is important to note that
promoting sustainability should not be done at the expense of undermining the stability of the
financial system. It should also not be confused with a weakening of the capital framework
under Solvency II.

Sustainability factors could also be made more explicit in insurance companies risk
assessments and stress tests. Under Pillar 2, European supervisors could insist and ensure
that long-term sustainability factors be incorporated in the Own Risk and Solvency Assessment
(ORSA) made by insurance companies. For larger firms with internal models, these already
embody a stress-testing approach. European supervisors could ensure that risks related to
sustainability issues, most obviously climate-related ones, are included in these stress tests
once a robust and widely accepted method has been established. EIOPA could be encouraged
to include good sustainability practices in Pillar II.

Insurance companies are both preparers and extensive users of sustainability disclosures.
Sustainability disclosures by firms in which insurance companies might invest enable the latter
to enhance their risk analysis and identify specific cases where the formers business models
could be exposed. Disclosures also enhance insurance companies ability to understand the
risk exposures associated with their own underwriting activity.

But there is currently no specific EU-wide regime requiring insurance companies to report
on sustainability issues as part of Pillar 3 disclosures. Under Frances Article 173, specific
reporting obligations are set out for a range of financial institutions, including insurance

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 companies, on how they integrate ESG factors and, specifically, on how climate change
considerations are incorporated. The incorporation of the final recommendations of the FSBs
TCFD by the EU and the development of an EU-wide equivalent to Article 173 would provide
strong foundations in that regard (see section on Disclosures). Insurance supervisors could
then review the adequacy and usefulness of the resulting disclosures from a prudential
perspective.

Policy direction
Possible implications of the market-consistent valuation approach currently applied in
Solvency II on long-term products and investments should be investigated. Attenuation of
some constraints to enable investment in equity and long-term assets should be considered.
European supervisors could insist and ensure that long-term sustainability factors are
incorporated in the ORSA made by insurance companies.

3. PENSION FUNDS
The investment policies of pension funds focus on long-term time horizons, which are where
the distinction between sustainable and non-sustainable assets becomes most visible.
Typically, sovereign wealth funds and endowments are liable to their beneficiaries over 50-
year time horizons while pension funds and insurance funds commit to 20-year horizons43.
Given that the beneficiaries of these collective retirement schemes expect income streams
over several decades, there is no need for pension funds to be overly concerned by short-term
pressures or liquidity risks. Instead, they can adopt what might be described as the purest
approach to sustainable finance.

Pension funds assets should be less prone to short-term financial risks, but they are
potentially more exposed to substantial long-term risks related to the real economy and
the environment. Failure to consider such long-term risks as the threat of climate change
could lead pension funds experiencing lower returns and valuation losses if, for example, they
are invested in stranded assets, such as fossil fuel reserves that may never be exploited.
Estimates of the total value of stranded assets defined as those which do not recover all or
part of their investment during the time that they are operational US$852 billion between
2014 and 2050 (US$320 billion for power and US$532 billion for production facilities including
US$120 billion for gas, US400$ for oil and US$12 billion for coal)44. There is a strong public
policy interest in pension funds ability to deliver on their promises to beneficiaries since
shortfalls could have large negative implications for national welfare systems.

Pension funds in the EU are highly heterogeneous, as member states have different mixes
of retirement funding between state-based pensions, occupational pensions and personal
pensions. At about 3 trillion, the balance sheets of pension funds in the EU correspond
to about a tenth of banks balance sheets and somewhat more than a quarter of insurance
companies balance sheets. Two countries the UK and the Netherlands account for 80% of
pension fund assets in the EU. But despite their relatively small size, pension funds still play an
important role in several other EU economies and their importance is rising.

The three sources of retirement funds are subject to different degrees of regulation at the
EU level. State-based systems are sometimes referred to as Pillar I of retirement financing;
occupational pension schemes linked to an employer constitute Pillar II; and private voluntary
plans or personal pensions form Pillar III. Of these, only Pillar II schemes have been subject
to EU regulation, but on 29 June 2017, the European Commission proposed a Pan-European
personal pension product (PEPP) a voluntary personal pension scheme that will offer
consumers a new pan-European option to save for retirement.

43 2 Investing Initiative, All Swans are Black in the Dark: How the short-term focus of financial analysis does not shed light on the long term risk, 2017
44 OECD report, Investing in climate, investing in growth, June 2017

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 Regarding Pillar II pensions, sustainability reporting and ESG integration of pension fund
investment have been the subject of intense debate, culminating in a new Institutions
for Occupational Retirement Provision Directive (IORP II). The directive was adopted in
December 2016 and will be transposed by January 2019. The balance reached in the IORP
II text is that occupational pension funds are encouraged but not obliged to take account of
ESG factors in their investment policies; but they must publicly disclose whether and how they
do so; and they must include such factors in their risk management systems. This does not
preclude a pension fund from stating that ESG factors are not considered in its investment
policy or that the costs of a system to monitor the relevance and materiality of such factors
and how they are considered are disproportionate to the size, nature, scale and complexity of
its activities.

If ESG factors are considered in investment decisions, a pension funds own risk assessment
must include an assessment of new or emerging risks, including those related to climate
change, use of resources and the environment, as well as social risks and risks related to
the depreciation of assets due to regulatory change. Pension funds must review a written
statement of their investment principles at least every three years with information how the
investment policy takes ESG factors into account and make this statement publicly available.
They must also inform prospective members whether and how ESG factors are considered in
the investment approach.

Regarding Pillar III pensions, the PEPP proposal adopted in June 2017 follows the same
logic. PEPP providers are encouraged but not obliged to take account of ESG factors in their
investment policies; but they must publicly disclose whether and how they do so; and they
must include such factors in their risk management systems.

Some member states have already moved in this direction in parallel to the new European
directive and before it enters into force. In the Netherlands, pension funds are already
required by law (Article 135.4 of the Dutch Pension Act) to adopt a policy setting out how ESG
issues are considered in investment decision-making. In France, Article 173 of the Energy
Transition Law requires pension funds among other financial institutions to report how their
investment policies align with the national strategy of energy and ecological transition. Funds
need to provide forward-looking analysis of how their portfolio is aligned with the energy
and ecological transition. Such analysis could reveal assets that might lose value over time
and highlight how the fund is invested in the target operating model of a low-carbon, more
environmentally friendly economy.

The new Shareholders Rights Directive requires both pension funds and insurance
companies to establish and disclose publicly an engagement policy. This means that these
institutional investors have an impact not only through their investment decisions but also
through their voting decisions in firms in which they are invested and through their overall
monitoring of these firms. They must focus on strategy, capital structure, and financial and
non-financial performance and risk. In exercising their voting rights, they must also manage
conflicts of interests in relation to their engagement.

Stress testing is an important tool of risk assessment and its future coverage could extend to
ESG risks. EIOPAs stress test of pension funds could potentially cover ESG risks in the future,
but only once sufficient expertise on sustainability has been built up to avoid undue scenarios
and outcomes45. For ESG risks other than climate, the quantification of scenarios and metrics
will be even more difficult. The HLEG considers that ESAs should build up sufficient expertise
on sustainability issues, scenario analysis and general ESG-factors related to medium- and
long-term risks.

Policy direction
Build up sufficient ESA expertise on sustainability, scenario analysis and ESG factors related
to medium- and long-term risks. Consider how the Article 173 approach at the EU level could
apply to all types of pension funds.

45 If there was a blunt focus on stress-testing related to current carbon emissions, it could hurt activities that are enablers of climate transition (for example,
production of insulation material for housing) and not duly discriminate between energy firms engaged in the energy transition and those not engaged.

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 4. ASSET MANAGERS
As the last stage of the investment and lending chain before capital enters the markets,
asset managers have a special role. Like other capital collectors, asset managers receive
money from the supply side of capital. They also act as capital allocators, defining appropriate
investment strategies (whether active or passive, quantitative or fundamental, and so on) and
ensure implementation within the scope given by regulators and their customers preferences.

Asset managers are uniquely placed to help capital flow towards more sustainable
investments, but they do not always do so. The short-term nature of mandates awarded by
asset owners and the diffuse nature of the retail market mean that most asset managers
have historically been focused on delivering short-term returns rather than the long-term
preservation of capital and addressing longer-term sustainability issues. This means that
many are not always concerned with engaging with firms on sustainable development issues
unless they are demonstrably relevant to a firm and a potentially material impact on its cash
flows.

Many asset managers in Europe are broadly committed to responsible investment policies.
Today, they account for nearly half of the PRI signatories in that category46. Globally, according
to a recent survey, half (54%) of asset managers who integrated ESG said they planned to
market at least 50% of their funds as ESG products over the next two years47. This increase
is a welcome boost to an investable universe that has traditionally been tilted towards
unsustainable products.

The current EU regulatory framework for asset managers has positive elements that could
be enhanced to promote a more sustainable approach. In particular, the UCITS and AIFM
Directives require asset managers to monitor short- and long-term risks relevant to the
portfolio or investment strategy. Yet there is currently no obligation requiring asset managers
to report on how they integrate ESG factors in their risk management or investment strategy.
The only exception is when the asset manager specifically targets ESG investments. An Eu-
wide equivalent of Frances Article 173, or an obligation to disclose how sustainability is taken
into account could boost sustainability investments48.

Many large publicly-listed firms complain that asset managers pressure them on short-
term results even if they have long-term mandates. Analysts focus their forecasts on the
short term: according to a Bloomberg survey, three quarters focus on the first three years and
about 95% in the first five years, leaving only a fraction of analysts with a long-term horizon49.
Some even see a gap between what executives of asset managers say, for example, in
public letters where they stress the need for long-term orientation and broad notions of value
creation, and the focus on the current year and financial metrics by their analysts and portfolio
managers. Finally, firms frequently report that the bulk of questions by asset managers are
about short-term financial information and only a fraction of investors want to hear about the
firms sustainability strategy. This long-term/short-term splits is one of the most fundamental
challenges to overcome for long-term finance.

A lack of accountability and transparency is breaking the ownership chain. There are
fundamental problems with todays ownership chain of influence50. For example, although asset
managers are expected to comply orexplain against the UK Stewardship Code, they are not
held to account on it by asset owners. By contrast, firms are held to account for delivery on the
Corporate Governance Code by investors voting at their AGMs. This means that investors can

46 According to PRIs database, as of June 2017.

47 BNP Paribas, Institutional Investors plan to double investment in ESG Strategies over the next two years, Press Release, 2017
48 There is also a need to mainstream climate-related financial risk disclosure and scenario testing among asset managers. There should be a requirement on
fund managers to demonstrate how investment products are, or are not, aligned with the low-carbon transition/sustainability objectives more broadly.
49 BNP Paribas, Institutional Investors plan to double investment in ESG Strategies over the next two years, Press Release, 2017
50 The capital markets ownership influence over corporate sustainable development originates mainly from the ownership rights associated with equities.
However, debt holders do nothave the legal ownership rights that are associated with equities.

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 evaluate the explanation and take action accordingly. Currently, there is no such equivalent
forum where investors explanations for their own stewardship work can be formally evaluated
by their clients.

Asset owners should make clear what they expect from their asset managers when it comes
to sustainability. The best way for them to do so is to list those expectations in the asset
management agreement when appointing their asset managers. Policy-makers can help by
providing model contracts. Asset owners should follow up on these expectations by engaging
both asset managers and the firms themselves. For example, one asset owner now polls firms
to know how its asset managers engage with them on long-term issues and whether its asset
managers provide active, informed and constructive engagement to firms in which they invest
as part of their mandate.

Asset managers should also be required to disclose their voting record publicly and pension
trustees to report to their beneficiaries on how their ownership rights have been exercised.
Some have actually started to do this on their own and asset owners are increasingly
demanding it51. For example, the worlds largest pension fund has recently announced it would
require its asset managers to disclose details on their voting records for each investee firm on
an individual AGM agenda item52.

The creation of a sustainability stewardship standard could help create a race to the top.
Such a standard would list minimum standards and procedures in stewardship to which
asset managers would adhere. Building on the Principles for Responsible Investment and the
UK Stewardship Code, this standard and benchmarkfor best practice could be developed to
improve accountability and good practice among asset managers.

Responsible ownership is a public good. Benefits of responsible engagement are enjoyed by
all owners, regardless of whether they behave as responsible long-term owners by investing in
stewardship. Consequently, the vast majority of short-term, profit-maximising commercial fund
management institutions are free-riders and either do no real stewardship at all, or invest only
token resources in this work. As with any public good, intervention is required to preserve and
maximise it.

Policy direction
Strengthen the ownership chain by providing model sustainability clauses that asset owners
can include in their asset management agreements. Move away from a short-term focus
to long-term orientation on the firms in which they are invested. Promote a race to the top
by creating a sustainability stewardship standard. Embed sustainability into stewardship
codes and require asset managers to report on how they integrate ESG factors into their
strategy. Maintain accountability by requiring asset managers to disclose how they voted on
sustainability issues.

5. CREDIT RATING AGENCIES

Credit rating agencies play an essential role in the investment and lending chain. They
help increase understanding of the credit risks associated with an investment or financial
instrument and reduce information asymmetry in credit markets. They provide an opinion
regarding the creditworthiness of an entity, asset or instrument that is an assessment of a
given entitys ability to meet its financial obligations, usually for the tenor of the debt. But as
yet, these core institutions are not playing a full role in helping the financial system align with
the objectives of sustainable development.

51 Bloomberg BNA, BlackRock Sheds Light on Proxy-Voting Decisions When Boards Balk, 2017
52 ShareAction, Asset Manager Voting Practices: In Whose Interests?, 2015

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 Todays credit ratings only partially account for long-term sustainability risk. Some credit
rating agencies take account of ESG criteria, but only to the extent they consider these risks
material for the credit risk of the instrument or issuer that is being rated. Since the timeframe
of a credit rating is usually short-term (typically three years), many long-term sustainability
risks are not fully taken into account as a result.

Other methodologies have been developed to compensate for that limitation, but fall outside
the credit rating space. Credit rating agencies have started to develop separate assessments
specifically for environmental and ESG risks. These include, for example, Moodys Green
Bond Assessments, and S&P Ratings Green Bond Evaluation and planned ESG Assessment.
Specialised ESG rating agencies have also developed over the last 20 years, such as
Sustainalytics, Oekom, Vigeo-Eiris, MSCI and Beyond Ratings. Other data providers, such as
Trucost and Bloomberg, have developed tools to help assess specific ESG risks at the issuer
and asset level.

The purpose of these ESG or environmental evaluations is to measure sustainability over the
lifespan of an asset as well as the specific climate impact, mitigation and adaptation of that
investment, regardless of whether they are relevant for creditworthiness. As a result, they
are conceptually different from a credit rating and may not always lead to a credit rating action
if those risks are not material to the time horizon of the credit rating, which is usually between
3-5 years. S&P Global Ratings, for example, clearly notes its ESG assessment tool is not a
credit rating53.

There have been no specific attempts by regulators to embed sustainability considerations

in credit ratings. Credit Rating Agencies are required to review their methodologies on a
continuous basis, in particular where material changes occur that could have an impact
on a credit rating, they are also required to take into account financial risks deriving from
environmental hazards where appropriate. However, there is no explicit mention of ESG criteria
and long-term sustainability risks and opportunities.

Policy direction
Foster the integration of sustainability and long-term perspectives into ratings. At the very
least, leverage the disclosure push that will follow the issuance of the TCFD guidelines by
requiring all credit rating agencies to disclose how they consider TCFD-related information
in their credit ratings and updating ESMA guidelines to help them make the best of the
newly available data. A comparative mapping to what extent ESG factors are included in rating
methodologies would be useful.

6. STOCK EXCHANGES
Stock exchanges play a pivotal role in bringing together issuers and investors, and can drive
the development of sustainable market-based solutions. In this context, stock exchanges
can act first as platforms for disseminating ESG information; second, as providers of market
infrastructure for sustainable asset classes; and third, as alternatives to bank finance for
small and medium-sized enterprises. The combined market capitalisation of the over 10,000
domestic firms listed on the regulated EU stock exchanges is equivalent to 78% of EU GDP54.

EU exchanges are global leaders when it comes to disclosure of ESG information, yet more
could be done. Seven EU stock exchanges are among the worlds top 10 as measured by
the ESG disclosure rate of their listed firms55. At the EU level, nearly three in four of the largest
firms disclosed their greenhouse gas emissions as of 2014, for example by far the highest
global average. These levels are likely to increase further in the EU with the introduction of the
Non-Financial Reporting Directive, which will affect around 6,000 firms.

53 As of May 2016, the following credit rating agencies had signed the PRI Statement on ESG in credit ratings: China Chengxin International Credit Rating Co.Ltd.
Dagong Global Credit Ratings Group Golden Credit Rating International Co., Ltd. Liberum Ratings, Moodys Corporation, RAM Ratings, Scope Ratings, S&P Global
Ratings).
54 World Bank Indicators, 2016
55 Corporate Knights, Measuring Sustainability Disclosure: Ranking the Worlds Stock Exchanges, 2016

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 Disclosure by EU listed firms of information related to products and services from green
industries, or green revenues, is also key to understanding the pace of the transition to a
low-carbon economy. In the EU, 22% of market capitalisation can be linked with low-carbon
sectors compared to 37% in North America and 23% in Asia Pacific56 and this green share
has increased by more than 7% annually since 2011.

The development of green bond markets has helped to enhance transparency in the
fixed income market. Many EU exchanges have already established a green, social and/or
sustainable bond display platform, segment or list: Borsa Italiana, London Stock Exchange,
Luxembourg Green Exchange (LGX) and Nasdaq Nordics. European exchanges can support the
integrity and growth of the green bond market by encouraging the development and application
of robust standards. This might involve leveraging existing standards and guidelines,
such as the ICMA Green Bond and Social Bond Principles, the Climate Bond Standard, to
promote international harmonisation, comparability and overarching transparency. European
exchanges should also consider opportunities for creating specialised segments for dedicated
sustainable products and support the development of sustainable stock indices.

Providing SMEs with greater access to capital markets is a key objective of the Capital
Markets Union. Exchanges can create market solutions that cater to the needs of early stage
firms by providing equity capital or allowing private SMEs to raise medium- to long-term debt.
Examples of programmes and markets set up by exchanges to bridge the gap between SMEs
and capital markets include Borsa Italianas ExtraMOT Pro, Deutsche Boerses Venture Match,
Euronexts AlterNext, Nasdaqs First North market, and the London Stock Exchange Groups
growth market AIM and Elite pan-European programme.

Policy direction
Stock exchanges could support the integrity and growth of the green bond market by
encouraging the development and application of robust standards.

7. GREEN FINANCIAL CENTRES

A growing number of financial centres have started to explore the implications of sustainable
development for their competitiveness and contribution to sustainability. Within the EU, key
centres such as London (Green Finance Initiative launched in January 2016), Luxembourg
(Luxembourg Green Exchange launched in September 2016) and Paris (Green and Sustainable
Finance Initiative launched in May 2016, recently renamed Finance for Tomorrow) have been
among the most active. Other centres such as Dublin, Milan, Stockholm and Frankfurt have
joined the race, with the Frankfurt Stock Exchange having launched its sustainable finance
initiative in May 2017. Many of these initiatives have moved from an initial focus on stock
markets and green bonds to a more systematic approach focused on developing an ecosystem
of products, services and expertise around sustainable finance.

This competition between centres is a welcome race to the top; getting to scale will require
collaboration and standardisation. Financial centres have a role to play in putting sustainable
finance in the mainstream by: mobilising financial institutions on shared issues (measure,
market infrastructure, research and innovation), creating a dialogue with other stakeholders
(firms, households, NGOs, policy) and stimulating the creation of joined up innovative products
and services. Cooperation between these centres will help to share best practice and build
convergence on key definitions, principles and measurement. Such a network would also help
to strengthen the pipeline of assets as well as help to provide the necessary capacity for other
markets to develop57.

56 Analysis run by FTSE Russell on all large, mid and small cap firms members of the FTSE Global All Cap Index.
57 Similar networks have been established for green banks (for example, green bank network).

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Given the global competition between financial centres and EU expertise on sustainability,
the EU is in a great position to take the lead. Action today will help to position EU financial
centres as global leaders of sustainable finance. Italys proposal, made during the G7 Bologna
Environment Ministers Meeting in June 2017, to host the first meeting of an international
network of financial centres is a particularly positive move in that regard.

Policy direction
The EU could establish a network of EU sustainable financial centres aimed at exchanging best
practices, aligning standards and achieving market scale. It should also encourage IOSCO to
work more closely with financial hubs to improve the disclosure of material and high-quality
ESG information in the global marketplace. At the very least, the EU should encourage and
support European financial centres in launching and strengthening green and sustainable
finance initiatives.

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V. Mobilising capital for a sustainable
economy
Mobilising capital for a sustainable economy requires action on two fronts. The first is
shifting the current capital allocation from an unsustainable pathway to a sustainable one.
The second is to fill the investment gap to ensure that objectives are achieved on time. In
the case of the EU climate and energy goals, the latest estimates put the annual investment
gap at around 177 billion between 2021 and 2030, or 1.77 trillion by 2030. But the next few
years should not just focus on climate. If a deeper re-engineering of the financial system and
its functioning is undertaken, it should also include the support of fundamentally important
sectors such as sustainable fisheries and sustainable agriculture. And it should support the full
range of environmental issues, such as water and air quality, biodiversity, waste and resource
efficiency, many of which are linked to the EUs Circular Economy Strategy.

It is not currently possible to measure accurately the share of green and sustainable assets
in Europe, in part because of the absence of a generally accepted system of classification.
One proxy is to track assets under management that integrate responsible investment
approaches. Sustainability-themed funds designed to finance sustainability, such as green
funds, have around 145 billion of assets under management58, which is very low compared
with the overall size of the European bonds and equity funds market (which were, respectively,
3.1 trillion and 3.4 trillion in 2016)59. As for banks, only a small fraction of their lending is
explicitly classified as green. While these numbers show that some have started to lead, much
more needs to be done to mobilise the overall market.

The absence of a financially material carbon price prevents investors from differentiating
carbon-intensive assets from carbon-efficient assets in their economic reasoning. The EU
emissions trading system (ETS) price of carbon for a DEC17 EUA is currently about 5. The EIB,
by comparison, uses a shadow cost of carbon of 32/tCO2 today, rising 1 each year to 45/
tCO2 in 203060. A price signal that better reflects externalities is also needed for understanding
and quantifying exposure to sustainability risk and opportunities. The need for a strong price
signal is not new: in the case of carbon, firms, investors and civil society have been calling for it
for years.

These and other barriers result in difficulties for market participants in assessing the risk/
return profile of sustainable assets, with maturity mismatches between long-term projects,
long-term risk materialisation and their short-term market liabilities.

A coherent policy strategy at EU level is urgently needed to translate sustainable

development ambitions into investment-grade opportunities. A consistent approach in this
sense would provide the incentives for all participants in the investment and lending chain to
invest consistently towards a positive transition economy. Failure or delay in achieving this
task would not allow for even the most ambitious tools to achieve a good result.

58 Eurosif, European SRI Study, 2016

59 European Commission, European Financial Stability and Integration Review, 2017
60 The European Investment Bank uses a shadow carbon price that is much higher than the current carbon price.

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 1. DEVELOPING A COHERENT EU STRATEGY TO
MOBILISE INVESTMENTS
Different options are available to build a coherent strategy that mobilises capital towards
a sustainable economy. Much of the following analysis is focused on mobilising capital to
meet the EUs climate and energy 2030 and 2050 goals but where applicable, the options are
developed to cover wider environmental and social issues, including the SDGs. Other important
areas where increasing sustainability would have a significant positive impact are the maritime
environment and agriculture. Preservation of nature, better nutrition, avoidance of waste and
circular use of materials need to be addressed in that context and there are few activities that
if conducted in the right way are more sustainable than fisheries and agriculture. The HLEG
will explore financing possibilities for investments in those areas in its Final Report.

1.1 Delivering long-term strategies and capital-raising plans

Member states need to provide a clear plan indicating to investors how they will mobilise
the capital needed to meet their 2030 and long-term climate and energy obligations under
the Energy Union and the Paris Agreement. One next step would be for member states to
develop national capital-raising plans setting out how they expect 2030 and 2050 targets for
greenhouse gas emissions reduction, renewable energy and energy efficiency to be financed.

The National Energy and Climate Plans (NECPs), to be developed by member states and on
a timetable to be notified to the European Commission in 2019, are a unique opportunity to
do this61. There would be immense value in the European Commission encouraging capital
mobilisation plans to be developed and submitted by member state governments as part of
their NECPs. The NECPs and forthcoming national long-term low emission strategies62 should
therefore include or at the very least refer to detailed national capital-raising plans that
combine the use of both public and private finance.

National capital-raising plans would represent a major investment programme to deploy

sustainable infrastructure and technologies. They would provide clarity to investors over
the scale of investment envisioned, signal where project pipelines will be developed, indicate
what tools and funding streams will be used to attract private finance and credibly set out how
the number of low-carbon projects is expected to grow as a result. This also makes national
capital-raising plans a powerful tool in answering the rising investor demand for sustainable
investments. Based on national capital-raising plans, an EU capital-raising plan can then be
established to maximise cross-border synergies.

Europes enormous investment needs may seem overwhelming, but in reality there is a great
deal of private capital available and willing to invest in long-term infrastructure. What is
more, a considerable part of the infrastructure needed for a low-carbon economy lends itself
well to private capital. Private lenders and investors including banks, insurance companies,
asset managers and pension funds essentially require three conditions: first, economic
viability of the project; second, largely predictable cash flows; and third, a stable pricing/tariff
environment over time.

A stable pricing/tariff environment is the condition that investors find breached most
often. Because of changes in feed-in tariffs, remuneration, tolls and other prices after
an infrastructure investment has been made, many long-term investors find themselves
confronted with changes in investment conditions. In a number in EU countries, changes in the
framework conditions for investments in renewable energies or infrastructure projects, either
governed by renewable energy support or concession regimes have a negative affected on

61 European Commission, Proposal for a Regulation of the European Parliament and of the Council on the Governance of the Energy Union, 2016
62 Communication from the European Commission, The Road from Paris, 2016

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existing and already financed projects, undermining investors confidence (see also Box 4). The
possibility of sudden, major changes in long-term, illiquid investments is a significant deterrent
for many investors engaging in such projects.

Looking forward, and while respecting the fact that policy authorities and parliaments are
sovereign in their decisions over time, the EU would be well advised to develop mechanisms
to provide as much planning stability and pricing/tariff stability as possible over time.

Box.4: Investor experiences with pricing/tariff changes in long-term infrastructure

projects in EU countries
The government removed the climate change related levy exemptions for renewable
energy producers by change of legislation. There was no grandfathering for existing
projects and no compensation. It resulted in an unexpected increase of cost and
reduced cash flows to pay debt service for those projects.
The government introduced new unexpected taxes/levies, on different grounds and
in different forms, for existing renewable energy projects. Suddenly, costs went up
and cash flows fell.
The government blocked concessions for toll roads, preventing road concessionaires
from implementing the full annual toll increases which they were entitled to under the
terms of their concession agreements to cover inflation and pass through of ongoing
capital expenditure costs. We could no longer collect the agreed toll revenues.

Source: HLEG member discussions with banks and insurance companies, June 2017.

A further aspect that needs to be developed is a better match-making facility between

infrastructure developers and infrastructure investors. Today, many local mayors across the
EU do not know to whom to turn to receive advice on how to structure, develop and bring on
stream infrastructure projects in a way that is attuned to the needs of private investors. The
current European Investment Advisory Hub (EIAH) at the EIB in Luxembourg is engaged in this
function but with 10 staff, it is very small compared with the thousands of potential investment
projects across the EU and also quite far away seen from many parts of Europe. Some
countries that are far advanced on infrastructure development for private capital maintain
organisations dedicated to this purpose.

Building on existing experience with the EIAH, the EU could for the next phase of the
Juncker plan create a kind of (Sustainable) Infrastructure Europe, a dedicated organisation
responsible for developing and structuring infrastructure projects and matching them with
investors. Because it would function at the EU level, perhaps with subsidiaries in the northern,
eastern, southern and western parts of Europe to ensure closeness to public authorities, this
organisation would be able to provide neutral advice on sustainable investment opportunities
across member states, apply lessons learned throughout Europe and direct investors towards
those matching their risk/return profiles.

In addition to the function of advising and match-making, Infrastructure Europe would help
structure capital-raising plans in a way that makes them appealing to investors, in terms of
both scale (for example, via securitisation) and risk/return profiles. Staffed with sufficient
resources and expertise, this organisation could play a key role supporting countries in their
efforts to access capital markets to finance their capital-raising plans. The new organisation
could be housed within the EIB or it could be an independent entity altogether.

Policy direction
Develop capital-raising plans at the member state and EU levels to provide investors with
visibility over the role they are expected to play in delivering on sustainability objectives.
Ideally include these plans in the NECPs as this would pave the way for an investable EU 2050
climate strategy shortly after, allowing the EU simultaneously to secure global leadership
in both climate action and sustainable finance. Create Infrastructure Europe responsible
for advising public authorities, match-making infrastructure projects with investors and

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 structuring capital-raising plans in a way that makes it investable to institutional investors, in
terms of both scale and risk/return profiles. Find ways to give private investors in illiquid long-
term infrastructure investments greater pricing/tariff stability over time.

1.2 Aligning public funds with sustainability

Targets for the allocation of public finance to support investment in sustainable development
priorities will also be needed. For example, the European Fund for Strategic Investments is
currently sending mixed signals to the market: while 55% of signed and approved investments
are low-carbon or low-carbon enabling (such as digital), 17% are high carbon63. Repurposing
EFSI 2.0 to have an explicit focus on a sustainable economy and then tagging EFSI-funded
investments as sustainable would enable private investors to identify and support these public-
private sustainable investment opportunities. The current proposal to include an explicit 40%
low-carbon target in EFSI 2.0 should be supported.

The EU Multiannual Financial Framework should be aligned with EU climate and energy goals
and with the SDGs, and explicitly move away from financing fossil fuels to clean energy.
The forthcoming revised MFF proposal is a significant opportunity. Consideration should be
given to increasing current levels of climate alignment from the current 20%64, and explicitly
excluding fossil fuels and other unsustainable projects and only supporting renewable energy
and energy and resource efficiency. This could then be complemented with further earmarking
of funds within MFF to support wider environmental and socially useful purposes. This would
have the effect of making all EU funds (including the Common Agricultural Policy, the Common
Fisheries Policy, Rural Development Funds, etc.) aligned with sustainability objectives as part
of making the MFF more sustainable. There are also upcoming opportunities to link climate
transition and employment impacts in a positive way through the proposed Just Transition
Fund, which should be supported.

In addition, public banks (the EIB and national promotional banks, NPBs) should continue
to innovate to scale up private sector investment. Again, the EFSI is key to enabling this,
conferring as it does the ability of the EIB and NPBs, which have a key role to play in leveraging
public capital to crowd in private capital, to finance higher value, riskier investments through,
for example, risk-sharing structures. But it should be noted that many private investors are
ready to take risks, and that NPBs are well advised not to take all (equity) risks or risk tranches
and issue only low-risk debt for private investors. The latter would resemble government bonds,
which are already in ample supply. But de-risking is useful in circular economy projects, where
innovation is key. So is ensuring that investments no longer support or de-risk unsustainable
investments such as fossil fuels. A focus on state aid treatment of sustainable public-private
investment approaches should be a key component of the 2018 review of state aid.

Public finance can be a powerful tool to crowd in private capital to low-carbon energy
infrastructure investment. Used properly, it can help to lower the level of risk associated with
sustainable assets and funds held by the private sector. Typical tools for risk-sharing include
public guarantees, purchasing subordinated debt and providing financial insurance. Risk-
sharing arrangements can also be enhanced by technical assistance or financial support for
the monitoring and evaluation of the impact associated with the investment. In addition to de-
risking, public banks also play an important role in demonstrating, supporting and promoting
market development. Some of the initiatives that could be pursued to crowd in private finance
to sustainable investments by the EIB but also by NPBs include: support for a proof of concept
role as cornerstone investors for new structures in the sustainable finance investment area65;
technical support programmes66; risk-sharing structures through layered funds, risk-sharing
facilities or guarantees67; improving the risk-return profile of climate-friendly assets through
credit enhancement initiative68 or of credit insurance; and supporting aggregation platforms

63 European Investment Bank figures on the EFSI as of May 2017.

64 European Commission, Statement of estimates of the European Commission for the financial year 2018, 2017
65 The UK Green Investment Bank investing in the worlds first listed offshore wind fund.
66 Since 2003 Estonias KredEx supported energy efficiency through a grant scheme that provided up to 50% of the costs of energy audits/technical advice
67 Bpifrance provides low-cost loans to SMEs subsidised using public funds.
68 KfW Bankengruppe offers energy efficiency loans for new buildings with interest rates linked to energy savings.

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 (with and without public funds) that can either match interested investors with assets or
hold greenfield assets so that they can be placed with institutional investors once assets are
operational and have a track record69.

Policy direction
Maximise the ability of public finance to mobilise private capital by demonstrating, supporting
and promoting sustainable infrastructure opportunities and sustainable financial products. In
parallel, ensure that public banks completely stop de-risking unsustainable investments as
this would result in private capital flowing to stranded assets.

1.3 Tackling the social dimension

Efforts should also be made to mobilise private capital for the social dimensions of
sustainable development. A high impact intervention would be to boost access to capital
for social enterprises, which work in the space between the public and private sector. While
some funding has been made available through the European Social Fund (ESF), investments
have been relatively small so far. For example, the Programme for Employment and Social
Innovation (EaSI) is due to provide 10-14 million per annum over the period 2014-2020 to
promote social protection, social inclusion and improved working conditions70. Its Microfinance
and Social Entrepreneurship axis supports micro-enterprises and social entrepreneurship for
vulnerable groups.

The EFSI could do more to invest in social enterprises, working to improve housing and
integration of refugees and migrants in education and training. The European Investment
Project Portal could also be used to provide higher visibility for projects in the social economy
and health sectors. To facilitate this, a consistent definition of social enterprise used by the EIB,
the European Investment Fund (EIF) and the European Commission would assist with targeting
support for this sector of the economy. The Commission could also consider increasing the
budget provided by the Horizon 2020 programme or allow for more investors to take an active
role in funding projects that meet Europes social objectives.

The EFSI is set to contribute to meeting the social objectives of the Europe 2020 Strategy
(typically inclusive growth) by supporting social entrepreneurship and other areas of the
social economy. The Commission is set to develop a Social Impact Instrument, which would
focus on two pillars: catalysing the establishment of Social Impact Funds (SIFs) or investing
in existing ones to support social entrepreneurship and the provision of social services by
social enterprises targeting vulnerable groups. The Social Impact Funds are meant to mobilise
investments from NPBs and the private sector.

Policy direction
Facilitate public funding for social investments by having a consistent definition of social
enterprise across key public financing bodies. Promote the visibility of social investments on
the European Project Portal.

1.4 Empowering citizens

Citizens are the least expert of investors: most do not have the time, skills or resources
to engage in capital market investing. To encourage citizens to allocate their savings to
sustainable ventures, retail funds for investment in sustainable securities with a range of risk-
return profiles are needed. The functioning and risk-return profile of those funds should be
transparently reported and easily understood by engaged citizens. This could be achieved by
giving retail investors access to socially responsible investing (SRI) funds for SDG investing by
classifying them as non-complex funds, for example.

69 One of the key roles of the EFSI is supporting the development of national financing platforms for energy efficiency in 7 Member States.
70 Among EFSI transactions approved by the European Investment Bank, just 4% are in social infrastructure.

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 Labels for sustainable investments would give confidence to savers and improve their
access to these opportunities. In this context, the review of the regulation on key information
documents for packaged retail and insurance-based investment products (PRIIPs) is an
immediate opportunity. By the end of 2018, the review is legally required to include the
feasibility, costs and possible benefits of introducing a label for social and environmental
investments (Art.33).

Given the growing interest in such investments, the European Commission should provide
proposals for trustworthy labels supported by reliable supervisory and enforcement
mechanisms. An important case study is the French Energy and Ecological Transition for
Climate Label. Among other things, funds applying for the label must exclude 20% of the initial
investment universe based on ESG criteria, or the average ESG rating of a portfolio must be
higher than the rating of the benchmark index used to measure its financial performance.
Ensuring an inclusive consultative process for designing the label will be key to rapid market
growth.

Opportunities for citizens to invest safely and with impact can also be created by offering
investment opportunities into dedicated funds that invest in sustainable or social projects,
for example, through providing microfinance71. One attractive option could be to establish
funds, either private or privately-led with the possibility of EU support (via the EIB or the EIF),
that enable a wider community of savers and investors to take an active role in the funding of
sustainable or social projects while increasing the scale and reach of finance.

Policy direction
Democratise sustainable investment opportunities by offering citizens the ability to invest
in microfinance projects and in funds with labels that guarantee the sustainability of the
associated investments.

2. AGREEING A CLASSIFICATION SYSTEM FOR

SUSTAINABLE FINANCE
The lack of commonly agreed labels, standards and taxonomies in sustainable finance has
been cited by many financial institutions as a barrier to more action. Such a classification
system is key to boosting investor confidence, in both the institutional and retail markets, and
it offers a protection against greenwashing as well as a condition for effective public policy
support. Classification is also important for a range of stakeholders: firms will have a better
understanding of what is expected of them (for example, how to measure the green share of
their activity); policy-makers will be able to make clear their objectives for transition as well
as flagging financial flows targeted towards those goals; and NGOs will promote the system
strongly as a way of putting the issues they care about in the mainstream.

Labels, standards for products and processes, and taxonomies are complementary
tools. Compliance with product standards certifies that a financial product meets certain
characteristics (for example, that 20% of an equity fund is invested in firms with more than
50% of revenues in green activities). Taxonomies are a core reference for product standards
as they define the potential pool of underlying sustainable assets (objectives and sectors) that
may be financed by a sustainable product. Compliance with process standards certifies that
procedures have been used throughout the investment process that respect ESG criteria. And
labels provide investors with reassurance that a product respects the provisions of a given
standard.

Classification of green bonds has made the most progress. Various taxonomies have been
developed by leading industry associations and public institutions as well as by member
states. The Green Bond Principles, high-level guidance established in consultation with

71 At European level, microfinance below 25,000 was provided through the European Progress Microfinance Facility funded by the EU and the EIB and managed by
European Investment Fund.

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 market participants, are complemented in the area of climate by the Climate Bond Standard
& Certification Scheme as well as the MDB-IDFC Common Principles for Climate Finance
Tracking72. Leading public institutions have developed their own green bond taxonomies, such
as the EIB Climate Action Bonds (CAB) eligibility criteria (a sub-set of the MDB-IDFC taxonomy),
the Nordic Investment Bank taxonomy and the China Green Bond Endorsed Project Catalogue
endorsed by the Peoples Bank of China. Other taxonomies have been developed for equity
products, such as the London Stock Exchanges FTSE Environmental Markets Classification
System (EMCS) and its Low Carbon Economy Industrial Classification System.

Market participants experience with green bonds confirms that the absence of a single
accepted system of classification for project policy objectives and project sectors creates
uncertainty and hampers efficiency. There is a lack of clarity for banks, investors and firms
seeking to identify sustainable assets that should be financed in a way that is compatible with
international sustainability goals and/or EU environmental policy objectives. The absence of an
established classification system makes it difficult for them to adapt their decisions as well as
their accounting and performance measurement tools. It also hampers comparability and it is
a hurdle for any kind of policy implementation in sustainability.

Figure 3: Standards for sustainable finance

Standards for sustainable finance

Standard on financial product Standard on process Labels

(sustainability of investments) (ESG quality of investment
process)

Taxonomy Technical characteristics

Purpose List of objectives, sectors Defines the characteristics Provides guidelines to Certifies and informs
and activities that of financial instruments that integrate the review of investors/customers that
contribute to increase invest in sustainable assets ESG risks associated with a given fund respects
sustainability and could (e.g.: what should be the operations into product standard and/or
be financed. Can include a percentage of green revenue investment processes a process standard
list of industries/activities of invested companies,
with a negative impact that associated reporting, etc.)
should not be financed

Examples GBP & CBI, MDB / French public TEEC label SRI label SRI /process labels
IDFC taxonomies standard specifications specifications (French (Luxflag ESG, French
SRI label, Luxflag ) public SRI label)
French TEEC label UNEP Positive Impact
Equator Principles,
taxonomy (based Finance Principles Green/ product labels
PRI, etc.
on CBI) (French TEEC )
EUROSIF
Transparency code

Added Defines and Defines products Guarantees ESG Enables customers/

value clarifies what the characteristics risks review investors to
standard entails Enables comparability Enables comparability understand and
Provides transparency, along standards criteria identify products
Differentiates
enhances confidence Differentiates products ESG product from Helps scaling up
Limits the risk investing in sustainability investment into the market
of greenwashing from ESG risks review sustainability

Pre- Endorsement of a reference Integration of a Disclosure on ESG Definition of EU

requisites taxonomy at EU level, taxonomy defined performance of taxonomy and
recognised by all market against EU taxonomy operations for entities/ reference standards
players to enable each Disclosure of the corporates and Controls organised
standard to position itself product/fund for projects by regulators
contribution to
sustainability (green
share and impact, etc.)
Enables products
comparability

Questions Coherence of each How to build on existing How to build on EU vs

raised standard taxonomy standards to define existing standards to industry roles
with an EU overall EU-level ones? define EU-level ones? Product and/or
sustainability taxonomy process labels
Incentives
and promotion

72 The Climate Bonds Initiative taxonomy has been used by the French Ministry of the Environment for its Energy and Ecological Transition for Climate, the Chinese
green bond definitions and is the basis for green bond index providers (Solactive, MSCI and S&P).

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 Policy-makers and market participants would be best served by a single EU classification
of sustainable assets that captures all acceptable definitions of sustainable. A shared EU
classification would allow policy-makers to match their policy goals and priorities with this
taxonomy, clarify their national transition trajectories, and communicate them (and any related
incentives) to capital markets and banks in the most effective way, so as to obtain maximum
support. It would also enable market participants to describe what they themselves consider
sustainable in a clear, unambiguous and comparable manner, while at the same time leaving
them free to invest and lend in line with their own preferences.

As a first step, the objective should be a common classification for assets serving green
policy goals such as climate change mitigation, climate change adaptation, biodiversity
loss, natural resource depletion, pollution prevention and control. An initial focus on climate
change of this kind would be preferable, given the progress already made in this area. The
taxonomy should distinguish green objectives and sectors and provide a sufficient level of
granularity to limit risks of controversies. These goals should be addressed step-by-step, with
the help of multiple key stakeholders, taking stock and building on the work already done and
in progress on green finance tracking definitions.

Establishing a common language also requires appropriation of the EU classification by

market participants through its integration into process guidelines and assessment (product
and process) standards. Standardisation of the market enables investors to compare different
sustainable investment products and helps them to make informed choices. This can be done
either through public or market standards.

To date, regulatory standards for sustainable products remain limited to general provisions
on ESG integration within EU regulations for financial products (for example, ELTIF, EuSEF,
UCITS, AIMFD, MiFID II, PRIIPS, etc.). These provisions do not specify what the integration
of ESG factors means, and very different approaches are mixed under the same vocabulary
(SRI, ESG, sustainable, green and social). This does not enable market organisation to reflect
investment choices and should be clarified.

To compensate for the lack of regulatory standards, market standards have been developed
by market participants, sometimes with the support of regulators. The most developed
market standards have been developed for green bonds, mainly the Green Bonds Principles,
which provide issuers with management guidelines for issuing a green bond, and the Climate
Bonds Standard & Certification scheme, an assurance framework for investors, which, in the
area of climate, incorporates the Green Bond Principles and adds a detailed taxonomy and
sector-specific criteria. These have been key enablers of the development of green bonds.
Standardisation is not yet complete, but it is within reach and should be leveraged by the EU
institutions and addressed as a priority, as an early commitment of the initial Capital Markets
Union Action Plan.

Aside from green bonds, there are few frameworks to define what should be the
characteristics of a financial product that provides financing for sustainability. Their
heterogeneity in terms of objectives and methodologies does not facilitate comparability.
One of the most advanced product standards is the French TEEC label, in which the threshold
requirements define how funds should invest in green industries. The Eurosif Transparency
Code has been developed as the reference framework for SRI products73 since its first launch
in 200974: it could serve as the basis for standardised SRI funds in Europe. Other generic
principles have been developed, such as the UNEP FI Principles for Positive Impact Finance
(see Box 3), and could be used to define impact-oriented frameworks. The definition of
taxonomies is a key aspect of product standards.

73 Through the integration of ESG criteria in the funds.

74 Today, over 700 SRI funds are registered to the Transparency Code and the Code has become the standard requirement for defining what is an SRI fund in
France.

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 Associating an EU classification of sustainable assets with widely accepted guidelines, such
as the Green Bonds Principles, would enable the development of European standards for
sustainable finance products.

Labels are essential signals to facilitate the expansion of markets as investors become
aware of the sustainable investment opportunities. To date, many heterogeneous and weak
labels are available but none serves as a reference for the market75. European labels could be
developed to validate the quality of SRI funds and impact-oriented funds.

Trust in the market also requires dedicated governance to ensure credible quality controls
or audits. To date, however, green assessments and label attributions (for example, by rating
agencies and consultants) are not controlled by market supervisors, industry associations or
public regulators. This creates uncertainty in the market and should be addressed through
appropriate systems of control supervised by public authorities.

In addition to labelling earmarked financial products, assessing the sustainability of existing

mainstream products is an important challenge and should be encouraged. Additional
systems are starting to emerge: for example, Morningstar ratings, the MSCI ESG rating and the
World Benchmarking Alliance (WBA), which aims to create a set of publicly available corporate
sustainability league tables, ranking firms on the level of integration of sustainability issues in
their strategy and management processes.

Policy direction
There needs to be an EU system of classification of financial products that captures
all acceptable definitions of sustainable. It should take account of existing principles
established, for example, for green bonds. Furthermore, trust in the market for green or
sustainable financial products could be built by establishing credible EU labels and quality
standards.

3. DEVELOPING SUSTAINABLE FINANCIAL

PRODUCTS
Well-designed investment products, in which the proceeds are ring-fenced for sustainable
investment, constitute a potentially powerful tool for closing the gap in sustainability
investment. For example, a thematic green market, as a subset of sustainability, can help to
make the link between low-carbon infrastructure and the broader agenda related to climate
change, the circular economy and sustainable development, while facilitating the connection
between demand from investors and supply. The growing popularity of associated financial
products can also help to demonstrate demand for more sustainable investment opportunities,
to build investor confidence and to accelerate the mobilisation of capital to support a
sustainable economy. There are many promising developments on which an EU Sustainable
Finance Strategy could help to build.

Making mainstream financial products sustainable could unlock substantial capital for the
sustainable economy. Characterising the sustainable positive impact of generic bonds, public
equities and bank loans is extremely challenging in the absence of appropriate disclosure by
issuers on the one hand and of accountability and appropriate disclosure by capital allocators
on the other hand. Passive management and ETF funds that are not linked with ESG or
sustainable impact-oriented indices also have an unknown impact on sustainability. Tagging
and disclosure of green loans has been encouraged in France with the implementation in 2017
of Article 173 of the Energy Transition Law. But there are no data at the EU and member state
levels on the share of green loans on banks balance sheet.

75 Some are process-oriented and validate the quality of ESG review (French public SRI label, Luxflag ESG label), other labels are product-oriented and validate the
financing of sustainability (Novethic Green Fund label, French Green, Luxflag Climate label).

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 3.1 Sustainable infrastructure

Sustainable infrastructure is essential for delivery on the SDGs and will determine the
EUs collective chances of meeting its contribution to limiting global warming to 1.5/2C76.
According to the OECD77, 60% of greenhouse gas emissions are hard-wired in infrastructure,
so the next 15 years are crucial for realigning capital to support a sustainable economy.
This is especially important as infrastructure can last from a few decades (in the case of
power stations, for example) to centuries (in the case of buildings, ports, bridges and water
infrastructure). In many ways, the EU 2030 climate and energy targets represent a clean energy
infrastructure investment programme.

Investors are increasingly willing to put money into infrastructure funds. This is shown by
the growth in popularity of renewable energy infrastructure funds (discussed in Chapter 2),
and there are good examples of sustainable infrastructure funds that could be scaled up
(Copenhagen Infrastructure Partners, for example). Host investors in infrastructure require
policy stability. Public authorities must be mindful that changing the rules can deter investors
and increase the cost of capital. Analysis by Agora also shows a highly differentiated cost
of capital for renewable energy financing across member states, in part driven by policy
uncertainty78.

New political risk guarantees could be considered at the EU level, underpinned by EU funds,
to reduce the highest costs of capital in return for voluntary agreements with member state
governments to delivery policy stability. Reform of fossil fuel subsidies should also be a
priority. For example, fossil fuel subsidies declined between 2012 and 2014, but were still
valued at US$372 billion in 201479.

As interest in infrastructure funds grows, consideration of ESG issues by these funds will
increase in importance. Several initiatives have been developed to promote ESG practices for
infrastructure projects, such as the Global Infrastructure Sustainability Benchmark (GISB) and
its equivalent for real estate (GRESB Global Real Estate Sustainability Benchmark). Currently
around 90% of 185 infrastructure funds and assets from 53 countries across six continents
have ESG policies and include ESG considerations in their investment processes80. But more
can and should be done to undertake quantified impact assessments and to tag sustainable
underlying assets. Two areas to develop include measuring the current carbon footprint of
existing infrastructure to understand whether it complies with EU climate targets, and providing
incentives for the development of new sustainable infrastructure. This can include the
retrofitting of existing high carbon infrastructure to high energy efficiency standards where this
is economically feasible.

3.2 Bonds

As the best-known instruments of sustainable investment, green bonds are an excellent

exemplar of how investor sentiment is changing on environmental investing. Having emerged
in 2007, green bonds are market debt instruments with proceeds earmarked exclusively for
financing and refinancing assets with environmental benefits primarily climate mitigation and
adaptation/resilience but also other positive environmental impacts such as biodiversity and
pollution reduction, sustainable transport and water projects.

Market-led standardisation has been a key enabler of the growth of green bonds. The
Green Bonds Principles, initially published in January 2014 and later amended in 2015 and
2016, provide issuers with guidelines on elements and processes required to issue a green
bond, for example. The Climate Bonds Standard is also addressing this issue by developing a
standardised assurance framework and definitions, reducing the work required by verifiers as
well as the due diligence required from investors.

76 The New Climate Economy, The sustainable infrastructure imperative Financing for Better Growth and Development, 2016
77 OECD, Investing in Climate, Investing in Growth, 2017
78 Agora Energiewende, Reducing the cost of financing renewables in Europe, 2016
79 Id.
80 GRESB Infrastructure, Infrastructure Assessment Report, 2016

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 The green bond market is benefiting from increasing policy support. This is happening both
within and outside the EU, with green bond market development committees arising in several
countries (Mexico, India and Brazil), guidelines being developed (for example, in China, India
and Morocco), investors pledging their commitments (in Brazil and Mexico) and governments
(in France and Poland) starting to issue green bonds in an effort to mobilise capital to meet
climate targets. While the market was initially dominated by issuances from multilateral
development and public investment banks, green bonds are now being increasingly issued by
firms, banks, municipalities and governments.

Despite this progress, the market remains small (less than 1% of total world bonds81) and is
marked by a tension between the need to guarantee its environmental integrity and the need
to increase market depth. This can be illustrated, for example, by green bond transactions
aligned with best market practice on transparency, but perceived as falling short on the level of
their green ambitions.

Greater clarity over eligible assets, taxonomy and procedures for sustainable finance
products issuance would help to strengthen investor confidence in the market. Achieving
such developments in the EU would enable the market to reach its full market potential,
estimated at US$74.6 billion of annual issuance by 2020 (compared with ~US$20 billion issued
as of mid-2016)82.

Another area of innovation in the bond market is around social bonds. Examples of social
investments include affordable housing, essential services (for example, health care and
education), basic infrastructure (for example, clean drinking water, electricity/energy, and
sanitation), employment, and food security. Given the focus of these investments, they will play
a role in reducing inequality and delivering inclusive growth opportunities. As with the early
stages of the development of green bonds, public investment banks are playing a major role
in creating the market. In early 2017, the Council of Europe Development Bank (CEB) launched
a new social inclusion bond of 500 million with proceeds that will go to financing loans to
support social housing, education and vocational training, and jobs in small and medium-sized
enterprises. More recently, the Dutch bank NBW issued a 2 billion social bond to finance
social housing projects in the Netherlands, making it the largest issuance globally to date83.

Policy direction
To help to spur market growth, the EU should consider introducing official European standards
for green bonds84; and could consider encouraging member states to subsidise the green
transaction costs for issuers for an initial period for pioneer issuers in specific jurisdictions
that have yet to see issuance. EU funds could possibly be used to cover some or all of these
costs.

3.3 Loans

Most banks and primary lenders do not track whether loans are sustainable. There are a few
exceptions, including Banca Etica, SEB and others that form part of the Global Alliance for
Banking on Values, but addressing this gap would enable primary lenders to keep track of their
exposure to sustainable investment and facilitate the securitisation of loans as asset-backed
securities (for example, green bonds). This is especially important in certain key sectors of
the economy, such as energy efficiency in buildings and finance for electric vehicles, as these
investments are too small for institutional investors to access directly.

Tagging and disclosure of green loans has been explicitly encouraged in France with
the implementation in 2017 of Article 173 of the Energy Transition Law which is now
stimulating a process of tagging and tracking sustainable lending among French banks.

81 G20 Green Finance Study Group, G20 Green Finance Synthesis Report, 2016
82 OECD, A quantitative framework for analysing potential bond contributions in a low-carbon transition, 2016
83 Responsible Investor, Worlds largest ever social bond attracts Credit Agricole, APG, AP2 and Robeco, 2017
84 The European Investment Banks work with the Climate Bonds Initiative to develop a European taxonomy for green assets that contribute to meeting the EUs
climate change objectives is a next useful step in this direction.

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 3.4 Equities and funds

There is growing interest among institutional investors in identifying and measuring

sustainable (and more specifically, green) activity in equities. Emerging tools and data sets
are being developed that enable portfolio exposure to green economy sectors to be measured
and for increasing allocations to those equities to be made. FTSE Russells Low Carbon
Economy Database is an example. The Norwegian Pension Fund, APG, PGGM, HSBC PF, NEST
are examples of pension funds that are targeting increased green economy exposure in their
equities.

In the absence of appropriate disclosure for equities, green funds have developed mainly as
equity funds invested in firms that have a positive environmental impact (for example, water,
energy and waste management). While green funds have been available in Europe for several
decades, the market really took off between 2006 and 2008 when green industries expanded
considerably. The market is now gradually diversifying with the emergence of green bonds
funds in 2015. In 2016, green funds represented 22 billion of assets under management85.
The European green funds market is also increasingly driven by investors appetite for clear
and readable strategies, which explains the success of environmentally themed funds such as
water or renewables.

What is at stake for this segments development is the pedagogy. The funds need to deal with
complex issues but must be distributed and sold with easy-to-read messages. Should market
dynamics get in line with the need for readability, this investment vehicle might soar and move
beyond its current niche position (less than 1% of the European UCITS are considered green
today).

The EU could accelerate the development of new green and sustainable assets and financial
products through improved structuring, possibly delivered through blended public/private
finance to encourage the development of sustainable securitisations, layered funds, green
covered bonds and thematic sustainable funds.

Much has been made of the potential impact of fintech on the financial sector. It remains to
be seen exactly how big the impact will be, but market practitioners and policy-makers should
consider developments in fintech when designing their products, services and policies.

85 Novethic, The European green funds market, 2017

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VI. Financing a sustainable European
economy: early recommendations
and policy areas for further
discussion
More than seven years after the financial crisis, questions are still being asked about when
the European economy will finally recover. Levels of investment and lending remain subdued.
Lack of competitiveness remains an issue in many parts of the economy, and sub-optimal
functioning of the financial system may add to that. While much has been done to strengthen
the financial system following the crisis, it still does not operate as effectively as it should.

The European financial reform agenda, which is provisionally outlined in this Interim Report,
is meant to deliver a stable and effective financial system. European policy-makers recognise
that what is needed is a financial system that is not just momentarily stable but that is helping
to deal with Europes key strategic challenges: employment, education, technology, retirement
funding, infrastructure all of which now have a sustainability dimension. The goal is a
financial system that promotes sustainable economic development rather than boom and
bust; sustainable social development rather than inequality and exclusion; and sustainable
environmental development rather than damaging the endowments of nature.

Proposed reforms will support the efforts of the Capital Markets Union initiative and create
a sense of purpose for the financial system by harnessing its power to deliver the major EU
agendas, including the Energy Union, the Circular Economy and the Digital Economy, boosting
green and high quality jobs, sustainable growth and prosperity in an inclusive manner.

This chapter presents early recommendations from the High-Level Expert Group for policy
action on sustainable finance. Given the emerging global policy context and the strong
policy momentum within the EU on sustainability issues, the HLEG submits a set of early
recommendations in the spirit of highlighting early policy orientations. These are submitted on
a tentative basis and may be further elaborated by the Group in the months to come.

This chapter also presents policy areas for further work and discussion with a wide range
of stakeholders. In addition to the immediate policy recommendations, the HLEG has
identified a number of other areas in which the behaviour of firms and financial institutions
could be directed towards a stronger focus on delivering a sustainable European economy.
Considerations on what is appropriate action by market participants and policy authorities
need to be discussed further, taking account of stakeholder feedback.

In summary, the early recommendations of the HLEG highlight:

An EU classification of assets and products that captures all acceptable definitions of
sustainable that is, that delivers a positive sustainable impact (environmental, social or
economic) and is not detrimental to any these three pillars of sustainability.
The introduction of an official European green bonds standard for green asset classes and
labels for SRI and sustainable funds.
The establishment of a single set of principles of fiduciary duty and related concepts of
loyalty and prudence.
Further strengthening of disclosures by firms and financial institutions of material
information on sustainability issues that can also be reflected in stock exchange rules and
benchmarks.
Sustainability tests of all future EU financial regulations and policies.
Considerations around Sustainable Infrastructure Europe: a dedicated match-making
facility between private investors and public authorities seeking to build and finance
infrastructure.

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 Positioning the European supervisory agencies on sustainability issues.
Publishing by Eurostat of revised guidance on how accounting standards for energy
efficiency investments are interpreted to boost investments.

Furthermore, the HLEG suggests for discussions in the following policy areas:
Providing a strong, credible and long-term policy framework to drive investments.
Fostering long-termism in financial and real economy investment decisions; reviewing
corporate reporting, stewardship and governance practices to ensure that they reflect ESG
and long-term sustainability; and promoting integrated reporting.
Integrating sustainability and long-term perspectives into ratings.
Integrating sustainability into accounting practices more effectively and examining whether
some aspects of current accounting frameworks aggravate undue balance sheet volatility
of firms focused on the longer term.
Fostering the potential of leading stock market and bond market benchmarks to reflect the
overall policy orientation towards sustainability and become more outcome and impact-
oriented.
Strengthening the role of banks in the early phases of infrastructure development;
facilitating project finance and specialised lending; considering green-supportive or brown-
penalising factors; and strengthening the sustainability oversight of banks.
Strengthening the role of insurance companies in equity and infrastructure investment; and
exploring whether some aspects of Solvency II could be adjusted to facilitate long-term
products and long-term investment, and to reduce pro-cyclicality.
Developing national capital-raising plans that provide investors with visibility over the
scale of investments envisioned and the role that they are expected to play in delivering on
sustainability objectives.
Enabling greater engagement of society on issues of sustainable finance via production
of sustainability research and corporate sustainability practices that build awareness
of current levels of performance, as well as the creation and promotion of sustainable
investment standards at the retail level as a way for citizens to invest safely and with
impact.

1. EARLY RECOMMENDATIONS
Recommendation 1: A classification system for sustainable assets

An EU classification of financial products that captures all acceptable definitions of

sustainable would be welcome. It should take account of existing principles established and
initially focus on climate change given the considerable progress in this area. Trust in the
market for green or sustainable assets will be built by establishing credible EU labels and
quality standards.

The classification system should serve to identify projects contributing to EU environmental

policy goals (climate change mitigation and adaptation, biodiversity loss, natural resource
depletion, pollution prevention and control). It should build on progress already made in Europe
and the OECD. The Commissions support is key to an appropriate and timely formalisation
of the classification system. The approach should be supported by an inclusive consultation
process to allow integration of stakeholders considerations and build consensus around
different constituencies. This work should be extended to other areas of sustainability (social),
building on the existing work from relevant institutions.

Against this background, the HLEG recommends that the Commission:

Organises the definition of a shared EU classification of sustainable assets applicable

for all sustainable finance products, starting with assets serving green policy goals given
the progress already made in this area. This development could be prepared rapidly with
different steps described below so as to be finalised for the end of 2018 when the PRIIPs
review takes place.

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 First, invites the European Investment Bank to coordinate the development of an EU
classification for climate change finance, conducted in consultation with relevant
constituencies (technical specialists, market practitioners, policy-makers and civil society
representatives) and taking account of work already accomplished or in progress in this
area. This process could be completed by the end of 2017 and its integrity would be
secured via monitoring by an independent party or appointed committee.
Second, defines the scope and modalities for the development of an EU classification for
other green policy goals (for example, biodiversity loss, natural resource depletion, and
pollution prevention and control). This process could be completed by the end of 2018.
In parallel, launches a multi-stakeholder process as a follow-up to set up a common EU
classification of sustainable assets applicable for all sustainable finance products by
December 2018.
Participates in these processes through the direct contributions of DG FISMA and DG ENV.

Recommendation 2: A European standard and label for green bonds and other sustainable
assets, as well as labels for sustainable funds

The EU green bond market has yet to reach its full potential and can serve as a basis for
other sustainable asset classes. To spur market growth, the EU should consider introducing
official European green bonds standards86.

Market-led standardisation has been a key enabler of the development of the green bond
market. Leading initiatives were convened, on the one hand, by the industry-led Green Bonds
Principles providing issuers with a set of relatively broad and flexible voluntary process-
oriented guidelines and, on the other hand, by the Climate Bonds Standard offering a science-
based standard, including definitions, eligibility criteria and a robust certification framework
thus reducing due diligence by investors as well as work required by issuers and approved
verifiers.

The development of an EU standard is now within reach, and the Commissions support can
ensure that an EU standard for green bonds will be fully developed.

Against this background, the HLEG recommends that the Commission:

Introduces official European standards for green bonds, based on the association of the EU
green taxonomy (once defined) and existing and widely accepted Green Bond Principles as
guidelines for market processes, promoting transparency and disclosure during the course
of 2018.
Supports the dissemination of these green bonds EU standards by helping member states
engage in sovereign green bond issuance.
Defines additional European sustainable product standards for other asset classes on
the basis of the approaches developed for green bonds, associating the EU common
sustainable taxonomy and market product standards such as the Green Bond Principles.
The Eurosif transparency code could serve as a basis for the review of ESG aspects in the
investment process.
Develops a sustainable finance label for funds invested in standardised green bonds and/
or in other sustainable finance products, with appropriate means of control endorsed by
public authorities and sizeable development means to ensure their use across markets.
The French TEEC and SRI labels could serve as a basis of reflection and feasibility should
be assessed by 2018.
Encourages the development of green securitisation and refinancing, layered funds, green
covered bonds and thematic sustainable funds; and explores the potential promotion of
such tools by incentives with sunset clauses.

86 See footnote 44 on EIBs work with the Climate Bonds Initiative.

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Recommendation 3: Fiduciary duty that encompasses sustainability

The time has come to establish a single set of principles of fiduciary duty and related
concepts of loyalty and prudence. These can then feed into the respective relevant laws
according to the specificities of market participants. Furthermore, regulatory authorities
need to make clear to all involved in the investment and lending chain that the consideration
and management of ESG risks is integral to fulfilling fiduciary duty, acting loyally to
beneficiaries and operating in a prudent manner.

The misinterpretation of fiduciary duty as requiring a focus solely on maximising short-term

financial returns is still common. The problem is a lack of appropriate standards in some
instances, as well as a lack of clarity of some existing rules. Some actions have already been
taken by financial institutions and EU regulatory authorities to incorporate sustainability
factors into the operation of fiduciary duty (for example, the IORPs II Directive on occupational
pensions).

In the consultation for the Mid-term review of the CMU, the Commission was urged to reflect
on steps that could be launched now to begin the recalibration of the EU financial policy
framework. Examples of issues that were identified include: clarification that fiduciary duties
of asset owners and asset managers include integrating ESG considerations into decision-
making.

Against this background, the HLEG recommends that the Commission:

Clarifies in upcoming legislation or regulatory reviews (of AIMFD, MiFID II, PRIIPs, UCITS,
EuVECA, EuSEF, CRD V, credit rating agencies, etc.) that the duties of loyalty and prudence
explicitly integrate material ESG factors and long-term sustainability. A certain level of
flexibility and proportionality will be needed to ensure this clarified fiduciary duty can
be applied across the investment and lending chain and its many different financial
instruments, building on the existing principles in relevant EU legal texts. This should
ensure that material ESG factors are integrated into the national definitions of fiduciary
duties.
Provides clarifications on the mandates of the relevant supervisory authorities to make
sure that the above considerations are duly taken into account.
Examines how to establish a single set of principles of fiduciary duty and related concepts
of loyalty and prudence that could apply across the entire investment and lending chain,
taking account of the specificities of market participants.
Displays global leadership by promoting a common interpretation of fiduciary duty at the
international level, including via an OECD convention on fiduciary duty.

Recommendation 4: Disclosures for sustainability

Disclosure by firms and financial institutions of material information on sustainability issues

should be further strengthened. This information is critical to management, investors,
employees, lenders, supervisors and other stakeholders. It should include relevant
considerations of policies, risks and opportunities as well as performance and impacts.

The HLEG acknowledges the efforts made by many EU firms to strengthen transparency on
ESG factors, and to improve reporting quality, comparability and relevance. Nevertheless, high-
quality integrated reporting on these matters remains far from being mainstream. The recent
TCFD recommendations should be integrated in a way that advances EU leadership on these
areas, while providing legal certainty and maintaining a level playing field globally. The 2018
review of the Non-Financial Reporting Directive represents an opportunity.
Against this background, the HLEG recommends that:

The EU should support further work on methodology and frameworks to help firms and
financial institutions improve their ESG disclosures, and promote harmonisation of metrics.
Financial institutions should disclose how relevant sustainability information is effectively
factored into the way that the money of clients and beneficiaries is invested (for example,
through mechanisms as those reflected in recent French legislation Energy Transition
Law, Article 173), including sustainability policies and targets, voting and engagement.

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 Firms and financial institutions should improve their transparency on climate change
aspects. In line with the TCFD recommendations or comparable frameworks, the
disclosure rules should be principle-based and leave room for flexibility and innovation
across four key elements: governance; strategy; risk management; and metrics and
targets. Forward-looking information such as relevant climate scenario analysis should
be encouraged, in particular for very large firms in sectors directly affected by the energy
transition, such as fossil fuels, utilities, extractives, energy-intensive industries and
transport.

Recommendation 5: A sustainability test in financial legislation

Sustainability has not yet been integrated properly into all the relevant EU financial
legislation. It would be useful to develop a sustainability test to ensure that sustainability is
embedded across all future EU financial regulations and policies.

In the CMU Midterm review, the Commission made a step forward by committing to develop an
approach for taking sustainability considerations into account in upcoming legislative reviews
of financial legislation87. As a concrete measure, DG FISMA should improve its methodology to
conduct impact assessments that guide the Commissions legislative and policy proposals.

More specifically, the HLEG recommends that the Commission:

Implements more effectively a key requirement of the Better Regulation Guidelines88,

namely that impact assessments of proposed legislation and policies include a
description of the environmental, social and economic impacts and an explicit statement if
any of these are not considered significant in order to guide legislative and policy options.
Moreover, mitigating ESG risks should be one of the objectives of any proposed EU policy
or legislation89.
Improves the methodology of environmental and social assessment by using and
developing tools #24 to #30 of the Better Regulation Toolbox90, as well as learning from
the experience of sustainable impact assessments of trade agreements and the existing
consultative process.
Incorporates the Think Sustainable First principle as a core component of the Better
Regulation Guidelines. ESG assessment needs to be taken into account to ensure that a
chosen policy or legislation proposal is contributing to the SDGs.

Recommendation 6: Create Sustainable Infrastructure Europe

A dedicated advisory and match-making facility between public authorities and private
investors would appear useful to boost Europes ambitious infrastructure plans, especially in
the area of sustainability investments. Today, many local mayors throughout the EU do not
know to whom to turn in Europe for advice on how to structure and develop infrastructure
projects in a way attuned to private investors. The current European Investment Advisory
Hub at the EIB in Luxembourg is engaged in this function but is very small compared with the
number of potential investment projects across the EU and it is remote from many parts of
Europe.

87 European Commission, Communication on the Mid-Term Review of the Capital Markets Union Action Plan, 2017
88 European Commission, Better Regulation : Guidelines on Impact Assessment, 2015
89 This would reinforce improve the mandate that a proper and full social and environmental impact assessment has to be done.
90 European Commission, Better Regulation Toolbox, 2015

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Against this background, the HLEG considers that:

The EU could create Sustainable Infrastructure Europe, a dedicated organisation

responsible for advising municipalities and other public authorities on structuring and
developing infrastructure projects and matching them with investors, with a particular
attention to sustainability investments and infrastructure developments needed to achieve
Europes climate objectives.
Because it would function at the EU level, perhaps with subsidiaries in northern,
eastern, southern and western parts of Europe to ensure closeness to municipalities,
this organisation would be able to provide neutral advice on sustainable investment
opportunities across member states, apply lessons learned throughout Europe and direct
investors towards those matching their risk/return profiles.
In addition to this function of advising and match-making, Sustainable Infrastructure
Europe would help structure capital-raising plans in a way that makes them appealing to
investors, in terms of both scale (for example, via securitisation) and risk/return profiles.
This might also include considerations on whether there would be benefits from a greater
standardisation of infrastructure projects in structure and process in terms of project
acceleration and better accessibility of information for investors.
Without becoming a large organisation, it should focus on expert staff, with expertise on
the arrangement of larger and cross-country infrastructure projects as well as expertise on
bundling together many smaller efforts. Sustainable Infrastructure Europe could also play
a key role in supporting countries in their efforts to access capital markets to finance their
capital-raising plans. The new organisation could be housed within the EIB or it could be an
independent entity.

Recommendation 7: Position the European supervisory agencies on sustainability

The role of the European supervisory agencies already includes considering systemic
risk and addressing any risk of disruption in financial services, as well as contributing to
better consumer protection and ensuring the orderly functioning of financial markets. ESG-
related risks for example, unprecedented and growing climate-related risks are not yet
properly integrated into financial risk assessment processes. The current review of the ESA
operations provides an excellent opportunity to clarify and enhance their role in assessing
ESG-related risks in order to secure the long-term stability of Europes financial sector and
benefits for a sustainable economy at large, even without changing their current mandate.

The HLEG recommends that the Commission ensures that:

The ESAs address sustainability issues within their existing objectives. In particular, they
could develop common guidelines and supervisory convergence on ESG disclosure by
investors and lenders at the EU level, creating a level playing field across borders and
investor categories (pension funds, insurance, mutual funds, asset managers, banks
and banks clients). This could be linked to the Non-Financial Reporting Directive and its
2017 guidelines, with the aim of improving ESG-related data to feed into risk assessment
processes.
The ESAs encourage a certain percentage of representatives in stakeholder groups to have
expertise on sustainability issues in the financial sector.
The ESAs play a role in facilitating general coordination between competent authorities on
sustainability issues, as already set out in ESA regulations.

Recommendation 8: Accounting standards for energy efficiency

Eurostats interpretation of public sector accounting standards on energy efficiency

investments needs to be improved.

Three quarters of the EUs 2030 clean energy investment gap is in the energy efficiency
sector. Public/private partnerships between governments/municipalities and energy service
companies (ESCOs) will be key to closing this gap through the deployment of energy
performance contracts (EPCs). Today, Eurostats guidance on the interpretation of IFRS rules
relating to EPCs makes these investments appear on the public sectors balance sheet even

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though the private sector provides financing and takes on the operational and financial risk.

This narrow interpretation of public sector accounting standards on government budgeting for
energy efficiency is one of the main drivers of under-investment in energy efficiency identified
by the Energy Efficiency Financial Institutions Group (EEFIG), and it has led many public sector
energy efficiency projects to be abandoned in member states. It does not recognise that
risk and rewards deriving from the installation and use of the assets mostly belongs to the
private sector (ESCO). As a result, energy efficiency investments are mostly on government
balance sheets while roads, if built via PPPs or concessions, might not. This rule discourages
governments and local authorities from developing energy efficiency investment programmes.
Possible impacts on the Maastricht debt definition would need to be investigated.

The HLEG recommends that the Commission:

Supports Eurostat in its reinterpretation, together with member states, of the present
guidance on the accounting consequences of energy performance contracts in order
to acknowledge the particular nature of EPCs. Given the economic owner of the assets
installed is the private partner (ESCO), such assets should not be on the government
balance sheet.

2. POLICY AREAS FOR FURTHER DISCUSSION

In addition to the policy recommendations described above, the HLEG is working on a
number of other policy areas that require further discussion and analysis. Taking account of
stakeholder feedback, additional recommendations will be considered in the final report on a
wide range of issues, including those outlined below.

1. Long-term policy signals to the private sector

The central objective is to align Europes financial system with the economic, social and
environmental challenges that demand a long-term perspective: job creation, long-term growth,
education, environmental protection, retirement financing, infrastructure, energy and climate
transition. No single policy parameter can switch off short-termism and move finance to the
long term, but progress can be made:

First, by continued emphasis from policy-makers that what is needed in particular is long-
term finance.
Second, a review of regulation and market practices to foster long-term decision-making.
Third, protection of those who take long-term risks in the face of short-term pressure by
financial markets.
Clear, credible and long-term policy signals are needed to enable the private sector to
identify where value is likely to be created and over what timeframe. Among a range of
policy options to consider, the early definition by 2018 of the EUs 2030 and 2050 climate
and energy goals seems particularly important.

2. Governance of firms and financial institutions

There is a strong link between good governance of both firms and financial institutions
and their performance, including on sustainability matters. Developing and promulgating a
set of principles of corporate governance and stewardship that incorporate long-term and
sustainable value creation and improve investor governance should be a central objective at
the European level. Ways of improving governance might include the following:

Defining European directors duties that incorporate value creation for the long-term and
sustainability.
Requiring suitable sustainability expertise on the governing bodies of asset owners above
a particular size threshold.

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 Developing a set of European corporate governance principles that address long-term
value creation and sustainability; and reviewing the potential to incorporate long-term value
creation and sustainability as part of the incentive framework in regulated industries.
Developing a set of European stewardship principles (building on established principles)
that incorporate active ownership and long-term value creation.
Requiring consultation with clients and beneficiaries about their ESG preferences.

3. Integrating sustainability in ratings

The EU should lead by example and foster the integration of ESG factors into ratings and the
tracking of long-term sustainability risk. At the very least, it should require all credit rating
agencies to disclose whether and how they consider information based on the Taskforce on
Climate-related Financial Disclosure in their ratings. The guidelines of the European Securities
and Markets Authority (ESMA) should also be updated to help them make the most of the
newly available data.

Credit rating agencies play an essential role in the investment and lending chain, but todays
credit ratings only partially account for long-term sustainability risk. It is time for long-term
sustainability to move from an add-on consideration to a built-in feature. Achieving this
transformation will require political will.

4. Frequency of financial reporting

Listed firms typically report on their financial performance quarterly, which requires continuous
attention to short-term indicators, potentially at the expense of a longer-term focus. European
legislation has been amended in 2013 to remove the obligation from issuers of listed securities
to publish financial information on a quarterly basis. Nevertheless, market practices continue
to expect such reporting by firms.

To explore current practices in greater detail and how regulation might affect them, the
Commission could invite ESMA to gather empirical evidence and examples on the assessment
of corporate reporting frequency by management, lenders and investors, differentiated by
sector.

5. Accounting frameworks

Accounting frameworks have an important impact on investment decisions. There is a need

to assess how to integrate sustainability more effectively into accounting standards and to
ensure that they do not prevent the pursuit of sustainability and long-term investment. Ways to
achieve such adjustments might include:

An invitation from the Commission to the European Financial Reporting Advisory Group
(EFRAG) to set up a working group with a mandate to review how sustainability factors are
currently factored into accounting standards and how they could be further captured.
The Commission could examine the impact of accounting standards on sectors such
as energy, banking and insurance and how accounting standards affect their ability to
lend long-term and invest sustainably across a range of equity instruments as well as
infrastructure.
A request from the Commission to EFRAG to examine how to foster integrated reporting,
as well as the integration of financial and non-financial/sustainability issues into firms
narrative reporting.

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6. Benchmarks

Indices and benchmarks are cornerstones of global capital markets. Investors rely on them
for measuring the market but also increasingly for capital allocation (passive investment
strategies). Because the standard market benchmarks only reflect ESG issues and risks to the
extent that the listed equity market (on average) more generally does, investment strategies
based on them will follow the status quo. The number of indices aligned with sustainability has
increased, but their significance in overall portfolio allocation, although growing, is still minimal
at this stage.

As a starting point, supervisors and asset owners could encourage the use of multiple
reference points by asset managers as a way to better align with sustainability.
The HLEG will review in greater depth the interplay between market benchmarks, indices
and sustainability investment.

7. Banking

Much work has been done in Europe on financial regulation, but there may be opportunities to
adapt prudential rules to better reflect long-term sustainability risks, opportunities and needs.
Analysis is suggested into whether long-term lending by banks is charged in terms of capital
over and above what is warranted by a risk perspective. Green-supportive or brown-penalising
factors could be investigated; Pillar II and Pillar III could be strengthened with regard to
sustainability.

8. Insurance companies

Possible implications of Solvency II on long-term products and investments should be

investigated and attenuation of barriers to equity investment in long-term assets should be
considered, as well as attenuation of factors fostering pro-cyclicality. In addition, European
supervisors could insist and ensure that long-term sustainability factors are incorporated in the
ORSA made by insurance companies.

9. Stock exchanges and green financial centres

Stock exchanges and financial centres have a key role to play in promoting the growth of
sustainable finance and the disclosure of material information related to sustainability.
They can also support the integrity and growth of the green bond market by encouraging
the development and application of robust standards. The EU could establish a network of
sustainable financial centres in Europe aimed at exchanging best practices, aligning standards
and achieving market scale. It could also encourage IOSCO to work more closely with financial
hubs to improve the disclosure of material and high-quality ESG information in the global
marketplace. At the very least, the EU could encourage and support European financial centres
in launching and strengthening green and sustainable finance initiatives.

10. A strong pipeline of sustainable projects for investment

Increasing the pipeline of sustainable projects, notably in energy efficiency, is a priority. Policy
options might include:

Developing aggregation mechanisms, notably through the EIB and the EIF, to bundle small
and middle-scale projects and make them sizeable for the capital markets.
The EUs state aid arrangements, due to be reviewed in 2018, need to be reconsidered in
the light of the restructuring of the EU economy from an unsustainable to a sustainable
one and to reflect and enable a stronger role for public/private partnerships. This is also an
opportunity to address the non-level playing field relating to energy efficiency and demand
side investment and revise state aid rules to enabled the crowding in of private capital to
deploy the new business models and technology needed.

The National Energy and Climate Plans (NECPs) being developed at EU and member state
level could include a national capital-raising plan. These capital plans would be key in

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 providing investors with visibility over the scale of investment envisioned and the role they
are expected to play in delivering on sustainability objectives. They would signal where
project pipelines will be developed, indicate what tools and funding streams will be used
to attract private finance and credibly set out how the number of low-carbon projects
is expected to grow. Ideally these plans should be included in the NECPs as this would
pave the way for an investable EU 2050 climate strategy shortly after, allowing the EU
simultaneously to secure global leadership in both climate action and sustainable finance
as a result.
Creating a new European Observatory function could be useful for aggregating the data,
track investment needs and financial flows, inform collective decision-making and help to
target further policy interventions in relation to climate change. This body could operate as
a cross-agency collaboration or be a new body.

11. Involvement of society in sustainable finance issues

It is essential for the financial system to reconnect with the society it is meant to serve.
Research-based public platforms and initiatives to increase global awareness of issues
of sustainable finance would help to develop this capacity, along with enabling greater
participation of citizens in sustainable investment opportunities. Initiatives might include:

Creating a public goods research unit that monitors ESG disclosure by firms and financial
institutions, provides public league tables of firms performance on key sustainability
issues and reports on the state of disclosure annually. This unit would initiate a
collaborative research process, building on the existing reference frameworks to define
a common set of financially focused metrics across the sustainability landscape and
highlight R&D related to this area. It would also provide a powerful complement to macro-
level efforts to evaluate member states performance in meeting the SDGs.
Securing a multiannual funding framework (2018-2020) in H2020 & Life budgets to finance
research in the field of green and sustainable finance.
Creating a dedicated EU website to promote leading developments in green and
sustainable finance, including, among other things, initiatives, front-runners, and state-of-
the-art methodologies.
Updating academic and professional curricula to increase financial literacy on
sustainability issues.
Promoting sustainable investment at the retail level as a way for citizens to invest safely
and with impact. Ways that could be explored in that regard include providing access to the
European Progress Microfinance Facility to citizens, as well as exploring the role that peer-
to-peer lending and investment could play in promoting social investments.

12. Social dimensions

Efforts should be made to mobilise private capital for the social dimensions of sustainable
development. A high impact area would be to boost access to capital for social enterprises,
which work in the space between the public and private sector. Initiatives might include:

Promoting social bond issuance, based on newly developed principles such as the social
bond principles.
Establishing a consistent definition of social enterprise used by the EIB, the EIF and the
Commission as a way to assist with targeting support for this sector of the economy.
Increasing the budget provided by the Horizon 2020 programme or allow for more
investors to take an active role in funding projects that meet Europes social objectives.

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VII. Next steps

This Interim Report captures some of the key elements identified by the High-Level Expert
Group on sustainable finance. It lays out the issues identified by the group since it began
working in early 2017, provides some early recommendations and sketches policy areas that
need further discussion and examination.

The hope with this report is to provide a basis for fruitful and constructive consultations as
the HLEG engages in the next phase of its work. No group, no matter how well composed, can
capture all the facets of such a complex topic. Nor can it realistically claim to have identified all
the solutions. We thus see stakeholder engagement as an important step in the next stage of
the HLEGs work.

The engagement and consultation phase will start with a high-level stakeholder conference
on 18 July 2017. It will be followed by a series of public consultations with key participants
in the investment and lending chain. An online questionnaire will also be made available to
ensure that everyone can provide input and comments.

All feedback is welcome and we look forward to insightful comments, questions and
discussions. Following the engagement phase, the group will reconvene from mid-September
onwards and develop further recommendations for inclusion in the final HLEG report to be
presented in December 2017.

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Members of the High-Level Expert Group
Christian Thimann, Chair, AXA

Julie Becker, Luxembourg Stock Anne-Catherine Husson-Traore, Novethic

Exchange Sean Kidney, Climate Bonds Initiative
Magnus Billing, Alecta Esko Kivisaari, Finance Finland
Pascal Canfin, WWF France Claudia Kruse, APG Asset Management
Stanislas Dupre, 2 Investing Initiative Richard Mattison, Trucost
Paul Fisher, Cambridge Institute for Arlene McCarthy, AMC Strategy
Sustainability Leadership
Flavia Micilotta, Eurosif
Mieczyslaw Groszek, Polish Bank
Michael Schmidt, Deka Investment Group
Association
Myriam Vander Stichele, Somo
David Harris, London Stock Exchange
Group Steve Waygood, Aviva Investors
Ingrid Holmes, E3G London office Philippe Zaouati, Mirova

OBSERVERS
Andreas Barkman, European Eila Kreivi, European Investment Bank
Environment Agency Nicholas Pfaff, International Capital Market
Pierre Ducret, European Association Association
of Long-Term Investors Paulina Przewoska, European Systemic
Lars Eibeholm, Nordic Investment Risk Board
Bank Nick Robins, United Nation Environment
Frank Elderson, Single Resolution Program
Board, De Nederlandsche Bank
Nathan Fabian, Principles for
Responsible Investment

EUROPEAN COMMISSION SECRETARIAT

AND OFFICIALS
DG FISMA | Yann Germaine
Niall Bohan, Head of Unit Sebastijan Hrovatin
Alain Deckers, Head of Unit Ewa Kozlowska-Sugar
Felicia Stanescu, Head of Unit Zsuzsanna Lantos
Martin Koch, Project Leader Santosh Pandit
Michelle Kosmidis, Project Leader Elena Loredana Puiu
Antoine Begasse Nico Spiegel
Nicolas Bernier Abad Tamas Szabo
Robin Edme Diego Valiante
Anna Grochowska Ren Van Merrienboer
Diego Pedraza Lahoz
Franca Poliani DG CLIMA| Eero Saue
Elia Trippel DG ECFIN | Peter Schulze
Erik Van Der Plaats DG ENER | Zita Csoka
Uwe Eiteljoerge DG ENV | Lore Genand; Julian Mclachlan
Paul Fraix DG JUST | Zsofia Kerecsen; Joanna Sikora-Wittnebel

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Acknowledgements

Members of the High-Level Expert Group have benefitted from exchanges in the process of
building the Interim Report and would like to thank the persons below for their insights and
advice.

European Commission
Valdis Dombrovskis; Jyrki Katainen; Maro efovi; Olivier Guersent; Daniel Calleja Crespo;
Paulina Dejmek-Hack; Elina Melngaile; Marlene Madsen; Gerassimos Thomas;
Martin Merlin; Benjamin Angel

Members of European Parliament

Burkhard Balz; Pervenche Bers; Reinhard Buetikofer; Esther De Lange; Sirpa Pietikinen;
Paul Tang; Jakob von Weizscker

European Investment Bank

Aldo Romani; Monica Scatasta; Christopher Knowles; Nancy Saich; Eugene Howard; Martin
Berg

From the public and private sectors, and civil society

Lesley Alexander, Simon Howard, UK Sustainable Investment and Finance Association; Anouk
Agns, Association of the Luxembourg Fund Industry; Annemarie Arens, LuxFlag; Ruulke
Bagijn, AXA Investment Managers; Corso Bavagnoli, French Ministry of Finance; Johannes
Behrens-Terk, DekaBank; Francesco Bicciato, Forum per la Finanza Sostenibile; Marc Bichler,
Ministry of Foreign and European Affairs, Luxembourg; Rintaro Tamaki, Timothy Bishop, Emmy
Labovitch, OECD; Martijn Bos, Eumedion; Jean-Philippe Bouchaud, Capital Fund Management;
Stphane Boujnah, Euronext; Arnaud de Bresson, Europlace; Eric Dugelay, Guillaume Brousse,
Deloitte; Wim Mijs, Sebastien de Brouwer, Denisa Mularowa, European Banking Federation;
Adrien Bullier, IEE and Horizon 2020 programmes; Siobhan Cleary, World Federation of
Exchanges; Ian Cochran, Hadrian Hainaut, Benoit Leguet, Morgan Nicol, Institute for Climate
Economics; Philippine Cour, HEC and SciencesPo; Grgoire Coust, Herv Guez, Forum pour
lInvestissement Responsable; Grard de la Martinire; Benjamin Denis, European Trade
Union Confederation; Karin Dohm, European Financial Services Round Table; Denis Duverne,
Emmanuelle Nasse-Bridier, AXA; Douglas Elliott, Oliver Wyman; Doyne Farmer, Cameron
Hepburn, Oxford University; Edouard Fernandez-Bollo, Laurent Clerc, ACPR Banque de France;
Javier Garayoa Arruti, Jaime Silos, Spainsif; Franois-Yves Gaudeul, Allianz; Alain Grandjean,
Jean-Marc Jancovici, Carbone 4; Laetitia Hamon, KPMG; Bianca Jagger, B.J. Human Rights
Foundation, Council of Europe Goodwill Ambassador; Olav Jones, Insurance Europe; Philippe
Joubert, Andrew Voysey, Cambridge Institute for Sustainability Leadership;Jean Jouzel, CEA-
CNRS-UVSQ; John Kay, LSE; Isabelle Kocher, Engie; Caio Koch-Weser, Laurence Tubiana:
Chris Barrett, Anna Mller-Debus, Benjamin Jullien, European Climate Foundation; Hans-
Helmut Kotz, Center for Financial Studies Frankfurt; Jan Pieter Krahnen, SAFE University of
Frankfurt; Anglique Laskewitz, Dutch Association of Investors for Sustainable Development;
Mark Lewis, Barclays; Michael Mainelli, LSE and Zyen; Isabelle Mateos y Lago, Blackrock;
Jeremy McDaniels, Simon Zadek, United Nation Environment Program Inquiry; Jochen Metzger,
Bundesbank; Corinne Molitor, Innpact; Carlos Montalvo, PwC Spain; Xavier Musca, Credit
Agricole; Wilfred Nagel, ING; Will Oulton, Eurosif; Olivier de Perregaux, LGT; Bertrand Perrin,
Vivendi; Wolfgang Pinner, Claudia Tober, Volker Weber, Patrick Wirth, Forum Nachhaltige
Geldanlagen; Marcus Pleyer, Federal Ministry of Finance; Michel Prada, IFRS Foundation
Trustees, Council on Global Financial Regulation; Andrew Rose, Global Infrastructure Investor

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Association; Verena Ross, ESMA; Jeffrey Sachs, Columbia University; Hans Joachim
Schellnhuber, Potsdam Institute for Climate Impact Research; Dirk Schoenmaker, Rotterdam
School of Management; David Shammai, APG; Alison Tate, International Trade Union
Confederation; Julien Touati, Meridiam; Dariusz Winek, Bank for Environmental Protection

The Group Members and Observers would like to thank their collaborators for their
contributions:
Alessandro Boaretto, Alyssa Heath, Will Martindale, Morgan Slebos, Principles for
Responsible Investment; Brendan Burke, Tricia Jamison, Jakob Thom, 2 Investing
Initiative; Chiara Caprioli, Julien Froumouth, Benoit Pauly, Jane Wilkinson, Luxembourg
Stock Exchange; Laurne Chenevat, Mirova; Kajetan Czyz, Cambridge University Institute
for Sustainability Leadership; Esther Delbourg, Amlie de Montchalin, AXA; Gorm Diege,
Magdalena Jozwicka, Stefan Speck, European Environment Agency; Rebecca Edwards,
Trucost; Sebastien Godinot, WWF; Lena Korkea-aho, Harro Pitknen, Nordic Investment Bank;
Peter Lw, Alecta; Sara Lovisolo, Beata Sivak, London Stock Exchange; Sam Maule, E3G;
Pauliina Murphy, Giulia Gioffreda, Marte Borhaug Aviva, Patrick Arber, Aviva; Maria Scolan,
Caisse des Dpts; Carina Silberg, Alecta; Bart Bos, Henk Jan Reinders, Martijn Regelink,
Maarten Vleeschhouwer, De Nederlandsche Bank; Mario Zelenak, Deka Investment GmbH;
Piotr Gazka, Krzysztof Pietraszkiewicz, Mariusz Zygierewicz, Polish Bank Association

The Group wishes to thank the two editors of this Interim Report: Elie Chachoua and Romesh
Vaitilingam.

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Acronyms and Abbreviations

A4S Accounting for Sustainability Eusef European Social Entrepreneurship Funds

ABP Stichting Pensioenfonds ABP EuVECA European Venture Capital Funds

AGM Annual General Meeting FSB Financial Stability Board

Alternative Investment Fund Managers FTSE-100 Financial Times stock Exchange 100 Index
AIFMD
Directive
Financial Times stock Exchange 4 Good
BIS Bank for International Settlements FTSE4Good
index

CAB Climate Action Bonds G20 Group of Twenty

CAC40 Cotation Assiste en Continu G7 Group of Seven

CEB Council of Europe Development Bank GDP Gross Domestic Product

CFO Chief Financial Officer GHG Greenhouse Gas

CMU Capital Markets Union Global Infrastructure Sustainability

GISB
Benchmark
CRD Capital Requirements Directive
GRESB Global real Estate Sustainability Benchmark
DAX Deutscher Aktienindex
H2020 Horizon 2020
Directorate General Financial Stability,
DG-FISMA HLEG High-Level Expert Group
Financial Services and Capital Markets Union

EaSI Emplyment and Social Innovation Programme The Hong-Kong and Shanghai Banking
HSBC
Corporation
EC European Commission
I4CE Institute for Climate Economics
ECBC European Covered Bond Council International Association of Insurance
IAIS
Supervisors
EEA European Environment Agency
IASB International Accounting Standards Board
EEFIG Energy Efficiency Financial Institutions Group
ICMA International Capital Market Association
EeMAP Energy Efficiency Mortgage Action Plan
IDFC International Development Finance Club
EFRAG European Financial Reporting Advisory Group
IFRS International Financial Reporting Standards
EFSI European Fund for Strategic Investments
IIRC International Integrated Reporting Council
EIB European Investment Bank
IMF International Monetary Fund
European Insurance and Occupational
EIOPA
Authority Directive on Institutions for Occupational
IORP-II
Retirement Provision
ELTI European Association of Long-term Investors
International Organization of Securities
IOSCO
ELTIF European Long-term Investment Funds Commission

EMCS Environmental Markets Classification System IPO Initial Public Offering

EMF European Mortgage Federation KIDs Key Information Documents

ESAs European Supervisory Authorities LCE Low Carbon Economy

ESF European Social Fund LGX Luxembourg Green Exchange

ESG Environmental, Social & Governance MDBs Multilateral Development Banks

ESMA European Securities and Markets Authority MIFID Markets in Financial Instruments Directive

ESRB European Systemic Risk Board MTFs Multilateral Trading Facilities

ETS Emission Trading System NECPs National Energy and Climate Plans

MFF Multinannual Financial Framework NFR Non-Financial Reporting Directive

EUR Euros NGO Non-Governmental Organization

EUROSTAT European Statistics NIB Nordic Investment Bank

Euro-Stoxx 50 European Stock Index 50 NPBs National Promotional Banks

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 Organization for Economic Co-operation and
OECD
Development

ORSA Own Risk and Solvency Assessment

P2P Peer-to-Peer

PEPP Pan-European Personal Pension Product

PFZW Stichting Pensioenfonds Zorg en Welzijn

PIE Public Interest Entities

PRI Principles for Responsible Investment

Packaged Retail and Insurance-based

PRIIPs
Investment Products

R&D Research and Development

SDGs Sustainable Investment Goals

SEB Skandinaviska Enskilda Banken

SMEs Small and Medium Enterprises

SRB Single Resolution Board

SRI Sustainable and Responsible Investing

Task Force on Climate-related Financial

TCFD
Disclosures

TEEC Energy and Ecological Transition for Climate

Undertakings for Collective Investment in

UCITS
Transferable Securities Directive

UK United Kingdom

UNEP United Nations Environment Programme

United Nations Environment Programme

UNEPFI
Finance Initiative

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