EP Report Examines Financial and Regulatory Challenges of Green Deal

The paper argues that main challenge to the framework for achieving climate-neutrality is how to coordinate and harness individual member states’, producers’ or investors’ efforts in a Union-wide pathway that embodies the common but differentiated responsibilities of the United Nations Framework Convention on Climate Change. The recommendation is to create and disseminate extended shared socio-economic pathways for EU, together with the associated shared climate policy assumptions, that can accommodate each climate action in a consistent perspective for consumers, producers, or investors. 

Th paper then discusses the “green investment gap” implied by the Green Deal, which is in the order of EUR 250 billion to EUR 300 billion annually, in addition to a baseline investment need of EUR 1.0 trillion to 1.5 trillion. If the absolute size of the green investment gap does not pose an impossible task, and demand for green investments appears insatiable, the key to a successful European Green Deal Investment Plan will be the ability to match supply and demand. The mismatch between demand and supply can be remedied by appropriate segmentation (carving up projects into risk classes), securitization (bundling different but related portions into investable packages), and synchronization of the “environmentally sustainable” activities in the EU Taxonomy, facilitated by credit enhancement and guarantee programs.

The paper highlights that the pace of the pathways will largely determine the risks to macro-economic and financial stability. Too fast a transition to a climate-neutral Europe may shock the financial system while a too slow transition risks damages to exceed regions’ resilience—again calling on central banks as a “lender of last resort.” There is also debate on whether central banks have an active participatory role to play in these complex systems, through fiscal, monetary, and prudential policy, or that they need to stand back as a watchful observer and regulator. However, the drive to promote sustainable investment suggests an active system-wide reallocation toward "green" investments that will need to be carefully monitored by those same central banks.

Additionally, the introduction of climate-related disclosures and natural capital accounting comes with a non-trivial complication that tends to be underestimated. One cannot simply add or exchange natural and financial capital. That makes evaluating the trade-off between the two essentially incommensurable "worlds" a delicate exercise. Also, keeping separate tabs on the economy or the financial system versus the social and natural environment—as in the naive approach to Environmental, Social, Governance (ESG) investing or sustainable development—decouples the links between the economic, environmental and social objectives of the Green Deal. The comprehensive pathways proposed earlier attempt to capture these links and trade-offs in a consistent dynamic framework.

Related Link: Paper (PDF)

Keywords: Europe, EU, Banking, Insurance, Securities, Green Deal, Climate Change Risk, ESG, Sustainable Finance, Disclosures, Taxonomy, Securitization, European Parliament