EU banking package and sustainability

On 27 October 2021, the European Commission adopted a review of EU banking rules (the Capital Requirements Regulation – CRR – and the Capital Requirements Directive – CRD IV). These new rules will ensure that EU banks become more resilient to potential future economic shocks.

The package implements Basel III, stablishes new sustainability rules, and provides stronger enforcement tools for supervisors overseeing EU Banks.

Concerning Sustainability, it intends to strength the resilience of the banking sector to ESG risks, aligned with the Commission’s Sustainable Finance Strategy. It improves the way banks measure and manage these risks, ensuring that markets can monitor what banks are doing. This proposal will require banks to systematically identify, disclose and manage ESG risks as part of their risk management. It includes regular climate stress testing by both supervisors and banks. Supervisors will need to assess ESG risks as part of regular supervisory reviews. All banks will also have to disclose the degree to which they are exposed to ESG risks. To avoid undue administrative burdens for smaller banks, disclosure rules will be proportionate.

The proposed measures will not only make the banking sector more resilient, but also ensure that banks take into account sustainability considerations.

More on https://bit.ly/3Gsbs0T

European Sustainability Reporting Standards

Cluster 2 of the EFRAG’s Project Task Force on European Sustainability Reporting Standards (PTF-ESRS)  has published a Climate Standard Prototype working paper as well as an accompanying basis for conclusions. EFRAG said that these documents are a “robust basis for future PTF-ESRS discussions and a further step towards a draft standard.” The PTF-ESRS continues to work on draft standards covering sustainability issues requested in the CSRD proposal

More on:

Basis for conclusions: https://bit.ly/2WGO5i4

Climate standard prototype’ working paper: https://bit.ly/3la2vkh

Climate Change and prudential policy

Central Banks’ objective of maintaining price stability, enables climate protection goals. For example, low inflation rates will allow households and firms to detect price signals from climate policy and adjust thus their behaviour. Putting the right price tag on greenhouse gas emissions is arguably the most powerful weapon  in the fight against climate change.

Central Banks should not slip into the role of a climate policy actor as they have different segregation of responsibilities. Unlike monetary policy, climate policy changes the distribution of resources and income distinctly and permanently. Democratic processes and direct political accountability are important when making such decisions. Central Banks should guarantee independence to safeguard price stability objective.

A clash of objectives could arise as well if, say, the Central Bank attempted to use its monetary policy asset purchase programmes  to pursue environmental policy objectives, as these programmes  need to be scaled back as soon as warranted  to ensure price stability. Ultimately, monetary policy is not a structural policy instrument: it is cyclical in nature, balancing each other out over the long run through  the interplay of monetary policy loosening and tightening.

However, Central Banks can step up their game to protect the climate without running the risk of overstretching their mandate of preserving price stability. As climate change affect firms and lenders, Central Banks need to ensure that climate-related financial risks are appropriately taken into account as part of risk management.

So, from a monetary policy, perspective, Central Banks are within their rights to request better information. The Eurosystem should consider purchasing or accepting as collateral only those securities whose issuers meet certain climate-related reporting requirements. Hence, the importance of the ratings of agencies to adequately and transparently reflect climate-related financial risks.

Other further measure may be to limit the maturities or the volume of securities from certain issuers in the monetary policy portfolio, if required to contain financial risk.

More on https://bit.ly/3AouqBB

Overhaul of the EU Emissions Trading System (ETS), the Energy Taxation Directive (ETD), and the introduction of a Carbon Border Adjustment (CBAM)

The European Commission has adopted a package of measures intended to put the EU firmly on the road to climate neutrality by 2050 with the intermediate step of a minimum 55% reduction in net greenhouse gas emissions by 2030. An overhaul of the EU Emissions Trading System (ETS) and of the Energy Taxation Directive (ETD), and the introduction of a Carbon Border Adjustment (CBAM) form part of the package:

A.- ETS overhaul: it would bring maritime transport within the scope of the ETS and accelerate the reduction of the number of emissions allowances that can be issued each year. A separate proposed directive would lead to the gradual reduction of free emissions allowances available to the airline industry. It also envisages the establishment of a separate emissions trading system for road transport and heating fuels which would apply from 2026 at the fuel supplier level. Its introduction would be accompanied by the establishment of a Social Climate Fund.
B.- ETD overhaul: the ETD does not reflect the current mix of energy products and criticized that it does not link the minimum tax rates to energy content and CO2 emissions.
Minimum tax rates would be based on the real energy content and environmental performance of each product, with most polluting fuels taxed at the highest level. The tax base would also be expanded – including through the removal of existing exemptions. An eye-catching change in this respect is that fuels for the aviation and maritime industries would lose existing exemptions.
The burden of higher minimum levels of energy taxation may be felt disproportionately by consumers and poorer households. The mitigation of this risk does, however, appear to be left mostly to each Member State’s tax system and the commission encourages Member States to consider using energy tax revenues to support vulnerable households.
C. CBAM introduction: the overarching aim is to prevent carbon leakage. The CBAM has been designed as a system of certificates to complement the ETS rather than, for instance, an import tax. Importers will be required to purchase certificates at a price to be set by the Commission on a weekly basis to mirror average ETS prices (which are established on a daily basis) in respect of relevant goods (being, at least initially, only iron and steel, cement, fertiliser, aluminium and electricity generation as per Annex I to the proposed CBAM regulation) imported into the EU customs territory from third countries. Imports from countries that participate in the ETS or have an emissions trading system linked to it are exempt from CBAM.

More on: https://bit.ly/3yYDk8a

EU social taxonomy and taxonomy extension linked to environment reports

The draft proposal for a social taxonomy will argue that in the face of a pandemic, unanswered social questions around a sustainable transition, continuing human rights abuses and continuously rising costs for housing, the time is right to identify economic activities that contribute to advancing social objectives. Just as the EU environmental taxonomy defines activities that substantially contribute to environmental objectives, a social taxonomy would do the same for social objectives.

Built on the foundation of international norms and principles like the sustainable development goals (SDG) and the UN guiding principles for businesses and human rights, a social taxonomy would help investors to contribute to finance solutions around ensuring decent work, enabling inclusive and sustainable communities and affordable healthcare and housing. A social taxonomy would be a tool to help investors identify opportunities to contribute to these objectives.

The Public Consultation Report on Taxonomy extension options linked to environmental objectives will be focussed on support for the environmental transition needed in the whole economy – it proposes further clarity on both: activities that are significantly harmful to environmental sustainability, and those that have no significant impact on it. The aim is to support transitions in areas currently of “significant harm”. They should transition to a level that at least does not cause significant harm, even if they do not actually reach substantial contribution (green). The report will set out options to build on the existing taxonomy and its use.

The Platform on Sustainable Finance will welcome stakeholder feedback on both drafts through two calls for feedback, which will run from 12 July to 27 August 2021. Platform’s advice on this will feed into Commission’s report on potential extension of taxonomy framework to be adopted by the end of 2021.

More on https://bit.ly/3AVvi1P

Commission puts forward New strategy for Sustainable Finance and proposes new European Green Bond Standard

The Commission also adopted yesteday a Delegated Act on the information to be disclosed by financial and non-financial companies about how sustainable their activities are, based on Article 8 of the EU Taxonomy.

Thus, EU took another major step towards achieving the goals in the Green Deal by ensuring a comprehensive approach to funding the green transition.

EU proposed incorporating climate-related risks into banks’ capital requirements. The challenge for lenders is weaning themselves off their lending exposure to fossil fuels. Their initial disclosures have been limited and commercial lenders still have “patchy” data regarding their exposure to climate change.

The ECB will hold a stress test next year to see how their balance sheets may fare as the climate and economy shifts. EU states will be asked to assess by June 2023 how their financial markets contribute to reaching the bloc’s climate goals. ECB will then calibrate the right pace for the transition by setting intermediate targets for the financial sector. Insurance capital rules may also be similarly amended.

The Commission confirmed it will publish taxonomy rules later this year for agriculture, certain industries and possibly nuclear and gas power plants. EU needed to guard against the risks associated with the transition, thus considering an “intermediate taxonomy” that would allow transition bonds.

The strategy seeks to empower individuals and the bloc’s 23 million SME by defining green loans and mortgages by 2022. New accounting rules may also be needed to “recognise and report” ESG risks in financial statements.

The strategy sets out a positive vision of the reform needed in the financial system to support the European economy.

More on https://bit.ly/3jRgriU

Network for Greening the Financial System (NGFS) update of their economic scenarios

Reaching net zero by 2050 could lift growth and employment but would require an inflation-boosting $160 per tonne carbon price — or equivalent “shadow price” — by the end of the decade. This will push up inflation and also raise unemployment in some countries with energy-intensive industries.

Only a relatively quick and orderly transition to a low carbon economy would add to growth while a delayed transition or no action would cut deep into the economy.If these changes occur in an orderly fashion, the scenarios suggest that it could lead to some increase in global GDP, and lower unemployment relative to prior trends.If the transition fails, the scenarios suggest that up to 13% of global GDP would be at risk by the end of the century, even before accounting for the potential consequences of severe weather events.

Currently about a fifth of the world’s greenhouse gas emissions are covered by a carbon price.

More on: https://bit.ly/3ziT7j6

EU-wide pilot exercise on banks’ climate risk by EU Banking Authority

The EU aggregated GAR stands at 7.9%, which identifies the institutions’ assets financing activities that are environmentally sustainable according to the EU taxonomy.

More disclosure on transition strategies and GHG emissions would be needed to allow banks and supervisors to assess climate risk more accurately. It is important banks to expand their data infrastructure to include clients’ information at activity level.

Regarding the EU taxonomy classification, banks are currently in different development phases to assess the greenness of their exposures. The two estimation techniques, banks’ bottom-up estimates and a top-down tool, are considered in the exercise and the report highlights the differences in outcomes.

The scenario analysis shows that the impact of climate-related risks across banks has different magnitudes and is concentrated in some particular sectors. The findings should be considered as starting point estimates for future work on climate risk.

More on: https://bit.ly/3ufO53o

Innovation is key for the Net‐Zero Emissions Scenario 2050 (NZE)

The @IEA just released the world’s first comprehensive roadmap for the global energy sector to reach net-zero emissions by 2050. They say almost 50% of the emissions reductions needed in 2050 in the NZE depend on technologies that are at the prototype or demonstration stage. This share is even higher in sectors such as heavy industry and long‐distance transport.
This is clearly ambitious, as most clean energy technologies that have not been demonstrated at scale today should reach markets by 2030 at the latest. Technologies at the demonstration stage, such as CCUS in cement production or low‐emissions ammonia‐fuelled ships, are brought into the market in the next three to four years. Hydrogen‐based steel production, direct air capture (DAC) and other technologies at the large prototype stage reach the market in about six years, while most technologies at small prototype stage – such as solid state refrigerant‐free cooling or solid state batteries – do so within the coming nine years.
In the NZE, electrification, CCUS, hydrogen and sustainable bioenergy account for nearly half of the cumulative emissions reductions to 2050. Just three technologies are critical in enabling around 15% of the cumulative emissions reductions in the NZE between 2030 and 2050: advanced high‐energy density batteries, hydrogen electrolysers and DAC.

You can read the report “Net Zero by 2050: A Roadmap for the Global Energy Sector” here

My new publication: “Public-Private Partnership in Energy Infrastructures: Experiences in Latin America”

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Energy infrastructures in Latin America deserve a particular study with regard to Public-Private Partnerships (PPPs). Its different regulatory frameworks and degrees of institutional and operational maturity, make them to have a unique map of risks, policies and best practices. My publication on “PPPs in the Energy Infrastructures: experiences in Latin America” thus is proposed. The demographic increase and the economic growth of the Latin America countries emphasize the need for large investments in infrastructure to reduce the gap, which are also linked to their plans for sustainable development, climate action and interconnection to the infrastructures of the region (for example, electrical networks, gas pipelines and gasification terminals), and the regional energy markets. It is expected that the Public-Private Partnerships can funnel these investments. To do this, governments must create an environment in which the private sector can grow, by developing transparent regulatory frameworks. These reforms should gain the confidence of investors in these countries, which now compete with the other countries in a globalized world, to attract Foreign Direct Investment (FDI) to their energy markets. All this leads to reforms in each country in order to establish a more attractive environment to do business. A new field of opportunities opens up, driven by the national and international expansion plans of the private sector, and the search for better returns by the large investment funds in a context of low interest rates. In this scenario, the International Financial Institutions (IFI) must continue supporting infrastructure development.

Publication available on http://www.scioteca.caf.com/handle/123456789/1225

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