EU embraces controversial plan to slash capital charges for green investing

The proposal is to introduce a ‘green supporting factor’

Banks may be offered lower capital charges if they invest in green projects and companies, in a controversial plan which has secured backing from the European Commission.

At the One Planet climate summit in Paris today, the Commission’s Vice President, Valdis Dombrovskis, announced its priorities around sustainable finance. As well as highlighting the need for a green taxonomy and an explicit statement on ESG in fiduciary duty definitions in Europe, he pointed to the importance of banks in the move to greening the European economy, saying they played a “major role”.

“To incentivise lending, we are looking positively at the European Parliament’s proposal to amend capital charges for banks to boost green investments and loans by introducing a so-called green supporting factor,” he told the audience.

“This could be done at first stage by lowering capital requirements for certain climate-friendly investments, such as energy-efficient mortgages or electric cars. We could model it on existing capital requirement adjustments for investments in SMEs or high-quality infrastructure projects.”

In recent weeks, legislation was passed at European level to force issuers that come to market with securitisations including real estate and vehicles, to disclose the environmental characteristics of the assets. This could include the energy rating, for example. Technical standards will now be developed.

But the green supporting factor proposal has been met with a mixed reception by the market, with some fearing the move will create ‘green bubbles’ – by incentivising over-demand on certain assets that cannot be sustained and may result in a crash over the medium- to long-term.

“We don’t need another weakening of Solvency II” – Sven Giegold, MEP

Others have suggested capital requirements are in place to manage lending risks that became apparent in the financial crisis, and should not be altered to incentivise behaviour that is not directly related to the immediate risk profile of assets.

“I really don’t want to see in the final report of HLEG (High-Level Expert Group) all these lobby demands, that in order to green finance you need lower capital requirements for green projects. The market is full of capital searching for profitable investment opportunities,” claimed Green Party MEP Sven Giegold, speaking at an event hosted by Finance Watch last week in Brussels. He added that “we don’t need another weakening of Solvency II”.

“Some sectors of the financial industry want alleviation of capital requirements anyway,” he said. “And we should not fall into the trap that we provide the fine green values that they can call up to justify that. That would be a mistake. We should force everyone to weigh risks properly and to take them into account,” Giegold concluded, adding that the evidence of a link between risk reduction and green investing was not strong enough to justify reducing capital requirements.

The green supporting factor is one of two capital requirement mechanisms being floated in Europe to help stimulate investment into climate-aligned assets.The other is a penalising factor: increasing capital requirements for investments into dirty projects, such as coal. According to insiders, this has been unpopular with banks, which have pushed for the Commission to embrace the green supporting factor in isolation, as this doesn’t come with any penalties or threats to returns. Dombrovskis did not mention EU support for this in his speech.

Speaking at the Finance Watch event, Olivier Guersent, Director General of the Commission’s DG FISMA (Financial Stability, Financial Services and Capital Markets Union), warned of the risks of incentivising green investing without official definitions of what would be eligible.

“If it’s profitable to invest in and we do not have a proper definition, then everything is going to become green and sustainable” – Olivier Guersent, DG FISMA

“If you want to promote sustainability, you need to know what is sustainable,” he said, in a keynote speech. “If you want to promote what is green, you need to know what is green. Otherwise, the inventiveness of the financial sector is limitless, so I can tell you that if it is economically profitable to invest in green and sustainable, and we do not have a proper definition, then everything is going to become ‘green’ and ‘sustainable’. And this is exactly what we need to avoid, because [if that happens] nothing will change. So it is absolutely essential that we know what we’re talking about.”

One of the other three priorities outlined by Dombrovskis today is the need for investors to have “a common language and classification system for what is considered green and sustainable”.

“After all, if we are telling investors to choose green products, we need to know what those look like. Our goal is to have an EU taxonomy – or a classification system – for sustainable finance. This is a necessary condition for sustainable finance to reach scale. And it would allow us to define EU standards and labels for Green Bonds and Green Investment Funds. This would also allow us to address market fragmentation and accelerate green investments by all types of investors.”

For more information on what is already being done by the European Commission and its High Level Expert Group on Sustainable Finance in order to speed up the development of pan-European green standards, see our analysis.
HLEG is expected to present its final report in the third week of January. It will prompt official responses from both the European Commission and the European Parliament. The former will launch an Action Plan in Brussels on March 22, to outline how it will take the recommendations from HLEG forward. Ahead of that, the Parliament will publish its own report, stating its position on the findings. The Commission will then be tasked with creating legislation around sustainable finance, which can ultimately be vetoed by Parliament if it is not aligned with its stated position.