Meaningful policy action on climate change entails costs and reforms for almost all economic activity, and at the European level we are starting to see what this means in practice.
A large proportion of stimulus spending – 37% of the Recovery and Resilience Fund – is devoted to the objectives of the Green Deal, while July will see a set of regulatory proposals to curtail the use of fossil fuels in transport. At the same time the Sustainable Finance agenda is explicitly seeking to drive institutional investors towards financing sustainable activities, with very little flexibility or nuance in how those are defined.
In the following items, GC experts look at the detail of what it means for the transport sector to be “fit” for the 55% emissions reduction that the EU has committed to by 2030; the detail of how funds will be spent in the crucial region of Eastern Europe; and whether the EU’s sustainable finance commitments could be the basis for global standards.
“Fit for 55” - the next frontier for European climate action
Ambitious EU plans to curb CO2 emissions in a range of sectors enter into force this year. EU proposals expected on July 14th 2021 promise to alter drastically how people and goods move to, from and around the continent, accelerating the “green transition” for shipping, road, rail and air transport. The “Fit for 55” package will extend emissions trading to aviation and shipping, tighten CO2 emissions standards for vehicles, mandate the use of more sustainable fuels, and promote development of charging and refuelling infrastructure. Meanwhile, a proposed Carbon Border Adjustment Mechanism will put pressure on global supply chains for automotive and aerospace manufacturers.
Automotive and aviation will be key sectors for accelerating emissions reductions. CO2 emissions performance standards for cars and vans will test the technological frontier (and the economic viability) of the internal combustion engine (ICE) at a time when European manufacturers are only beginning seriously to produce alternatives. Environmental NGOs have even sought outright bans for the ICE, while automakers (backed by France, Germany and Italy) advocate a more gradual phase out, in part to give time to develop charging infrastructure. Emissions from aviation are growing faster than any other transport mode and CO2 emissions from flights within Europe have increased 26% since 2013. Aviation has already been hit hard by the covid-19 pandemic but achieving the EU net-zero target will mean reducing aviation emissions by 90% by 2050. Although aviation will also be targeted by the strengthening of the EU ETS, the introduction of sustainable aviation fuel (SAF) quotas is attracting much of the political debate. The industry is divided between large carriers and smaller operators on a few contentious points, including the geographical mandate of the quota obligation mandate and the definition of sustainable aviation fuels.
With “Fit for 55”, the commission is attempting for the first time to address each mode of transport’s specific issues through carbon pricing and tighter emissions regulation. Although member states broadly agree on the need to curb emissions in transport, business interests will reflect in conflicting national positions on the speed of emissions reductions and the sharing of the decarbonisation burden. Whilst airlines’ leverage with member states has been weakened by bailouts made conditional upon emissions reduction, automakers will use their industrial weigh to shape member states’ positions. Ensuring a just transition will also be key to finding agreement between the parliament and the council, with the debate around subsidies taking centre stage.
Building a taxonomy for sustainable finance in the EU
The EU’s first-mover advantage on sustainable finance appears to be creating new incentives for investors, financial institutions, and corporates seeking finance within the internal market. The EU has defined the architecture of its sustainable finance regulatory framework at speed over the past year. Its stated mission is to provide consistency and build investor confidence, as well as mobilise private capital to invest in green technology. It is built around a green taxonomy that defines what is ‘sustainable’, complemented by rules governing disclosure. Early successes such as the appearance of greeniums demonstrate investors’ appetite for green assets, and this will be followed with an ‘ecolabel’ for financial products echoing the longstanding approach to certifying the environmental footprints of consumer goods.
But EU aspirations to be a global rule maker have clashed with the unwillingness of other countries to become rule takers. The commission has at the same time sought to establish its domestic rules as nascent global standards, improving the chances of overseas market access for EU firms and reducing the risks of regulatory arbitrage. However, this has proven far harder for financial services than for consumer goods: the US has rebuffed calls for it to follow the EU approach and, like the UK, it is developing its own approach. The UK’s announcement on June 9th about producing its own taxonomy is a strong sign that investors (and companies seeking to appeal to them) will have to navigate multiple frameworks at least in the medium term.
The EU's sophisticated framework has however set a high bar for global standards, setting the path to global alignment. Third countries’ snubbing the EU’s pretended leadership is not the end of the story. The EU will seek alternative ways to influence and promote its standards on the international scene by leveraging its seat at the table of influential multilateral bodies such as the G7, G20, and OECD. With President Biden at the table, all G7 members now recognise the need to align the current landscape marked by a multitude of sometimes competing and sometimes complementary ESG disclosure frameworks.
COP26 will be the preferred platform to endorse global disclosure requirements and accounting standards. Amongst all available ESG disclosure standards the IFRS framework will be the favoured route, building on its experience and success in delivering global accounting standards. The ambition has already been solidified by the G7’s endorsement to align global standards to the Taskforce on Climate-related Financial Disclosure (TCFD) recommendations. The decision will be promoted by the EU who already announced it would align to the TCFD recommendations in its recently adopted Corporate Sustainability Reporting Directive.
The EU sustainable finance framework
Post-covid economic recovery trends in the CEE region
The CEE economies have stabilised the epidemic situation and opted for growth stimulation through increasing levels of public investment. True to a region that brandishes itself as the most dynamic part of the EU, gloomy predictions over deep economic contraction compared to the non-pandemic baseline turned out to be less damaging with a smaller drop in GDP than the EU average with the notable exception of tourism reliant Croatia. Reasons for this include a relatively successful management of the first wave and a largely intact manufacturing sector. In their recovery efforts, the countries in the region can rely on a minimum of three financial sources: EU MFF 2021-2027 funds, funds from Next Generation EU, including the Recovery and Resilience Facility (RRF), and their own resources. Given that most countries used lower GDP growth forecasts at the time of the adoption of the 2021 budget, in an optimistic scenario this latter might create an opportunity to be generous with the extra money later this year.
The region seeks to learn lessons from the pandemic to reimagine its economic model and invest accordingly. Some countries created an overarching vision for future economic prosperity, such as Poland’s Polish Deal making a good use of all available resources, including the Just Transition Mechanism, or Latvia’s National Industry Strategy aiming to create higher value-added services and products by 2027. Public investments seek to boost a conducive legal and fiscal environment for innovative sectors, which is expected by both EU institutions and FDI providers. CEE countries also hope discussions about nearshoring will result in heightened interest for their offers. On the other hand, a sense of overreliance on imports has awakened as well, with some countries creating production lines for future production of vaccines and Poland earmarking funds for the production of active pharmaceutical ingredients. With the availability of RRF, other countries have opted to do their homework to create national plans along the lines of the European Commission’s guidance, meeting the minimum expenditure benchmarks of 37% for climate and 20% for digitalisation.
Looking at the top priorities of the national recovery and resilience plans is a good indicator of local realities wrapped in international trends. The green transition will be the main focus to catch up with ambitions formulated in the EU Green Deal, with different interpretations focusing on investments in mobility and green transport or renewable energy. In parallel with being visionary, finances are also needed to address structural funding gaps. The pandemic has served as a reminder that CEE governments have often left the health sector underfunded and pressure for political accountability for the lives lost have contributed to prominent allocations for the sector. Investment in digitalisation in the public administration aims to cut red tape: in the health sector it could allow for health data collection used for R&D and in education it could replenish the competitive workforce. In the meantime, misspending remains a concern and debates are ongoing about an additional mechanism to guarantee the proper use of EU funds, with a possible suspension of payments as an ultimate penalty.
This is one of our three pieces written as part of Global Counsel's 'Reshaping the EU' conference. You can read the team's insights on the digital transition here, and on the effect of the German elections on the balance of power in Brussels here.