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Impact Investing

IPE special report May 2018

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ESG: A sustainable capital markets union

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The idea of greater harmony and union has always been at the heart of the European project, so it is not surprising that two of the key policies at the heart of Jean-Claude Juncker’s new European Commission are the creation of an energy union and a capital markets union (CMU).

During his confirmation hearings, the commissioner for financial services, Jonathan Hill of the UK, offered up little detail of what such a union could entail, only noting that the European long-term investment fund (ELTIF) and green bonds could play a part. But what would the creation of a single capital market mean in practice, and how might it help pension funds pursuing sustainable returns?

Hill offered the first glimpse of his vision at a conference devoted to the CMU days after he took office in November, once again highlighting the need for the regulation launching the ELTIF to pass through the European Parliament swiftly. He did not reference ‘green’, ‘climate’ or ‘sustainable’ once during his speech, but promised a consultation with civil society, NGOs and the financial sector ahead of an action plan in 2015.

He also struck a careful balance, appeasing those who fear his free-market outlook, by saying there would be no “bonfire” of regulation, but promising to look at any and all regulation if it is deemed to be stifling growth.

This careful balance, not explicitly ruling out further regulation, could pave the way for changes that could boost the sustainable and green investment market in Europe, not least through the ELTIF.

François Passant, executive director of Eurosif, the umbrella group for European sustainable investment groups, says he sees the CMU as an opportunity to address the fragmentation in markets that drive up costs for investors, and that he supports the Commission’s objective to stimulate growth. “That said, Eurosif’s view is that the CMU roadmap cannot be decoupled from the sustainability objectives of the EU.”

The European Commission on the CMU

“Over time, I believe we should complement the new European rules for banks with a Capital Markets Union. To improve the financing of our economy, we should further develop and integrate capital markets.”  Jean-Claude Juncker on the CMU in his manifesto for the presidency

“My ambition is clear: to help unlock the capital around Europe that is currently frozen and put it to work in support of Europe’s businesses, particularly SMEs. And that is where the Capital Markets Union, a new frontier of Europe’s single market, comes in.” 

Jonathan Hill during a speech in Brussels in November

Growth in climate bond issuance and investments could help meet sustainability and carbon reduction targets, and the Climate Bonds Initiative has over the last six months launched working groups on standards for climate-friendly property, agricultural and water infrastructure bonds. Transport and energy infrastructure would be other areas where a green slant could be explored, with greater connectivity of power networks one of the areas pension funds should invest in, according to the Institutional Investors Group on Climate Change.

Most of these areas are already aided by climate bond issuance from national and international development banks, such as the European Investment Bank (EIB). Additionally, the Luxembourg-based institution is expected to be pivotal to Juncker’s proposed €300bn growth plan, now due to be published before Christmas, leading to the prospect of climate-friendly projects and economic stimulus hand in hand. 

As part of this, Passant accepts that industry-led standard setting for matters such as climate change can play a part in attracting investment. “At some point, however, if the market is not in a position to come up with unified standards that meet the needs of investors, then there might be the case to add legislative action but this is, in our view, far too early at this stage.”

Getting the Commission to endorse industry standards is also one of the goals of Sean Kidney, chief executive of the Climate Bonds Initiative. He says the matter is the subject of a report his organisation is currently drafting. Kidney says the executive would not have to develop issuances such as green bonds, but that it should be “assessing and promoting appropriate standards in the context of Europe’s transition to the low-carbon economy.”

Kidney jokes that Hill’s mention of green bonds during his confirmation hearings shows he was well-briefed as to what would play well in parliament. “Being well-briefed is perfectly good. It means Hill has the right staff. It’s as close to genuine as you can get nowadays in politics.”

He says that it remains to be seen if the mention would come to anything, but notes that there is now a prominent place reserved for the sustainability debate among mainstream investors, especially with central bakers like the UK’s Mark Carney now accepting the premise of stranded assets.

Concerns were raised by MEPs and European Parliament president Martin Schulz that none of the commissioners had to consider sustainability as part of their brief, with the suggestion that vice-president Jyrki Katainen could have been tasked with considering the matter as part of his broader remit for jobs and growth. But Kidney questions the need for such categories. “I do not believe that putting things in silos is the most productive approach at this stage.

“At the same time, I think it is imperative that those who do have responsibility for economic development in Europe, for financial regulation, as well as energy, transport, agriculture, all understand that climate change is a dominant factor in their decision-making they need to take into account.”

For the immediate future, Hill’s focus is on attracting funding for small and medium-sized companies for the longer-term, an area where the ELTIF can potentially help. But simply launching the ELTIF will not suffice to attract pension investors, notes James Walsh of the UK’s National Association of Pension Funds.

“One of the requirements for successful roll-out of the ELTIF will be a pipeline of suitable investment opportunities, and this is one area where the EC and national governments have a role to play.

Getting patient, sustainable capital invested in the European real economy would be the ultimate goal of the new vehicle, but Walsh, the organisation’s EU policy lead, insists that the ELTIF will be just one of the “key building blocks”. He also says guarantees can potentially play a part in attracting pension investors to the ELTIF, echoing suggestions by the NAPF’s European sister organisation Pensions Europe that the EIB could either evaluate projects or underwrite them.

The bottom line, at least for Kidney, is that environmental sustainability should simply be a matter that informs all decision-making on European level, citing the way in which it is second nature for laws to be reviewed regarding their impact on privacy and human rights. 

Passant concurs. “During the process of defining what CMU means, there is an opportunity to think how the emphasis of capital markets can be placed more on the long term, away from excessive short-termism. In that agenda, environmental, social and governance matters have a key role to play.”

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