Europe is the source of the next big shake-up in banking regulation, with the European Green Deal at its centre – and the prospect of rich opportunities. By Justin Pugsley.
What is happening?
The next revolution in regulation has started and this time banks are much more welcoming, as it may present a cornucopia of new business opportunities to rejuvenate a struggling industry.
The EU is embarking on a massive change to its economy, and the Covid-19 pandemic has placed these ambitions on steroids. The European Green Deal sits at the heart of this great recovery plan and the recently agreed €750bn rescue package for EU member states, which includes a mix of cheap loans and grants, has ‘sustainability’ baked into its objectives. In short, the green deal aims to mobilise a staggering €260bn every year for a decade to build new green infrastructure – and banks, as capital allocators, have a crucial role to play.
In an effort to capture the magnitude of those ambitions, the US-based private bank Brown Brothers Harriman described it as “not simply an Apollo programme, it’s an Apollo programme every year of the next decade. And that’s just for one pillar of the Green Deal.”
The chief aim of this transition is to reach zero carbon emissions by 2050, which will require a radical rethink of economic activity. These green objectives are rapidly filtering their way into banking regulation and supervisory expectations. And even though the ‘E’ in environmental, social and governance (ESG) garners most of the attention, the ‘SG’ part also has major implications for banks, such as their management, their reporting, workforce diversity and how they treat customers. This will require banks to create new models, new data sets, definitions and methodologies.
Why is it happening?
The main reason for this change is because the EU leadership believes economic activity must become sustainable to respect the environment, which is reaching the limits of how much degradation it can survive. But it’s also an opportunity to fire up a sluggish European economy, set the global growth agenda and to place the EU at the centre of this global transformation.
The US and China may have unrivalled technological prowess, but the EU has regulatory ascendency as the world’s largest market, which it intends to use to tilt global economic activity in its favour.
What do the bankers say?
Yes, ESG means banks making more changes to their governance and reporting structures – even rethinking their entire businesses – which requires yet more investment. However, unlike with the torrent of new rules that gushed into the sector following the 2007-09 global financial crisis, this particular regulatory shake-up may come with a bounty of business opportunities. Simply put, the Green Deal targets the entire economy and society.
There’s the potential to create all kinds of new green financial and investment products: entire industries are going to need financial help to transition to low-carbon business models, while new industries emerge to fulfil new sources of demand. And for the fleet of foot there will be tremendous opportunities for ‘green’ financial innovation.
Some bankers have also commented favourably on how the EU is threading together all its various ESG regulatory initiatives. For instance, there is the taxonomy regulation, which clarifies what is an environmentally sustainable activity and aims to eliminate ‘greenwashing’. This relates closely to amendments to the Benchmarks Regulation, which is to introduce a climate transition benchmark and an EU Paris-aligned benchmark. In turn, these will help underpin the EU’s green bond standard, which could ultimately replace all the various voluntary standards.
Other crucial initiatives include the Disclosure Regulation, a review of non-financial reporting disclosures, the Shareholder Rights Directive II and Ecolabels for retail financial products. Meanwhile, ESG considerations are to be embedded in the Markets in Financial Instruments Directive II, the Undertakings for the Collective Investment in Transferable Securities and the Alternative Investment Fund Managers Directive.
All these regulations and amendments are a work in progress, with many not coming into force until late 2020 onwards. There are also plans for changes in prudential regulation.
Will it provide the incentives?
Whether or not the EU achieves its breathtaking green ambitions is another matter. Many an EU plan kicks off in a flurry of hyperbole only to disappoint later. However, it is clear that there is massive political, social and even business momentum behind these green initiatives, so if they miss the target it probably won’t be for lack of trying. Indeed, the EU does have some precedent in achieving the seemingly impossible – think of the euro, expanding to encompass 27 countries, and the creation of the single market.
For banks, meanwhile, this economic transformation could turn out to be a massive opportunity, rather than just being another regulatory compliance headache.
