Sustainable finance markets taking concrete form

For the finance sector, things are now getting serious: the Federal Government wants to make Germany a leader of sustainable finance and has commissioned a Sustainable Finance Advisory Council to prepare corresponding proposals. At the third German Sustainable Finance Summit, experts discussed a first position paper.

“The very foundations of our lives are under pressure as a result of the established production and consumption patterns of our time.” This statement does not come from an environmental association but has its source in the first position paper from the Federal Government’s Sustainable Finance Advisory Council, which took up its work in June. Sights are set high: the Federal Government wants Germany to assume a leading role for sustainable finance markets.

The Council is itself composed of representatives of banks, asset managers, Deutsche Börse AG, rating agencies, the industry, insurers, the scientific community, NGOs and public authorities. The German Council for Sustainable Development (RNE) is also represented as an observer – and has published a paper detailing its position with respect to the Federal Government’s sustainable finance strategy. At the third German Sustainable Finance Summit, the majority of the Council’s 38 experts made themselves available for a discussion panel with interested specialists for the first time. Below you will find a summary of the key discussion points.

“What do we mean by ‘sustainability risks’?”

This was the question Jörg Kukies, State Secretary at the Federal Ministry of Finance, asked rhetorically at the summit in Frankfurt. The idea behind the question being that unsustainable action on the part of businesses as a commercial risk for investors and their clients, i.e. you and I, should be made transparent and measurable. This seems to be beyond the sector’s current capabilities. “Many groan and ask if that means there will be still more regulations. Many are also scared away and worried about the work itself, as they don’t have any experience with the topics of ethics, sustainability or human rights,” says Silke Stremlau, assessing the mood in the finance sector. She represents the ethical-social business association Hannoversche Kassen, which offers company pension schemes. Kukies assuaged these worries, saying that no concrete new regulations were on the table, rather the aim were to expand existing guidelines in order to take up sustainability criteria in the risk categories used to date.

The German Federal Financial Authority (BaFin) recently published an official notice on this subject, which is open for consultation until 3 November, containing examples of such risks: such as if a pension fund invested in a chemicals company that did not operate sustainably. An abrupt change in market sentiment would lead to devaluations. This is a classic market risk that today already has to be accounted for. Or, for instance, following a flooding disaster, customers pull their assets from a local credit institution in order to finance repairs of the damage – a classic liquidity risk. Overall, the BaFin notice had brought “tears of joy” to the eyes of many in the sustainable finance sector, as it required of numerous classic players that they take up a concrete position with respect to sustainability, Stremlau commented. Other commentators held back as the notice did not apply to system-critical banks, as these were subject to the supervision of the European Central Bank.

Data, data, data

In addition to risks, Frank Pierschel, Head of the BaFin Banking Supervisory Division, pointed out that major opportunities also await in the form of investment in the economic transformation. Both aspects – risks and opportunities – require extensive data. Despite the EU requirement that large corporations prepare sustainability reports, the data is insufficient. The Council’s position paper assesses that “currently, there is no common understanding regarding the key ESG data that are to be provided by the real economy and financial sector and be evaluated by investors”. There were thus many questions posed at the summit in Frankfurt relating to this issue. One working group prepared a whole list of these questions: is the quality of data on sustainability performance adequate for guiding capital flows? Is the data even being prepared and applied? Do banks, insurers or other players have the software for processing such data? Simply including the full range of climate data in the accounting is quite a mountain of work, one participant remarked.

Another question was what incentive the business sector had to provide detailed figures on sustainability, which could possibly grant competitors significant glimpses into their operations. Many firms have access to affordable capital right now anyway as a result of the zero-interest phase: is the effort required to become attractive to sustainability-oriented investors even worth it? The journey seems long yet, as many companies still do not view social- and climate-related topics as part of their core corporate reporting, one participant noted. A further open question was how companies that are still part of the old “brown” economy could be rewarded for taking up the process of transformation. Here, too, classification is needed. For many of these issues, possible solutions are already proposed. Global sustainability standards could be derived from the recommendations of the Task Force on Climate-related Financial Disclosures.

Also regarding the question of so-called double materiality, there are differing views: according to one, companies must disclose how the climate crisis affects their operations. That alone is complicated, some participants noted. From the other perspective, companies should additionally provide reliable figures on how they themselves contribute to climate change or impact society positively or negatively. “Is that taking things too far?” one working group asked – and suggested a pragmatic approach of simply applying existing models, such as the United Nations’ Principles for Responsible Investment, and seeing what progress can be made. The RNE is itself currently working with the fintech start-up Arabesque S-Ray on an open data solution for ESG data (i.e. data on ecological, social and governance aspects of companies’ operations) based on the data that is available through the Sustainability Code (DNK).

Obligatory or voluntary?

Imagine if every financial product would in future carry an indicator as to what extent the companies or projects it finances are compatible with the international climate goals. A label such as that for refrigerators would be conceivable, a participant suggested. The question of whether or not financial actors should be obligated to provide such information – or do it on a voluntary basis – was a contentious one. The taxonomy, a uniform definition of what constitutes a sustainable financial product, currently being developed by the EU is applied on a voluntary basis. The Council has not yet made a decision on this matter. “Statutory regulations neither guarantee achievement of an intended impact nor are voluntary-basis approaches by definition without impact,” is the stance taken in the position paper.

Within the expert body, the need for a “systemic approach” was undisputed, commented Kristina Jeromin from Deutsche Börse AG, who sits on the new council. Sustainability should not just be limited to a small niche of the market. ‘Systemic’ should not be equated with an obligation to provide information on financial products’ sustainability. Rather, the summit concluded, it was about achieving a transformation of the financial system by leveraging the market’s own dynamics. Not more, but different, regulation was a sentiment frequently uttered. This enables a new narrative of how companies and financial market players can become future-proof by following the societal drive for more climate and environmental protection.

Leadership responsibility and the role of the Federal Government

Such a vision gives rise to a responsibility to be borne by corporate executives and policymakers. “The public sector has a key example to set in the transformation of the financial system and the real economy towards sustainability,” points out the Council’s position paper. In its own recommendations, the RNE goes a step further: “Sustainability must become the criterion for setting the national budget and therefore also the basis of assessment for both the budget committee and the audit offices.” Georg Schürmann, Managing Director of Triodos Bank Deutschland, called on policymakers to create clearer framework conditions: “We can only finance those things that actually develop in the real economy. We can’t finance wind farms if they aren’t being built, like in 2019,” he commented, emphasising how important it was for the real economy to be represented in the new council of experts.

The finance industry itself could also send clearer signals to the political sphere, added Karsten Löffler of the Frankfurt School of Finance & Management and Chairman of the Sustainable Finance Advisory Council, pointing to the Dutch finance industry, which had publicly taken up a position in clear support of the government’s climate protection policy. “It would send a strong signal if we were able to do that in Germany, too,” commented Löffler.

Matthias Kopp, responsible for sustainable finance at the WWF and a member of the Council, called for Germany to provide an impulse that would energise debate at European level – after all, Berlin would soon be holding the presidency of the Council of the European Union. “It would be my wish to see Germany progress from a reactive role to a constitutive one,” Löffler added. Silke Stremlau had a similar view: “My idea is that we show the Federal Government our support and say: we in the finance sector want a higher carbon tax; we want the SDGs [the global sustainability targets of the UN] to be a yardstick for future financing.” In the task of reaching this consensus, the Council would be beneficial.

The European and global levels of sustainable financial markets were uncontroversial at the summit. “It is a multilateral process where Europe has a true leadership role,” commented Pierre Ducret, President of the French organisation Finance for Tomorrow. Within the EU, however, it was said that certain countries would need to take the agenda forward. The Netherlands were predestined for this role, but the most important thing here was an old relationship that has long been a driver of European unity: “We need strong bilateral cooperation between Germany and France,” said Ducret.