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Recently, during the ongoing coronavirus crisis, the EU presented an important component for decarbonising the economy over the coming decades: heads of state and government have after years of deliberation adopted a definition framework that applies to the entire EU and lays out what is required for businesses to be considered operating sustainably – the so-called taxonomy. All that is needed is approval from the European Parliament, though this is regarded as a mere formality, and the new set of regulations will come into force.

Several experts have declared the taxonomy to be the right tool coming at the right time. Because following the agreement of emergency support for the economy in the wake of the coronavirus pandemic, the EU is planning a stimulus package comprising possibly trillions of euros – recovery should, as Executive Vice-President of the European Commission Frans Timmermans advocates, be a green one. In mid-April, an alliance comprising 13 EU environmental ministers, among them the German officeholder Svenja Schulze (SPD), as well as company heads and representatives of unions and non-governmental organisations called for a “green upturn”.

Concrete suggestions as to how that could be accomplished consist usually of facilitating environmentally friendly technology and measures like e-mobility, public transport, building renovation or the hydrogen economy. “These are all very good points, but also very expected ones,” says Matthias Kopp, Head of Sustainable Financial Systems as WWF. “What doesn’t come up in the discussion at all is how such technology is translated into how the financial sector works,” Kopp adds. Regarding this particular question, the EU member states and the European Commission have executed trailblazing work by directly employing their tools for a more sustainable finance industry in their credit programmes administered by, for instance, the Kreditanstalt für Wiederaufbau (KfW) or the European Investment Bank (EIB).

Sustainable Finance Committee: apply the taxonomy

The taxonomy lies at the heart of this. It defines in detail when a company’s economic activities (not necessarily the company as a whole) can be considered to be sustainable and it does so for numerous different sectors, from grain cultivation to steel production through to the automotive sector. The underlying principle applied is the idea that an activity can be considered ecologically sustainable if it makes a positive contribution to one of the six EU environmental targets – such as climate protection, transition to a circular economy or restoration of biodiversity. At the same time, the activity may not have a negative impact on any of the goals. In addition, minimum social standards must be fulfilled, and the impact must have been evaluated using scientifically sound methods. The Sustainable Finance Committee of the German federal government has now advocated the application of the taxonomy. “Economic stimulus packages should therefore be based on the approaches of the European Commission including among others the Net-Zero 2050 goal, the multi-year EU financial framework, including the European Green Deal and the Sustainable Finance Action Plan, as well as the Taxonomy Regulation,” the Committee writes.

“The taxonomy not only looks at what is green and sustainable now, but also takes transition into account and thus the path to get there,” explains Karsten Löffler of the Frankfurt School of Finance & Management, who is also Chairperson of the Sustainable Finance Committee. As part of the group of technical experts, he helped prepare the details of the taxonomy for the EU. “Linking investment requirements to the taxonomy is definitely conceivable,” says Löffler. For instance, the EU could link its long-term policy goals, like carbon neutrality by 2050, with the path to recovery from the crisis. That said, the taxonomy does not yet take into account all aspects of sustainability – like for example social issues, where currently only minimum standards apply. “If you view sustainability holistically, it’s about much more than just the environment. Nevertheless, the taxonomy is a good place to start,” Löffler believes.

Kopp even goes one step further: “The taxonomy is designed to find out what exactly makes ecological transformation possible. It is thus virtually obligatory that the framework be applied. Europe is already integrating it into a variety of different legislative projects,” says Kopp. This includes, for example, the Green Bond Standard and the new disclosure requirements for companies by which financial market players are to be able to assess whether or not their investments accord with the Paris climate targets. “It would almost be foolish not to apply the taxonomy now, though it is assuredly not yet developed through to its final form,” adds Kopp.

Klein: it’s about risk management

Christian Klein is a professor of sustainable finance at the University of Kassel and has examined how the taxonomy could now be applied in concrete terms. “Let’s just imagine for a moment that we put a CO2 clause in the requirements for companies seeking credits. A concrete reduction target. If a company achieves the target, repayment is deferred or part of the repayment is even waived,” puts forward Klein. Companies must already lower their emissions regardless in view of the EU’s reduction targets. Here it’s now about the state’s risk management. Companies that do not adjust are less competitive and there’s thus a higher probability of them defaulting on the credit.

“If the state is going to be handing out such gigantic sums, it should make sure the companies are future-proof and not set to go bankrupt,” Klein proposes. The exact nature of the clauses and carbon benchmarks could be taxonomy-oriented. There is currently still time to do so as the recovery programme as a result of the coronavirus crisis is still under discussion. “Just imagine how many highly qualified individuals suddenly have space in their heads right now for new thoughts. When will we ever again have an opportunity like this to think strategically about the coming decades?” he asks.

WWF’s Kopp throws in the idea of giving every company a good faith bonus, but to then link additional advantages to certain conditions. “The point that is absolutely central is that companies need concrete plans and paths for the climate adjustments coupled with transparency of progress.” The state has a right to require a path to net zero emissions when it hands out taxpayers’ money. Many companies are prepared for this path, he says, as there are after all corresponding reporting standards. The European Commission had planned to rework its Sustainable Finance Strategy in any case and the consultations are currently under way.

Kopp and Löffler as well take a similar view to Klein: it’s about risk management. “It’s very important for policymakers that climate aspects be incorporated into credit and investment decisions,” says Löffler. “In the private sector, you can see the credit institutes are taking into account more and more the risks associated with business models that are not adapted for a lower-carbon future.” The state would do well to follow this example.

Berlin, 31.10.2019 – The German Sustainability Code (DNK) has been awarded the ISAR Honours 2019 by the United Nations Conference on Trade and Development (UNCTAD). The award ceremony took place on 30th October 2019 in Geneva at the annual session of ISAR (Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting).

This international award recognises initiatives that deliver an outstanding contribution to transparency regarding sustainability in businesses, particularly through enhancing the comparability and quality of companies’ reporting on sustainability issues. A Review Committee of distinguished international experts selects the award winners based on their effective encouragement and assistance for companies’ reporting on sustainability performance. The experts were impressed by the Sustainability Code’s user friendliness for both the reporting companies and the reports’ target audience. Readers can access and compare the reports by means of the Code’s free online database and external users can also conduct meta-analyses. A technical interface allows immediate usage of the published information in other evaluation systems. As an open source solution for ecological, social and governance (ESG) data, the Code therefore also contributes to Sustainable Finance.

For Yvonne Zwick, Deputy Secretary General and Head of the Sustainability Code Office, the Code’s users are a pillar of its success. “We are very grateful to accept the ISAR Honours 2019 Award on behalf of all the companies that comply with the Sustainability Code and thus promote standardised and focused sustainability reporting”, she commented. “We would like to thank the Review Committee for its positive evaluation of the Code. This award supports our ambition to establish the Code internationally – as a standard that is open to all and easy to use”, she added.

“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.

Chinese and German sustainability stakeholders came together this summer to engage in dialogue – the Sino-German Sustainability Summit, which was held in Beijing at the end of June and was organised by TÜV Rheinland, and a business round table on the following day served as a forum for discussing urgent sustainability issues and possible joint contributions to the 2030 Agenda. The German corporate network Econsense and the German Council for Sustainable Development (RNE) were event partners.

For some years now, TÜV Rheinland has been organising regular summits in China on a variety of topics such as standardisation and quality management. This year’s focus was sustainability. TÜV Rheinland therefore brought the corporate network Econsense, the Sino-German Center for Sustainable Development (organised within the GIZ office in Beijing) and the agency Schlange & Co. on board as supporting organisers, alongside the RNE.

The meeting of approximately 260 Chinese and German sustainability stakeholders was also attended by two members of the RNE Office, namely Yvonne Zwick, RNE’s Deputy Secretary-General and Head of the Sustainability Code Office, and Project Manager Florian Harrlandt.

Fruitful dialogue

On the first day of the summit, Yvonne Zwick moderated a panel discussion on the topic of sustainable finance and, in the afternoon, a workshop on transparency and sustainable development. Florian Harrlandt gave a speech introducing the Sustainability Code. “The personal discussions we had were also interesting as they gave us insight into the challenges faced locally in China,” said Harrlandt. For example, there was very little recognition of the correlation between individual, healthy lifestyles and sustainability at the corporate level.

On the second day, a smaller circle of attendees convened for a round-table discussion, including representatives of businesses and civil society such as TÜV Rheinland, EY Germany, the Global Compact Network China, the Emerging Market Multinationals Network for Sustainability and Econsense.

Proportion of SMEs high in both countries

A surprising lesson learned over the two days was the fact that Germany and China face very similar challenges: “We were surprised by how many parallels could be drawn between the German and Chinese economic structures,” noted Harrlandt. Yvonne Zwick thus firmly believes these talks will serve to trigger ongoing dialogue.

In both countries, most of the major enterprises have already developed approaches with which to contribute to sustainable change. Equally, however, both countries have a high proportion of small and medium-sized enterprises (SMEs) within their economies and these still often see the Sustainable Development Goals (SDGs) as an abstract political concept with which they have few touchpoints. In the course of the Sino-German dialogue, both Ya Yuan, who works as a consultant to the China Business Council for Sustainable Development (CBCSD), and David Wang, General Manager of RKS Ratings, stated that a sound basis for sustainable development achievements by companies in China was still lacking.

Possible follow-up event in Germany

“It was a similar problem which prompted the RNE to facilitate a structured approach to sustainability reporting years ago in the form of the Sustainability Code,” explained Florian Harrlandt, who went on to say that it was therefore hardly surprising that the Chinese dialogue partners were interested in this instrument.

An array of other services and instruments which the RNE has already put to the test, such as the Sustainable Shopping Basket, the dialogue of mayors and the Regional Hubs for Sustainability Strategies (RENN), likewise caught the Chinese dialogue partners’ interest; they believe these could be applied in a modified form in China, too. There is also interest on both sides in consolidating this Sino-German dialogue and in holding a follow-up Sino-German Sustainability Summit in Germany.

RNE Chairwoman calls for “clear signals to the market”

EU action plan results in action

Expertise, primacy of the policymakers and education

• The field of politics needs to have primacy over the markets: The policymakers must ensure that the new principles and transparency with regard to sustainability matters are actually observed in the world of finance. Additionally, they must not back away from what has already been decided: “The most important political battle in the years to come will be to get politicians across the spectrum to stick to the goals of the Paris Agreement,” said Molly Scott Cato.
• Establishing role models: Public institutions and the policymakers must actively practise the values and see sustainability as a top priority. Marlehn Thieme, Chairwoman of the German Council for Sustainable Development, called for the policymakers to not only regulate the financial markets, but also act as role models themselves in the case of government investments.
• Developing expertise: There is a lack of basic knowledge of sustainable business practice in many areas, be it in vocational training, university studies, career experience, or on supervisory boards and within federal institutions. There is therefore a need for further education and new textbooks. For example, Ralf Frank, Managing Director and Secretary-General of the German Association for Financial Analysis and Asset Management (DVFA), took a look at various training programmes for investment professionals as part of a study. “The topics of ESG and sustainability didn’t feature in any of the textbooks,” he criticised.

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