Sustainable finance began to occupy a prominent place in the European Union’s policy agenda following the signing of the Paris Agreement on climate change in 2016 and the adoption of the United Nation’s Sustainable Development Goals (SDGs).Footnote1 The EU policy agenda was given significant support by the creation of the High-Level Task Force on Sustainable Finance in 2016, the EU Action Plan on Sustainable Finance and the Technical Expert Group on Sustainable Finance in 2018. The European Commission followed these initiatives by adopting the EU Green Deal in 2019 consisting of an ambitious package of legislative measures to assist EU citizens and businesses in benefitting from the transition to a sustainable green economy with particular focus on companies and the financial sector. The recognition of the urgency of financing the transition to a low-carbon economy and the need for mitigation of and adaptation to environmental sustainability risks are at the heart of the EU’s sustainable finance strategy, which aims to mobilise and channel capital towards green and sustainable activities, products and projects.
Likewise, the EU’s policy agenda and regulatory framework reflect the need to finance the green transition and limit the potential for risks and threats that could undermine economic and financial stability through a prudential approach to climate and environmental risk management, where financial institutions are expected to commit to building a resilient and sustainable financial system.
The Covid-19 pandemic also contributed to a major push for the EU’s sustainable finance agenda, as it fostered the EU's green financial capacities through the NextGeneration EU (NGEU) instrument, where around 30% of the NGEU’s Recovery and Resilience Fund (RRF) will be financed through green bonds.Footnote2 The EU has also recognised the urgency for financial institutions to integrate ESG factors into their business models and risk management strategies, with the aim of ensuring that the entire financial sector plays a key role in driving the transition to a sustainable economy, and also intends to continue exploring new ways to increase the mobilisation of private capital towards sustainable investments. On the latter, a number of important new policy initiatives have been emerging, but much remains to be done to address ESG-related challenges.
As policy developments are moving quickly, they represent a major challenge for financial institutions and their regulators and legal advisers to adapt to these policy changes while at the same time striving to contribute to a resilient and sustainable economy and financial system. Recent EU legislation to address climate change and broader ESG challenges have precipitated a major debate across the Atlantic and globally regarding whether financial regulation and corporate governance should integrate climate and ESG concerns into day-to-day risk management and business practices. EU legislation, such as the Taxonomy Regulation, the EU Green Bond Standard, the Sustainable Finance Disclosure Regulation (SFDR), the Corporate Sustainability Reporting Directive (CSRD) and amendments to the Benchmark Regulation (extending its application to Climate Benchmarks) are influencing legislative and regulatory developments in many countries outside the EU.
The three articles in this special issue analyse different aspects of environmental and social sustainability in the context of commercial, corporate, and financial regulation and the challenges for companies and financial firms in managing Environmental and Social Governance (ESG) challenges. The first article, A Behavioural Law and Economics Approach to Sustainability Information by Aline Darbellay, critically analyses the mandatory disclosure paradigm that underpins corporate disclosure requirements in capital markets law in respect to sustainability information. The article considers the literature to show how the mandatory disclosure model based on the rational investor expectations theory has been modified in light of behavioural finance theories that hold that investor decision-making is based on various cognitive and psychological factors and not only on the financial materiality of information. The article argues that although the current EU sustainable finance disclosure requirements are mainly based on mandatory disclosure of financially material information, the behavioural science theories demonstrate that the disclosure-based market discipline approach is flawed, and that policymakers and regulators should account for behavioural findings in the context of sustainability information by incorporating other types of information that triggers investor behaviour particular in respect of environmental and social sustainability information.
The second article, Integrating ESG Matters into Suitability: Legislative Concepts and Implications for Product Governance and Organization by Markus Winkler, focuses on how ESG (particularly environmental risks) ratings are increasingly used as a regulatory tool to align investments with the transition to a low carbon economy. The article discusses how ESG is becoming more of a mainstream investment strategy for many financial institutions that is leading to increased engagement with their customers regarding their suitability to invest in sustainable financial products. The article argues that this trend is likely to develop into an industry practice over time, especially because of the new legal requirements by the European Union in the Market in Financial Instruments Directive II to require regulated financial firms to conduct suitability assessments of their customers regarding their preferences for ESG products. The article discusses some of the challenges for integrating ESG preferences into investment strategies including the design of investment strategies that can achieve long-term value for customers while promoting a low-carbon transition. Also, the design of ESG investment products include data inconsistency in measuring performance and achieving ESG goals, and lack of comparability of ESG criteria and ratings methodologies, The article argues further that these challenges could constrain how the integration of ESG criteria affects asset allocation and if not addressed by policymakers the pace and scale of ESG capital allocation necessary to achieve tangible progress to support long-term value and low-carbon objectives could hindered. The article reviews the EU legal and regulatory developments to address these challenges and compares them with the principles-based approach of Swiss legislation and regulation. The article ultimately argues that the EU Green Deal provides a more coherent foundation for integrating ESG criteria into EU financial law and regulation that would reorient capital flows to more sustainable investments. This would necessarily involve the adoption of more comprehensive rules that address all aspects of financial services provision, particularly product governance and organisational requirements.
The third article, Climate Change: Obligations and Risks for Swiss Companies by Marie-Cristine Kaptan, analyses some of the recent legal trends in Europe involving climate litigation against corporations. It discusses some of the leading cases, including the Shell Oil case, to highlight the legal liability issues and risks for companies and their boards of directors in the context of damages caused by climate change. After reviewing some of the recent cases in Member States of the European Union, the article addresses the specific issues of Swiss law that apply to corporate and board liability for climate litigation risks with practical recommendations for companies to mitigate such risks.
These articles address how the multiple manifestations of the environmental and climate crisis have brought a previously unknown spectrum of legal and financial risks to the fore. Weather events and chronic shifts in temperature, as well as changes in policies and consumer preferences brought about by the transition to a low-carbon economy, are only a few examples of potential drivers of financial risks that can spill over into the banking and financial sector and the broader economy. Indeed, financially material environmental sustainability risks are posing major challenges for financial regulatory authorities.
The articles all recognised how sharing and learning from best practices are essential steps which could contribute to the global sustainable finance agenda. Against this backdrop, ESG challenges, including climate-related financial risks, have profoundly transformed, and are transforming the business strategies, governance practices and risk management of commercial and financial firms.
Disclosure statement
No potential conflict of interest was reported by the author(s).
Notes
1 In January 2015, the UN General Assembly began the negotiations on the post-2015 development agenda that culminated in the subsequent adoption of the 2030 Agenda for Sustainable Development, which included the 17 Sustainable Development Goals, at the UN Sustainable Development Summit in September 2015. See https://sdgs.un.org/goals.
2 European Commission, ‘NextGeneration EU Green Bonds’: https://ec.europa.eu/info/strategy/eu-budget/eu-borrower-investor-relations/nextgenerationeu-green-bonds_en.