How are Financial Institutions impacted by European Commission Green Labelling Nuclear gases and power plants?

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What is the EU Green deal, and how does it shape the EU Taxonomy?

The European Union is transitioning towards a new strategy, prioritising climate neutrality, zero pollution, and affordable and secure energy. In 2019, the EU set foot to launch the European Green Deal, outlining the actions that need to take to transform Europe into “the first climate-neutral continent in the world”. The commitment from the EU commission with the Green Deal is to be climate neutral by 2050 and to reduce greenhouse gas emissions by at least 55% in 2030 compared with 1990^[1]. The Commission has estimated an additional investment worth €260 billion, which is 1.5% of the GDP when compared to the nominal GDP of 2018^[2]. The Commission will provide funds through its current budget and the Recovery and Resilience Facility (an initiative to mitigate the economic and social impact of COVID) to be funded by NextGenerationEU. With the help of NextGenerationEU, EC will raise over €800 billion (5% of the GDP) through funding operations on the international capital markets during 2021 – 2026^[3].

The EU Commission developed an EU Taxonomy, a classification system that establishes a list of environmentally sustainable economic activities under the EU Green Deal. The EU Taxonomy plays a vital role in helping the EC scale sustainable investments and implements the Green Deal across Europe. The EU Taxonomy provides companies, investors, and policymakers with the benchmarks and definitions for which economic activities can be considered sustainable, helping companies to become more climate-friendly and mitigate market fragmentation^[4]. Soon, companies need to invest a part of their portfolios towards “green” activities to be labelled green from the EC. An economic activity that is “Taxonomy aligned” will be considered sustainable. For that, the movement needs to contribute to one of the pillars of the taxonomy and do no significant harm to the other pillars^[5].

What do the EU Green Deal and Taxonomy imply for financial institutions and Banks? 

In Europe, financial institutions, bank lending, and debt markets play an essential role in financing economies. Financial institutions and banks will be the key to sustainable finance, leading to the EU Green Deal. The banks lead the capital market financing and constantly work on different solutions to bear the transition risks associated with the Green Deal and the Taxonomy. Financial institutions have shown a rising interest in climate-linked and green bonds; with the rise of the Green Deal, the issuance of green bonds has significantly risen at a corporate and sovereign level^[6]. Additionally, Asset owners/managers and insurance companies will play a crucial role with banks as they will need to align their portfolios to meet sustainability objectives. However, the EC is constantly changing the EU Taxonomy concerning the Green Deal, and financial institutions will need to align with the regulations to be successful.

What is the rationale behind the EC to label nuclear investments as green investments?

Recently, the European Commission has published that nuclear power plants and gases will be considered a sustainable investment if they meet a specific criterion in the EU Taxonomy as a part of the Green Deal. Compared to their previous draft, the requirements are expected to include minor changes that make it easier for some gases and plants to earn a green investment label. Currently, the draft grants plant the green label until 2030 if they meet the criteria with emission limits and a requirement to burn down fewer carbon gases by 2026 and be 100% low–carbon gas in 2035^[7]. The rationale behind the decision Is underlined by the Technical Expert Group, advising the EC; they mentioned that nuclear energy represents low–carbon energy sources, which is in line with the IPCC, OECD, and the UN Economic Commission. 

How are banks impacted by labelling nuclear investments as green investments?

Now the question that arises is, what does the EU Green deal and the green labelling of nuclear energy imply towards financial institutions and banks? According to the EU Taxonomy, Banks will need to increase their disclosure to offer clients to identify green investments and ensure credibility; keeping this in mind with EC labelling nuclear investments as green, many banks will invest in nuclear powerplants. Research by Wealer in 2019 has shown that investments in nuclear energy have a negative expected NPV with high capital costs^[8]. However, in countries like France, where 70% of the power supply is from nuclear energy, banks like BNP Paribas and Crédit Agricole have invested over €9000 million in nuclear initiatives EU Green Deal. Financial institutions and banks must evaluate the key transitioning, physical, and credit exposure risks. They will have to address both regulatory and political pressures as Europe moves forward to meet its sustainability goals as a part of the Green Deal. 

However, the green transition is linked to the financial sector’s transformation with the emergence of premium paid for climate-friendly activities. The EIB Investment Report, 2020 – 2021, has shown that with the rise of the ESG regulations in financial institutions, their shares tend to outperform than then equity markets, concerning green equity portfolios outperforming the brown equities since the global financial crisis^[9]. Additionally, research conducted by ECB also shows that financial institutions that disclose their climate targets have reduced their emissions, resulting in a better credit rating. Investors have shown a significant interest in green assets and bonds over vanilla bonds, with the preference of portfolios with a sustainable profile. They are ready to pay a premium willing to lower their returns to hold greener stocks but only when they are more transparent about their environmental activities^[10].

Banks need to prepare the forthcoming regulations in the EU Taxonomy.

Following the EU Taxonomy, the ECB and EC are developing numerous regulations. They will put the banks and financial institutions through rigorous stress tests to analyse different macroeconomic scenarios. The European Commission is constantly expanding the Taxonomy to further align it with the EU Green Deal. For Banks and Financial Institutions to be prepared for the EU Taxonomy and the different tests, they will need to ask themselves additional questions on how well they have interpreted the Taxonomy concerning the various sections and the stress tests, ECB plans to do conduct or on how they are planning to be updated and aligned with the constant changes in the Taxonomy. 

We at IBM Consulting have launched a new initiative that supports banks and financial institutions with their ESG practises and goals, in line with the EU Taxonomy. We are developing an IBM sustainability platform that banks and financial markets can leverage for a sustainable future have all the information at their glance to establish a sustainable ecosystem. IBM’s ESG platform is infused with AI and automated data gathering tools that collect, analyse, organise, infusing data sources located anywhere to extract ESG specific information from reports and third-party sources. Additionally, clients can leverage IBM’s technologies and capabilities to align themselves with the four pillars of sustainable banking: ESG Qualifications & Assessment, Sustainable Operating Model, ESG Regulatory Reporting & Compliance. Stay tuned to find out more on how IBM, with hybrid cloud and the sustainability platform, help banks and financial institutions prepare themselves with the EU taxonomy by aligning themselves with the regulations and achieving their sustainability-based targets. 

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References

^[1]The European Green Deal Road Map. EUR. (n.d.). Retrieved February 24, 2022, from https://eur-lex.europa.eu/legal-content/EN/TXT/?qid=1576150542719&uri=COM%3A2019%3A640%3AFIN#document2

^[2]Insights Equities EU green deal and investing in June 2021 … (n.d.). Retrieved February 24, 2022, from https://www.ssga.com/library-content/pdfs/insights/eu-green-deal.pdf

^[3]Recovery plan for Europe, NextGenerationEU. European Commission – European Commission. (2022, February 1). Retrieved February 24, 2022, from https://ec.europa.eu/info/strategy/recovery-plan-europe_en

^[4]The new EU Taxonomy on Sustainable Activities. (n.d.). Retrieved February 24, 2022, from https://www.wbcsd.org/contentwbc/download/9495/144218/1

^[5]EU taxonomy for Sustainable Activities. European Commission – European Commission. (2022, February 2). Retrieved February 24, 2022, from https://ec.europa.eu/info/business-economy-euro/banking-and-finance/sustainable-finance/eu-taxonomy-sustainable-activities_en

^[6]Insights Equities EU green deal and investing in June 2021 … (n.d.). Retrieved February 24, 2022, from https://www.ssga.com/library-content/pdfs/insights/eu-green-deal.pdf

^[7]Person, & Kate Abnett, S. S. (2022, February 1). EU to propose Green Investment label for Gas and Nuclear Energy, Source says. Reuters. Retrieved February 24, 2022, from https://www.reuters.com/business/energy/eu-propose-green-investment-label-gas-nuclear-energy-source-says-2022-02-01/

^[8]Economics of Nuclear Power Plant Investment: Monte Carlo Simulations of Generation III/III+ Investment Projects. (n.d.). Retrieved February 24, 2022, from https://www.diw.de/documents/publikationen/73/diw_01.c.698579.de/dp1833.pdf

^[9] Eib. “EIB Investment Report 2021/2022: Recovery as a Springboard for Change.” European Investment Bank, European Investment Bank, 12 Jan. 2022, https://www.eib.org/en/publications/investment-report-2021.

^[10] Born, Alexandra, et al. “Towards a Green Capital Markets Union: Developing Sustainable, Integrated and Resilient European Capital Markets.” European Central Bank, 19 Oct. 2021, https://www.ecb.europa.eu/pub/financial-stability/macroprudential-bulletin/focus/2021/html/ecb.mpbu_focus202110_3.en.html.

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