Hlavní práce70505_migm00.pdf, 857.4 kB Stáhnout

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University of Economics in Prague

Faculty of Finance and Accounting Department of Banking and Insurance

Field of study: Finance

Regulation of Sustainable Investments

Author:

Thesis supervisor:

Martina Migilová

prof. PhDr. Petr Teplý Ph.D.

Year of defense: 2020

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Declaration:

I hereby declare that the bachelor thesis “Regulation of Sustainable Investments” presented here is my own work. All the literature and sources used are fully stated as references.

In Prague, day 21. 8. 2020 Martina Migilová

Čestné prehlásenie:

Prehlasujem, že som bakalársku prácu na tému „Regulation of Sustainable Investments“

vypracovala samostatne a použitú literatúru a ďalšie pramene som riadne označila a uviedla v priloženom zozname.

V Prahe dňa 21. 8. 2020 Martina Migilová

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Acknowledgements

I would like to express my sincere gratitude to my thesis supervisor prof. PhDr. Petr Teplý Ph.D. for his advice when choosing the topic as well as for his constructive suggestions and materials provided. Most importantly, I deeply appreciate help and the support of my family and friends throughout my studies.

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Abstract

This bachelor thesis is concerned with regulations in the field of sustainable investments and portrays a complex intersection of green finance terminology. This thesis introduces key regulation initiatives emerging from the sustainable finance action plan, which was presented in 2018 by the European commission and aims to prove its relevance and importance. Part of the thesis deals with the risks associated with climate change and sustainable investment products, including green bonds and green loans. The empirical part consists of case studies of selected banks from different regions, which adhere to the principles of responsible banking. The analysis focuses on selected aspects of their sustainable environmental strategy such as risk management, sustainable products, defined objectives and compliance with the TCFD recommendations. The results show an increase in the financing of sustainable projects, green bond issues and also the implementation of TCFD proposals in risk management by all analysed banks, which proves the broad coverage of the European initiative. Based on the information published in their annual and sustainability reports, it is possible to state their diversity in scope and content, underlining the meaning and need for regulation.

Key Words

sustainable investments, sustainability, regulation, taxonomy, disclosures, climate-related risks, low-carbon economy, sustainable finance

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Abstrakt

Táto bakalárska práca sa zaoberá reguláciami v oblasti udržateľných investícií a prináša komplexný prierez terminológiou zelených financií. Predmetom práce je predstaviť kľúčové regulačné iniciatívy vyplývajúce z akčného plánu o udržateľnom financovaní, ktorý v roku 2018 predstavila Európska komisia a dokázať ich relevantnosť i dôležitosť. Časť práce je venovaná rizikám spojeným s klimatickou zmenou, udržateľným investičným produktom, medzi ktoré mimo iné radíme zelené dlhopisy a zelené pôžičky. Empirická časť pozostáva z prípadových štúdií vybraných bánk z rôznych regiónov, ktoré sa riadia zásadami zodpovedného bankovníctva. Analýza sa zameriava na vybrané aspekty ich udržateľnej stratégie vzhľadom k životnému prostrediu ako riadenie rizika, udržateľné produkty, vymedzené ciele a súlad s odporučeniami TCFD. Výsledky ukazujú nárast financovania udržateľných projektov, emisií zelených dlhopisov a taktiež implementovanie návrhov TCFD do riadení rizika zo strany všetkých analyzovaných bánk, čo dokazuje široké pokrytie európskej iniciatívy. Na základe zverejnených informácií v ich výročných správach a správach o udržateľnosti, je možné konštatovať ich rôznorodosť v rozsahu aj obsahu podčiarkujúc zmysel i potrebu regulácie.

Kľúčové slová

udržateľné investície, udržateľnosť, regulácie, taxonómia, zverejňovanie informácií, riziká spojené s klímou, nízkouhlíková ekonomika, udržateľné financie

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1 Introduction

Fostering sustainability in the financial sector is crucial for a very simple reason. To maintain the life on the Earth and to avert threating scenarios stemming from climate-related risks, huge sustainable investments have to be channelled towards the transition to a low-carbon economy. With the increasing concern for sustainability, the so-called greenwashing appears more frequently. Therefore, it is necessary to determine what can be considered as sustainable and to remove ambiguities arising from this issue in the financial market. Moreover, regulation will require the financial market participants to behave in a more sustainable way. The aim of this thesis is to provide a comprehensive overview of regulation initiatives regarding sustainability and to emphasize its importance.

The theoretical part consists of several chapters dealing with terminology in the field of sustainable finance. The first subchapter introduces the term sustainable investments and its diversity. The second part concerns the description of the selected banking products which are gaining popularity globally, such as green bonds, green loans and others. I further present the basic risk classification and define the climate-related risks which arise from two physical and transition impacts of climate change (TCFD, 2017). Since the climate-related risk is not considered as a separate risk type, a few examples of potential manifestations of transition and physical risk are reflected into a common risk structure – financial and non-financial risks. The fourth subchapter relates to the core of this bachelor thesis – regulation. It focuses on the initiatives proposed by the European Union, as an international leader in financial regulation, including the Taxonomy Regulation, the Disclosure Regulation, Low Carbon Benchmark Regulation and certain amendments to the existing policies. Since this thesis has been created during the COVID-19 pandemic crisis which shifted the centre of attention and will undoubtedly affect further course of events around the world, policy implementations resulting from this crisis are considered as well.

The empirical part deals with the analysis of four banks – ING, Citibank, YES BANK and Standard Bank from various regions which are members of the Principles of Responsible Banking. I closely examined their sustainability approach regarding the environment from recent data available in the bank’s annual or sustainability reports. I focused on their strategies, risk management, sustainable banking products long-term goals, if specified, and whether the information published are in alignment with the Taskforce for Climate-related Financial Disclosure (TCFD. Recommendations).

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2 Theoretical Background

2.1 Defining „Sustainable Investment “

Defining sustainable investment is the main issue of this bachelor thesis since there is no agreed definition yet. However, the European Union defines sustainability which means

“making economic prosperity long-lasting, more socially inclusive and less dependent on exploitation of finite resources and the natural environment (European Commission, 2018, p.9).

The term investment is familiar to most of us. However, many actions are called

“investments” which might also cause significant chaos in defining sustainable investment.

Since there is no single approach to sustainable investments, there is no general definition. In regard to the term “sustainable investment”, we come across several different labellings.

According to Impact Economy Glossary, firms are using nearly 80 various terms to depict different forms of sustainable investing such as ethical, clean, green, socially responsible and so forth. Nevertheless, each of these relates to different forms of sustainability. The heterogeneous terminology in this sector might be confusing and therefore make it hard or even impossible for the investors as well as for the clients to compare the products or see the difference in offers. In order to clarify the meaning and scope of action, it is important to provide definitions of key terms used in context of sustainable investments.

Ethical Investment (also known as Values First) represents an investing approach originally rooted in religious beliefs (of Christianity, Judaism and Islam), expressed as negative screens in sectors including tobacco, weapons, alcohol and fossil fuel. Values First investment decisions are associated with the non-economic criteria (Krosinsky, 2016; Mercer, 2017).

Socially Responsible Investment and Ethical Investment are terms which have been used interchangeably. Nonetheless, SRI is considered to be a new version of Ethical Investment and illustrates the integration of social and environmental objectives into investment decisions.

(Sparkes & Cowton, 2004; Schueth, 2003). That is to say, investors restrict their investment options to securities of firms which provide socially acceptable activities.

„ESG investing is the research and investment strategy framework that evaluates environmental, social and governance factors as non-financial dimensions of a security’s valuation, performance, and risk profile.” (Sherwood and Pollard, 2018, p. 23). Environmental factors within the ESG framework include areas such as environmental footprint (e.g. energy and water consumption, carbon emissions, pollution), environmental governance and

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environmental product stewardship (automobiles with low fuel consumption) (Swiss Sustainable Finance, The World Bank Group, 2018). Social factors refer to human rights, education, diversity, labour standards, community relations, supply chain standards and many others (Swiss Sustainable Finance; The World Bank Group, 2018). Governance factors concern the system of policies and practices provided by a company referring to corruption, transparency and institutional strength, rule of law and so forth (Swiss Sustainable Finance;

The World Bank Group, 2018).

Responsible Investment (RI) is defined as „a strategy and practice to incorporate environmental, social and governance (ESG) factors in investment decisions and active ownership “(Principles for Responsible Investment, 2019, p. 4). Although ethical, SRI and impact investing aims to combine financial incentives with ethical requirements, RI can also be in demand by investors whose sole interest is in financial return however they are aware of the consequences in case of their inactivity.

Impact Investing has emerged as an objective for investors whose intention is environmental and social impact of their investments alongside financial return expectations (Krosinsky, 2016; GIIN). It has contributed to better access to medicine, education, healthcare and housing in the Third World Countries (Krosinsky, 2016). Thematic Investments are associated with a contribution in both environmental and social issues in a specific field such as renewable energy, climate risk, carbon footprint, clean technology, water industry and so forth (Swiss Sustainable Finance; Schroders, 2018).

Sustainable Investments are about combining investor’s financial motivation with their interest to act in compliance with ESG. (Eurosif, 2010b).

Darmstadt Definition of Sustainable Investment (Hoffmann, 2004) gives the most concise insight on what is sustainable investment. For that reason, although the definition is very lengthy, I will cite its whole form below:

“From an economic perspective, sustainability requires that

− profits are made on the basis of long-term production and investment strategies instead of short-term profit maximalization;

− profits from financial investments are in acceptable relation to the profits from real added value;

− the fulfilment of basic needs is not in danger.

From an ecological perspective, it is required that profit-making is compatible with

− increase of resource productivity;

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− the investment in renewable resources;

− sound global and local ecological systems;

− the regaining and recycling of used materials and substances.

From social and cultural perspective, it is required that profit-making is compatible with

− the development of human capital (education and further education, respect for the individuality of people, responsibility for jobs, support for self-dependent work, compatibility of job and family);

− the development of social capital (creations of opportunities for gainful employment, balance of the generations, no discrimination against minorities, functioning regions, support of civil-society activity);

− the development of cultural capital (respect for cultural variety in consideration of the protection of personal civil rights and liberties and societal integrity, mobilizing the potential of cultural variety).”

Inconsistency and lack of clarity in terminology is one of the key barriers in underpinning the continued growth in this sector. According to the survey provided by UBS in Switzerland, 72% of respondents stated that the terminology is confusing (UBS, 2018). Results from Schroders, the investment firm, shows that more than 50% of the investors surveyed in about 30 countries did not invest more in sustainable investments because of scarcity in information and understanding what is considered as a sustainable investment (Schroders, 2018). In December 2019, the European Parliament and the European Council reached the political agreement to establish the “Taxonomy Regulation”, a common framework for investors to define what activities can be marked as “environmentally sustainable”. This will be discussed in the following chapters.

2.2 Banking Products Regarding Sustainable Investing

Due to the increasing concern for the environmental issues, still more and more banks are integrating climate-related aspects into their core business processes and launching dedicated green products in order to satisfy expectations of their stakeholders and clients as well as to improve their brand image. (Carè, 2018). The examples of banking products regarding sustainable investing include the following.

2.2.1 Green Bonds

Green Bonds, as one of the main tools in green finance, were first issued in 2007 by the European Investment Bank labelled Climate Awareness Bond (CAB). A green bond is a fixed-

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income instrument which differs from a regular one by its label which refers to a commitment that the funds raised will be used exclusively to finance or refinance “green” assets, projects and business activities that deliver climate or environmental advantages (Green Bond Principles, 2015). It represents a loan from a private investor to governments, international banks or corporations, while commercial banks are the most active issuers among all of the financial institutions (Climate Bonds Initiative, 2017). The green market opens up a number of benefits for both issuers and investors. It encourages responsible investors to extend their investment portfolios without taking on any additional risk and in turn issuers are allowed to reach different investors and promote their environmental credentials (The World Bank, 2015, International Bank for Reconstruction and Development) and it helps issuers with improving relationships with their debt providers as well (Institute for Climate Economics, 2016).

However, since there is yet no common definition of what exactly constitutes a “green” use of proceeds, the presence of greenwashing is spreading. The term greenwashing, as a concept, refers to companies claiming that their engagement in environmental responsibility is greater than in reality with the aim of gaining advantage in terms of reputation (Bachelet, Becchetti, Manfredonia, 2019). For that reason, various voluntary guidelines, reviews and forms of certification have been established to guide the market such as Green Bond Principles promoting an integrity in the green bond market through recommending transparency and disclosure, Climate Bond which has developed Green Bond Standards, Green Bond Indices, Cicero Shades of Green and so forth. Nevertheless, these private ordering might not be fully satisfactory and therefore general forms of regulations are necessary to increase investors’

interest in this asset class. Moreover, although green bond issuance and investors’ demand for green assets has continually increased in recent years, however, the green bond market remains still really small in comparison with the overall bond market what is evident from the Figure 1 below.

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Figure 1 Share of IG green bonds in global gross issuance (in %, based on EUR data)

Source: Dealogic, 2020 (retrieved from:

https://www.ecb.europa.eu/press/key/date/2020/html/ecb.sp200717~1556b0f988.en.html)

2.2.2 Green Loans

Green loans are defined as “any type of loan instrument made available exclusively to finance or refinance, in whole or in part, new and/or existing eligible green projects” (Loan Market Association, 2018) accessible for both private persons and companies. The green projects categories, developed by the Green Loan Principles, the concept with the same purpose as the Climate Bond Principles, include renewable energy, energy efficiency, clean transportation, green building, among others. With the average maturity of over 15 years, the green loan market is on its way to grow into an essential source for financing long-term sustainable infrastructure projects (Institute of International Finance, 2019). Customer might take advantage of green loan practices due to decline of interest rates by green performance evaluation (Escarus, 2018). On the other side, banks can provide a closer examination of clients’

underlying assets and therefore to gain better view of their credit worthiness (Keown, 2017).

According to data gained from the China Banking and Insurance Regulatory Commission

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(CBIRC), the banks with a higher ratio of green loans are characterized with a lower non- performing loan (Cui, Geobey, Weber, Lin, 2018). However, this study could have been carried out due to the Chinese disposal of official definitions for green loans. The absence of the generally accepted definition of green products in the world turns out to be a huge barrier in measuring performance, tracking and comparing these products.

2.2.3 Green securitization

Securitization is a non-interest income of banks and a strategy whereby “a number of non-tradable loans or receivables with similar parameters (maturity, amount, interest) are transformed into a trust (pool)” (Mejstřík, Pečená, Teplý, 2014, p. 471) and then passed along to a separate entity known as a special purpose vehicle (SPV) which issues new securities – bonds that are sold by the issue arranger (usually a prestigious investment bank) to final investors, having no connection to the risks arising from the previous owners of the claims (Mejstřík, Pečená, Teplý, 2014). Process of securitization is illustrated in the Figure 2 below.

Securitization can be considered as “green” when “the underlying cash flows relate to low- carbon assets or where the proceeds from the deal are earmarked to invest in low-carbon assets” (Climate Bonds Initiative, 2018). The pool would commonly include assets such as mortgages on certified buildings, mortgages regarding energy efficiency upgrades, loans/leases on electric vehicles and hybrids as well as on solar and wind assets and so forth. (Climate Bonds Initiative, 2018). Green securitization unlocks the capital and allows investors better access to financing small-scale sustainability-related projects at lower cost (Kidney, Giuliani, Sonerud, 20171). However, securitization might be a potential threat for financial system what turned out to be a case in 2008 when many investors had to face hidden weaknesses of the packages of securitized securities as well as its inadequate collateral (Mejstřík, Pečená, Teplý, 2014). The need for regulation, that accompanies us throughout the thesis, is no less emerging in context of green securitization.

1 under the auspices of the Center for Climate Change Economics and Policy in collaboration with the Climate Bonds Initiative.

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Figure 2: Process of Securitization

Source: Diamond Hill, 2016 (retrieved from: https://www.diamond-hill.com/mechanics-benefits-securitization/)

2.2.4 Private Equity

Private equity industry refers to investors whose aim is to invest in various projects ranging from venture capital investments such as start-ups with significant risks but high possibility for achievement to buyout investments of mature companies (Mejstřík, Pečená, Teplý, 2014). The rationale of the investment process, briefly speaking, is that the investor acquires a stake in the firm, gets the right to manage the business and after some period of time he sells the stake acquired for a price which exceeds his investment costs and makes a profit (Mejstřík, Pečená, Teplý, 2014). As the demand for green finance increases, interest of integrating sustainable investment principles is also reflected in private equity firms within banking groups which are incorporating ESG performance indicators into monitoring of companies’ portfolios. A good example is the European Investment Bank with its Global Energy Efficiency and Renewable Energy Fund anchoring private equity funds which invest in private sector energy projects in Africa, Asia, Latin America and the Caribbean (European Investment Bank, 2016).

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2.3 Climate-related risks

Since 1988 with the establishment of the Intergovernmental Panel on Climate Change (IPCC) which first provided policymakers with regular scientific assessments on the current state of knowledge about climate change, the awareness and the importance of considering the risks arising from this concern has increased among the general public and all spheres of society and economy not excluding financial and banking sector. Unfortunately, before the second decade of this century, risks arising from climate change related to this industry had been often addressed as non-financial, affecting mainly the reputation of an institution (Oliver Wyman, 2019). A milestone in approaching this issue was the Paris Climate Agreement in 2015, signed by nearly 200 countries around the globe. Its aim to “keep the rise in global temperatures below 2°C above pre-industrial times, and to pursue efforts to limit it to 1.5°C” (UNFCCC, 2015) requires a fast but prudent transition to a low-carbon economy. It also highlights the need for making finance flow compatible with lowering greenhouse gas emissions and climate-resilient development (UNFCCC, 2015) and therefore to fill the existing gap between the current sustainable financial flows and those which are required to achieve the intended goal (Sahni, Savvas, & Ward, 2016). However, the transition poses significant uncertainty and risk exposure to the financial market. Certain industries for instance coal and gas have already started experiencing particular restrictions and such changes will be subsequently reflected in the balance sheets and operations of banks as well as various regulations and policies are being put into effort (Global Association of Risk Professionals, 2019) as part of the transition process.

First and foremost, the effects of climate change such as more droughts, stronger hurricanes, rising of sea level will most likely increase over time, translated into the language of financial institutions – causing potential disruption of economic activity and trade, lower investments and resource shortages among others (Network for Greening the Financial System, 2019) and on the other hand bringing numerous opportunities (Stern, 2008).

Generally speaking, climate-related risks arise from two primary channels 1) physical and 2) transition impacts of climate change (TCFD, 2017). Some also work with the third risk – liability2. According to Luis de Guindos (2019), the Vice-President of the European Central Bank, climate-related risks can potentially evolve into systemic for the euro area financial system, specifically if the risks are not being priced properly (de Guindos, 2019). And whereas the fundamental principle of the banking business is to manage a bank to maximize its value for shareholders under risk conditions (Mejstřík, Pečená, Teplý, 2014), it is essential to

2 for example Bank of England.

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implement this changeableness regarding climate change into bank’s risk management to

“break the tragedy of the horizon”(Carney, 2015).

2.3.1 Risk Classification

Risk can be defined as uncertainty in terms of future net returns (Mejstřík, Pečená, Teplý, 2014), including both positive and negative outcomes (Bessis, 2015). According to the source of underlying uncertainty, we distinguish between financial and non-financial risks (Mejstřík, Pečená, Teplý, 2014). Financial risks which cause loss on a bank directly are divided into credit, market and liquidity risk. Credit risk is considered as a centre of attention of the risk management in any institution due to its greatest representation among all banking risks which is around 60-80% (Mejstřík, Pečená, Teplý, 2014). It relates to the probability of the loss resulting from failure of a counterparty to fulfil its contractual obligation according to the terms under which the bank has become a creditor of the counterparty because of its inability or incapability or for some other reason. (Mejstřík, Pečená, Teplý, 2014; Joseph, 2013). Market risk is the risk of losses in on or off-balance-sheet positions arising from movement in market prices, exchange rates and interest rates. Compared to other risks, it is less difficult to quantify (Mejstřík, Pečená, Teplý, 2014; Ghosh, 2012). Liquidity risk is an uncertainty for banks emerging from the ability to meet their financial obligations as and when they arise (Mejstřík, Pečená, Teplý, 2014; Ghosh, 2012).

Secondly, non-financial risks, indirectly impacting the bank’s financial condition, consist of operational, model, settlement, legal, taxes, regulation, political, reputational risk, and other.

However, in relation to the topic, it is sufficient to define only some of the named. We can consider operational risk as the most important of this group, representing 5-30% of banking risks. Operational risk for the bank means the risk of losses which arises from the insufficient or ineffective internal processes, individuals, systems as well as from external circumstances including legal risk but excluding reputation and systematic risk (Mejstřík, Pečená, Teplý, 2014). This risk pertains to almost all bank departments – investment, credit, information technology department, treasury and so forth (Ghosh, 2012). Reputation refers to a bank’s image and goodwill in terms of its competency, operational integrity and reliability resulting from the perception of stakeholders (Zaby, Pohl, 2019). Reputation risk is a risk of damage of repute and trustworthiness as the result of mismanagement of some issues or infringement of rules of behaviour within the corporate governance (Ghosh, 2012).

Climate-related risk is not a new risk type, however being reflected to the existing risk structure (Paisley, 2019), I will give a few examples of potential manifestation of transition and

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physical risk into other mainstream risks within the classification shown above, especially into the three main ones – credit, market and operational risk as well as on the liquidity and reputation risk.

2.3.2 Climate-related transition risk

Transition risk relates to the process of transformation towards a low-carbon economy which can lead to far-reaching political, legal, technological and market changes aimed at mitigating and adapting to climate change requirements (TCFD, 2017). The transformation process results in exposure to credit risk, causing higher probability of default due to more investments in new alternative and potentially riskier technologies, drastic devaluation of carbon-based assets (Pointner, Ritzberger-Grünwald, 2019). Furthermore, depressed debtors’

earnings due to their non-alignment with the transition may cause inability to meet obligations, especially in the case of sectors such as transport, energy, agriculture (Bank of England, 2018).

Banks are being exposed to market risk in regard to climate change for various reasons. For instance, as the interest in environmental topics increases, customer behaviour undoubtedly changes which results in demand shifts and price volatility (Pointner, Ritzberger-Grünwald, 2019). Transformation process might evoke abrupt and unexpected shifts in energy costs (TCFD, 2017). Inter alia, increase in carbon tax burden causes growth in inflation expectations and therefore leads to a significant uncertainty about real interest rates. Due to booming disclosure requirements, reporting obligations and regulatory frameworks, banks’ operating costs are rising as well as their exposure to the operational risk. Since stranded assets can no longer be traded, more write-offs and capital depletion occur in financial sector (Pointner, Ritzberger-Grünwald, 2019), while public and politics exert pressure to invest in illiquid long- term green investments (Banks for International Settlements, 2019), affecting the bank’s liquidity. Shifting to a low carbon economy undoubtedly changes customer preferences and stakeholder concern and creates a stigmatization of the sector which obviously influences bank’s image. Inadequate awareness and sustainability strategy might cause harm to banks in the form of reduced demand for goods, revenue, capital availability (TCFD, 2017) along with downgrade in ratings or less employee attraction (Pointner, Ritzberger-Grünwald, 2019).

2.3.3 Climate-related physical risk

Physical risk represents potential economic and financial losses from climate-related hazards. It can be divided into acute hazards and chronic hazards. Acute physical risks are event-driven, arising from extreme climate events such as hurricanes, cyclones, droughts, or floods. Chronic physical risk is related to long-term changes in climate patterns for instance

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higher temperature, increasing sea level and changes in precipitation (TCFD, 2017). However, these risks are not futuristic but already impacting the financial system in all its strength. Global economic costs due to natural disasters have exceeded the 30-year average of USD 140 billion annually in 7 of the last 10 years (Munich Reinsurance Company, 2018).

Increase in frequency and severity of natural damages could make insurance unaffordable for most people3 or even become unavailable in certain risky areas. And therefore, in case of uninsured damage, the public has to face significant losses and its ability to repay its loans decreases as well as the value of properties. For banks it means an increase of credit risk on their loan books as both the likelihood of default and loss given default rises (Grippa, Schmittmann, Suntheim, 2019). Despite constant technical improvement, there is still particular uncertainty about the extent and intensity of natural disasters what might cause higher risk premiums for banks. Furthermore, in case of sudden outflows of capital, volatility of exchange rates might increase. (Grippa, Schmittmann, Suntheim, 2019). However scary it may sound, climate change can soon have an impact on the operational side of banks in terms of infrastructure, offices, processes and employees. Moreover, the prices of water, energy and insurance could increase which would be, in consequence, reflected in the bank’s risk management (Bank of England, 2018). Physical risk poses a liquidity threat in various ways.

Firstly, there might be a call on deposit/savings due to an increased demand for emergency rebuilding or unexpected migration after natural disasters (The First MicroFinanceBank Ltd, 2013), as well as high demand for emergency loans (Pointner, Ritzberger-Grünwald, 2019).

Although the reputation risk regarding physical risk is not so evident as in the case of transition risk, implementing physical risk into risk management might be a sign of awareness and responsibility from bank’s side.

I am of the belief that these two channels of climate-related risks should not be treated separately however seen as interconnected threats. Based on the graph (Figure 3) below, it is obvious that the higher transition risk banks are exposed to, the lower physical risk they have to face. Nevertheless, the potential risks arising from transformation process are greater in scenarios where the shift of capital and policy measures happen unexpectedly or disorderly (Network for Greening the Financial System, 2019) which means that although steps need to be taken promptly, they should be rather forethoughtful, standardised and controlled.

3 Nicolas Jeanmart, the head of personal insurance, general insurance and macroeconomics at Insurace Europe, retrieved from: https://www.theguardian.com/environment/2019/mar/21/climate-change-could-make-insurance- too-expensive-for-ordinary-people-report

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Figure 3: Transition-physical risk trade-off

Source: Finity, 2020 (retrieved from: https://www.finity.com.au/2020/01/14/how-insurance-concepts-can-help- build-support-for-managing-risk)

Another notion of risk that arises in the context of this bachelor thesis and which will be applied in the following chapter is „sustainability risk “. It is defined as „an environmental, social or governance event or condition that, if it occurs, could cause an actual or a potential material negative impact on the value of the investment arising from an adverse sustainability impact “ (Proposal for a Regulation of the European Parliament and of the Council on sustainability-related disclosures in the financial services sector, Article 2).

2.4 Regulations

Regulation in the financial markets refers to „the rules and laws firms operating in the financial industry, such as banks, credit unions, insurance companies, financial brokers and asset managers must follow. However, regulation is not just about rules– it’s also about enforcing them and supervising. The need for the regulation in the banking industry mainly arises from systemic risk, high leverage of a bank and particularly from information asymmetry, overcoming of which is considered to be the biggest problem in banking (Mejstřík, Pečená, Teplý, 2014). When it comes to regulation in terms of sustainability, the need is even more pressing since we are racing against time, uncertainty and confusion. In order to ensure sustainable growth, we must not rely on public pressure and the resulting voluntary actions of

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financial institutions. Business and financial market regulations are increasingly seen as crucial for scaling up sustainability (Wiesbrock & Sjåfjell, 2014). The Figure 4 below shows the increasing trend of policy intervention in the world. The European Union, as one of the biggest markets in the world, therefore “has the power to shape progress towards a sustainable development regime” (Ahlström, 2019) and has committed to become a global leader in sustainable finance (Norton Rose Fulbright, 2020) and regulatory frameworks. For that reason, the Europe’s steps will be further discussed.

Figure 4: Cumulative number of policy interventions per year

Source: Principles for Responsible Investment, 2019 (retrieved from: https://www.unpri.org/sustainable- markets/regulation-map)

2.4.1 The EU Action Plan on Financing Sustainable Growth

Before describing the individual regulatory proposals, it is appropriate to indicate the background that led to these initiatives. The European Commission introduced its Action Plan on Financing Sustainable Growth (the Action Plan) in March 2018 as a response to High-Level Expert Group (HLEG) on Sustainable Finance. It aims to achieve sustainable and comprehensive growth through reorienting capital flows to sustainable investments, to manage financial risks arising from climate change, natural disasters, environmental degradation and social issues as well as to support strengthening the transparency and long-termism of financial and economic activity The Action Plan announced a list of forthcoming crucial steps such as establishing an unified terminology for sustainable finance, creating standards and labels for sustainable financial products, strengthening disclosures related to sustainability, integrating sustainability into prudential requirements and explaining the responsibility of institutional investors and asset managers to ensure that they address ESG concerns in their investment

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decision-making process in an appropriate manner and become more transparent towards their clients4. Lastly, it came up with several legislative proposals – taxonomy, disclosure, benchmarks and amendments to sustainability preferences regarding MiFID II and the Insurance Distribution Directive.

2.4.2 Taxonomy Regulation

The Taxonomy Regulation5 is an official and unified EU-wide classification also called common language for “environmentally sustainable investments” and constitutes a fundamental part of the regulation package introduced by the European Union Sustainable Finance Action Plan. The EU Taxonomy, developed by a technical group, does not itself define sustainable investments but provides financial market participants with a list of activities based on performance criteria which are compatible with Europe’s involvement in achieving a carbon neutral future by 2050 and improving climate resilience. Its purpose is to clarify diversity of sustainable activities and to channel more capital towards greener businesses as well as to ensure investors that their investment is truly environmentally sustainable and not attempt at

“greenwashing” (Humphreys, 2020).

For economic activities to be qualified as environmentally sustainable, they need to meet the following requirements (Article 3)

1. The economic activity must substantially contribute to one or more of the following six particularized environmental objectives (Article 5)

1. climate change mitigation;

2. climate change adaptation;

3. the sustainable use and protection of water and marine resources;

4. the transition to a circular economy;

5. pollution prevention and control;

6. the protection and restoration of biodiversity and ecosystems.

2. It does no significant harm to any of the six objectives above.

3. It is carried out in compliance with the minimum safeguards laid down in Article 186.

4 Communication from the Commission to the European Parliament, the European Council, the Council, the European Central Bank, the European Economic and Social Committee and the Committee of the Regions Action Plan: Financing Sustainable Growth COM/2018/097 final

5 Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088 (Text with EEA relevance) PE/20/2020/INIT OJ L 198, 22.6.2020, p. 13–43

6 including the OECD Guidelines for Multinational Enterprises, the UN Guiding Principles on Business and Human Rights, etc.

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4. It complies with technical screening criteria that have been established by the Commission7. To give an example, it shall identify the most relevant potential contributions to the given environmental objective while respecting the principle of technological neutrality, considering both the short- and long-term impact of a given economic activity, specify the minimum requirements that need to be met to avoid significant harm to any of the relevant environmental objectives among others.

The Taxonomy Regulation assumes that asset managers will make use of the technical screening criteria to evaluate economic activities and to decide whether the activity meets the taxonomy criteria and then the percentage of taxonomy matching at investment and product level is aggregated (TEG, 2020). It is based on the most recent scientific and business research but at the same time responsive to changes in technology, data, science and activities (Humphreys, 2020). We can consider technical screening criteria as an "encyclopaedia" of environmentally sustainable activities (Ashurst, 2020)

In March 2020, the Technical Expert Group released the final EU Taxonomy Report giving the recommendations in regard to the design and implementation of this classification system. The report provides “guidance on how companies and financial institutions are to determine whether an economic activity substantively furthers two of the six objectives: climate change mitigation and climate change adaptation” (Huber, Zilberberg, Harshman, 2020). The report is complemented by the Technical Annex which contains a revised set of technical screening criteria that can make a significant contribution to climate change mitigation or climate change adaptation including an evaluation of significant harm to the other objectives.

The TEG recommendations are arranged around the EU’s NACE (TEG, 2020) defining economic activities on the basis of this industry classification system.

The Taxonomy was initially proposed in 2018 by the European Commission8 and reached the political agreement on the text of a proposed Regulation in December 20199, On 22 June 2020, the long-awaited regulation was published on the Official Journal of the European Union. However, it will be adopted in two phases according to the criteria. The legislation covering the first two objectives – climate change mitigation and climate change adaptation are expected to be adopted at the end of 2020 and come into force a year after that,

7 Requirements for technical screening criteria are set out in Article 19.

8Proposal for a Regulation of the European Parliament and of the Council on the establishment of a framework to facilitate sustainable investment COM/2018/353 final,

9 Regulation of the European Parliament and of the Council on the establishment of a framework to facilitate sustainable investment, and amending Regulation 2019/2088 on sustainability-related disclosures in the financial services sector (Text with EEA relevance)

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whereas the adoption of legislation regarding the remaining four objectives is scheduled with one year following distance and therefore will presumably enter into application from 1 January 202310 The Table 1 below shows the key dates regarding the taxonomy. The Taxonomy will be an underpinning base for the other legislative initiatives whose explanation follows.

2.4.3 Regulation on sustainability-related disclosures in the financial services sector

The Disclosure Regulation (2019/2088) as a part of the Action Plan strategy came into force in December 2019 and will be applied sequentially, beginning at March 202111. By requiring financial institutions to provide sustainability-related disclosures (on a “comply or explain” basis), the European Union aims to increase transparency, accuracy and scrupulosity regarding integration of sustainability risks and factors into investment decision-making and advisory processes. As a result, consumers will have better access to sustainable products in parallel with more accurate information about their background (Rogers, Richardson, 2020). It applies to a wide range of entities specified as “financial market participants” and “financial advisors. Financial market participants include fund managers, pension providers, insurance- based product providers, MiFID investment firms and credit institutions whereas financial advisors refer to financial advisers, including certain insurance intermediaries and providers of investment advice among others. A complete list of mandatory participants within the scope is available in Article 2. It excludes insurance intermediaries and investment firms offering investment advice with less than three employees as well as natural persons and self-employed persons (Article 17). The Regulation covers various disclosure obligations, which differs in the manner of publication – on the website, in periodic reports or in terms of pre-contractual documents as well as in the scope of obligations among financial market participants and financial advisors. Due to a potential disorientation in terms of perspective used, I will describe requirements in relation to the manner of publication and the extent of requirements among entities.

Website disclosures: Both financial market participants and financial advisors must disclose information about their investment policies explaining their integration of

10 Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088 (Text with EEA relevance) PE/20/2020/INIT OJ L 198, 22.6.2020, p. 13–43

11 Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability‐related disclosures in the financial services sector (Text with EEA relevance) PE/87/2019/REV/1 OJ L 317, 9.12.2019, p. 1–16

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sustainability risk into the investment decision-making process/investment or insurance advice (Article 3), as well as the information about their remuneration policies and how these policies are in line with the integration of sustainability risks (Article 5). Regarding entity-level considerations, financial market participants are required to publish their due diligence policies they apply to consider the main adverse impacts of investment decisions on “sustainability factors” (environmental, social or employee issues, human rights, anti-corruption and anti- bribery matters), or in case of not considering such impacts, they have to state the clear reasons why they do not take them into account and whether they plan to do so (Article 4). In case of financial advisors, whether they take into consideration the principal adverse impacts in their investment/insurance advice or not. If not, they have to state the reasons why along with whether and when they plan to begin considering them (Article 4). Moreover, if the financial market participants offer a product promoting “ESG characteristics” or having sustainable investing or carbon reduction as an objective (“ESG objective”), they are required (Article 9, Article 16):

− to describe the relevant ESG characteristics/objectives,

− to disclose the information on the methodologies for assessing, measuring and monitoring ESG characteristics of the product and/or the impact of the product on the ESG objective,

− to disclose the information how the ESG characteristics are met,

− where the index is designed as a reference benchmark for the ESG objective, to disclose whether and how is the index consistent with these characteristics and the source of the methodology for the index,

− where the index is designed as a reference benchmark for the ESG objective, to disclose the information about the index alignment with the objective and an explanation on how that index differ from the broad market index along with the source of the methodology for the index,

− where no index is designed as a reference benchmark for ESG objective, to explain how that objective is to be achieved.

Pre-contractual disclosures: In-scope entities have to disclose the way in which sustainability risks are integrated either into their investment decisions or their insurance/investment advice and the results of an assessment of the likely effects of sustainability risks on the return either on the financial products they make available or they advise on (Article 6). If the financial product supports ESG characteristics, how those

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characteristics are met is required to be disclosed along with whether and how any benchmark is in line with those characteristics (Article 8). Similar obligations exist in relation to financial products with ESG objectives (Article 8). This information has to be added to the disclosures already provided to the clients under sectoral legislation (e.g. the prospectus required under the UCITS Directive, MiFID II.) (Article 8).

Periodic reports. (Article 11): Where financial market participants make available financial products promoting ESG characteristics, they will need to disclose the information to which extent are those characteristics met. For those products having sustainable investment as their objective, a description has to include information about the overall sustainability impact of the financial product through relevant sustainability indicators. Where an index has been designated as a reference benchmark, the impact mentioned has to be compared with the impacts of the designated index and of a broad market index through sustainability indicators.

Nevertheless, firms are not provided with much detail about the Regulation and have to wait for the draft Regulatory Technical Standards which are about to be released by the end of 2020. It means that “there could be a very short window for firms to become compliant” (Shaw, 2020).

2.4.4 Low Carbon Benchmark Regulation

Since there is a great number of low-carbon indexes available in the market, which are being tagged and marketed likewise despite their various degrees of ambition, the EU aims to clarify these objectives in order to avoid growing concerns regarding “green washing” through a regulatory policy. The Regulation (EU) 2019/2089 also known as Low Carbon Benchmark Regulation came into force along with the Disclosure Regulation in December 2019 amending the Benchmark Regulation from 201612, which establishes uniform rules for benchmarks in the European Union, sets up three regimes based on whether one qualifies as a benchmark administrator, contributor or user and defines a benchmark as “any index by reference to which the amount payable under a financial instrument or a financial contract, or the value of a financial instrument, is determined, or an index that is used to measure the performance of an investment fund with the purpose of tracking the return of such index or of defining the asset allocation of a portfolio or of computing the performance fees” (Article 3). The Low Carbon Benchmark introduced two categories of benchmark – EU Climate Transition Benchmark and

12Regulation (EU) 2016/1011 of the European Parliament and of the Council of 8 June 2016 on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds and amending Directives 2008/48/EC and 2014/17/EU and Regulation (EU) No 596/2014 (Text with EEA relevance) OJ L 171, 29.6.2016, p. 1–65)

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EU Paris-Aligned Benchmark, which aim is to provide benchmark users with consistent understanding.

A Climate Transition Benchmark are selected, weighted or excluded so that the resulting benchmark portfolio enhances “decarbonization trajectory”. Decarbonization trajectory is defined as a “measurable, science-based and time-bound movement towards alignment with the objectives of the Paris Agreement” (Article 1).

A Paris-Aligned Benchmark, which is more ambitious than the latter, selects, weights or excludes the underlying assets to have resulting benchmark portfolio’s carbon emissions aligned with the objectives of the Paris Climate Agreement. It includes only those components which already effectively lead to the attainment of targets set out in Paris, primarily to keep the rise of temperature below 2 °C (Article 1).

Additionally, the Regulation also mandates benchmark administrators to make sustainability-related disclosures. By imposing the obligation on them to disclose significant information about the methodology used for measurement and reconciliation of ESG factors and low-carbon factors in the composition of benchmarks, the EU seeks to provide investors with accessible methods for comparative analysis of a low-carbon benchmark. The certain disclosures are mandatory for administrators of all benchmarks. The requirement to disclose information regarding the alignment with the Paris Climate Agreement pertains not solely to these benchmarks but all benchmarks except for interest rate and currency ones will be required to do so from 2022 (Article 19d).

2.4.5 Amendments: MiFID II

MiFID, the Markets in Financial Instruments Directive, which came into force in 2007 (MiFID I) is a pillar of the EU’s regulation of financial markets, which aimed to foster harmonization of their functioning, increase their competitiveness and improve protection of investors (ESMA). MiFID II, a revised version from 2018, intends to strengthen investor protection, promotes greater transparency for all participants and build up assurance in the financial industry, which might have been lacking after 2008 (ESMA).

The proposed amendments MiFID II will require financial intermediaries in Europe to implement ESG considerations and client’s preferences into their advice and suitability assessments (Katten, 2020) before providing investment advice, which goes further than simply asking clients if they have any sustainable preferences. The Taxonomy is therefore crucial for identifying client’s preferences as well as for recommending products that match those preferences.

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2.4.6 Non-Financial Reporting Directive (NFRD)

Besides those three legislative proposals mentioned above, there is also the EU Directive on Disclosure of Non-Financial Information (Directive 2015/95/EU) which has been applied since 2018. Uncovering the non-financial information of companies plays a key role in achieving transparency and coming closer to the fulfilment of the sustainable goals in Europe.

Non-Financial Reporting Directive obligates large companies with more than 500 employees including listed companies, banks, insurance companies and other ones designated by national authorities and public interest entities in Europe to disclose particular statement about their policies, risks and impacts in relation to environmental protection, social responsibility and treatment of employees, human rights, corruption and bribery, diversity within a company (in terms of age, gender, education and profession). The companies to which the regulation applies have to publish non-financial information as part of their annual reports from 201813 (European Commission). Although having been used for more than 2 years, its objectives have not been completely achieved. According to the research provided on 1000 firms, the way of reporting information is of poor quality and comparability. In case of climate change, 82 percent of companies have policies, but only 35 percent have targets and even fewer - 28 percent - report on their outcome (Alliance for Corporate Transparency, 2019). Being aware of these shortcomings, the European Commission opened for the public consultation and its subsequent review, which is currently underway, is expected to bring better comparability, transparency and consistency of information disclosed.

2.5 Voluntary Guidelines and Frameworks

Applying mandatory regulatory policies is undoubtedly an inevitable step towards achieving clarity and transparency in the financial industry as well as subsequent control over the institutions on the way to address the biggest challenge we face today. However, as discussed above, the regulations are just proposals, whose application is not immediate. Given the urgency of the situation and the need for the institutions to take sustainable action as soon as possible, I believe that voluntary sustainable guidelines and frameworks play an important role before and also after the regulations become mandatory. Voluntary sustainable guidelines can be considered as a self-regulation adopted by institutions “on their own in order to address

13 Directive 2014/95/EU of the European Parliament and of the Council of 22 October 2014 amending Directive 2013/34/EU as regards disclosure of non-financial and diversity information by certain large undertakings and groups Text with EEA relevance OJ L 330, 15.11.2014, p. 1–9

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issues around corporate sustainability “(Weber, Adeniyi, 2015). The reasons why these guidelines and frameworks are developed and adopted is among others to indicate commitment to focus on societal issues such as environment to show off the god corporate citizenship as well as to protect the reputation of an organization (Weber, Adeniyi, 2015).

One of the very first financial sustainability guidelines is The United Nations Environment Programme Finance Initiative (UNEP FI) (Weber, 2012) established in 1992 and based in Geneva, aims to „create the most effective network for sharing knowledge and best practice and to amplify the collective voice of the finance sector in policy debate, engaging policymakers, regulators and supervisors on the role of the financial sector in contributing to sustainable development“ (UNEP FI). The UNEP FI consists of more than 300 bankers, insurers and investors plus over 100 supporting institutions. The framework covers three following principles, Principles for Responsible Investment (PRI), Principles for Sustainable Insurance (PSI) and Principles for Responsible Banking (PRB). The Principles for Responsible Banking are most relevant for this thesis and deserve the attention, while the members (banks) will be empirically analysed in the following chapter. The PRB, as “a guide for the global banking industry to respond to, drive and benefit from a sustainable development economy “(Guterres, 2019). The bank members of which there are more than 180, represents one third of the banking industry. They incorporate sustainability at the strategic, portfolio and transactional levels and in all areas of business. There are six principles to be followed. Firstly, the alignment which means that the members should align their business strategies so that they are consistent with and contribute to the needs of individuals and the goals of society while being in harmony with the Sustainable Development Goals, the Paris Climate Agreement and other frameworks.

Secondly, they will intensify the positive impacts of their activities, products and services on people and environment while reducing the negative effects. The third principle is client and customer-oriented, focusing on the responsible partnership with clients and customers and on encouraging them to adopt sustainable practices and activities. The next one is based on the responsible consultation, engagement and cooperation with stakeholders to achieve society’s goals. The fifth one, governance and culture, says that their commitment to the Principles will be implemented through effective governance and a culture of responsible banking. The last one refers to the promise of transparency and accountability (UNEP FI, 2019). The progress of signatories is reviewed every year and within four years a bank must have met all requirements set out in the key steps to implementing the Principles for Responsible Banking. Besides the UNEP FI, there are many other voluntary frameworks and guidelines operating globally as well

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as locally such as The Equator Principles, Green Loan Principles, Green Bond Principles, Social Bond Principles and Global Reporting Initiative.

2.5.1 The Recommendations of the Task Force on Climate-Related Financial Disclosures

In the context of this work it is necessary to mention The Recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD) which aim to help financial-sector organizations such as banks, insurance companies, asset managers and asset owners to identify, access and better communicate their crucial climate-related information. The Task Force, consisting of 32 members from different organizations, established universally adaptable recommendations which are structured around four core elements: governance, strategy, risk management, metrics and targets. They suggest institutions to disclose the board’s oversight of climate-related risks and opportunities, strategies to address these risks including its resilience as well as taking into consideration various climate-related scenarios, further also to describe companies’ processes for identifying, assessing and managing climate related risks and their integration into the overall risk management. Regarding metrics and targets, organizations are encouraged to provide disclosures of the metrics and targets used to assess and manage risks and opportunities arising from climate change if such information is material. They recommend participants to publish these disclosures in their mainstream financial filings available to the public. The Task Force believes that with adaption of these recommendations, financial risks and opportunities will become a regular part of organizations’ processes and therefore their understanding of this issue will grow, information will be more useful in decision-making and risks and opportunities will be more accurately assessed allowing for the more efficient allocation of capital (TCFD, 2017).

2.6 Summary of regulations

The European Union Action Plan for Sustainable Finance launched in 2018 develops a range of policies which aim to support sustainable growth within Europe as well as globally.

Measures introduced include three proposals in regard to create an EU sustainable finance taxonomy, make the disclosure of information on sustainable investments and risks more transparent and to establish low-carbon benchmarks. On 18 June 2020, by adopting the Taxonomy Regulation, the EU took an important step towards clarity in language regarding sustainability. It will prevent financial market participants from greenwashing. The Taxonomy is accompanied by the Disclosure Regulation which will require financial firms and advisers to

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report on their approach towards sustainability risks and adverse sustainability impacts and disclose the sustainability-related information about their products. Low-carbon benchmarks divided into two categories – Climate Transition Benchmark and Paris-Aligned Benchmark, will help to understand the extent to which an investment can contribute to meeting the Paris Agreement. Moreover, the EU also introduced measures amending the existing regulation such as MiFID II, which I described in more detail. However, each of these measures is being applied at different times. The Figure 3 below represents their key dates. Besides that, there is also the EU Directive on Disclosure of Non-Financial Information applied since 2018 which, although not related to the EU Action Plan, fosters transparency by requiring large companies to publish information about their approach towards the sustainability.

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Figure 5: Action Plan Timeline of Relevant Dates

Source: Sustainalytics, 2020 (https://www.sustainalytics.com/esg-blog/eu-sustainable-finance-action-plan-final- taxonomy-report-published-developments/)

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2.7 Policy implications resulted from the COVID-19 crisis

In recent months, the world has been exposed to a real-life “stress-test”, probably the greatest one since World War 2 after which the society had to be completely and urgently rebuilt. The coronavirus (COVID-19), we face these days, will require renewal of similar scale which gives us an opportunity to rethink the current structure of the economy and to shape the sustainable future we want. Undoubtedly, this crisis has taught us how far-reaching damages can be caused by a lack of prevention and delayed action. Consequently, it may be much easier to imagine the drastic consequences of the climate crisis that may occur if we do not transform into a low carbon economy. Nevertheless, it is clear that the crisis “will cause a significant increase in public and private debt burden” (Schnabel, 2020). Government and corporate bond issuance are reaching record levels. The best way how to avoid the risk that the increasing debt will cause a long-term burden on society, is to shift the investments towards sustainable growth.

Responding to the crisis through bond issuance provides an opportunity to deepen the green financial market. Nevertheless, “fast progress is needed on disclosure and standardisation”

(Schnabel, 2020). And therefore, during this period, it is crucial to find a way how to avoid greenwashing tendencies and to ensure that the funds are allocated rightly and truly sustainably.

Although the prevailing policy priority of governments is to protect public health, the European Council committed to integrate the needs of the green transition in the Roadmap for Recovery from the COVID-19 pandemic (European Central Bank, 2020) what indicates that the sustainability goals will be a substantial part of the EU recovery strategy. In May, the EU Commission proposed a recovery instrument, called Next Generation EU which will put € 750 billion to prepare for a better future14. To invest money in fair and shared way, the Commission aims to cooperate with various resources for instance based on the Emissions Trading Scheme and a Carbon Border Adjustment Mechanism. In order to support green transition, the Commission seeks to provide additional funding for the Just Transition Fund and the European Agriculture Fund for Rural Development (European Commission). Moreover, the Commission states that the EU Taxonomy will guide investment throughout recovery.

Nevertheless, the transition after the pandemics requires a long-term framework and thoughtful steps in sectoral programmes. The Commission will therefore closely collaborate

14Communication from the Commission to the European Parliament, the European Council, the Council, the European Economic and Social Committee and the Committee of the Regions: Europe’s moment: Repair and Prepare for the Next Generation {SWD(2020) 98 final}.

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with the European Parliament and the Council to get done with the agreement so “the new long- term budget could start running and driving Europe’s recovery on 1 January 2021”15

15 Communication from the Commission to the European Parliament, the European Council, the Council, the European Economic and Social Committee and the Committee of the Regions: Europe’s moment: Repair and Prepare for the Next Generation {SWD(2020) 98 final}.