Sustainable finance in the fight against climate change
Climate change and the destruction of the environment are among the greatest challenges of our time. This has given sustainability high priority in economic, political and social matters. ‘It is a megatrend that is here to stay,’ said Jürgen Zehetmaier, Management Board member at msg systems.
Sustainability and the associated regulatory requirements pose significant challenges for the financial and insurance sectors. Even so, there is enormous potential in sustainable investments, as an increasing number of people want to invest their money with a clear conscience in an environmentally sound way. The following blog posts examine this topic in greater detail, providing an overview of the most important European regulations while highlighting the life insurance industry’s crucial role in the transition to a climate-neutral economy. Further articles will focus on current debates, criticism and opportunities.
European Green Deal
At the end of 2019, the European Commission unveiled its European Green Deal. In accordance, the EU seeks to support the targets recognised in the Paris Agreement on climate change and the 2030 Agenda for Sustainable Development, both presented by the United Nations (UN) in 2015. In Paris, the international community committed to limit global warming to less than 2°C compared to pre-industrial levels. With the 2030 Agenda and the 17 Sustainable Development Goals (SDGs) formulated in this agreement, the UN intends to promote sustainable development on an economic, social and ecological level.
The EU’s Green Deal aims to achieve climate-neutrality and net zero emissions in Europe by 2050. Launched in 2018, the EU’s Sustainable Finance Action Plan is a cornerstone for the transition to a climate-neutral economy, putting environmental, social and corporate governance (ESG) at the heart of the financial system. Going far beyond environmental protection, the ESG approach also encompasses societal concerns, such as fair working conditions or ethical and responsible corporate governance.
In the financial sector, ESG criteria have been playing a key role in defining sustainable investments for many years now. The abbreviation ESG was coined by Ivo Knoepfel. In 2004, the Swiss financial strategist first mentioned ESG in a paper titled ‘Who Cares Wins’ for UN Global Compact, an initiative for sustainable and responsible corporate governance. The report included recommendations from the financial industry on how to better integrate environmental, social and governance issues into analysis, asset management and securities brokerage.
Channelling financial flows into sustainable investments
The EU’s Sustainable Finance Action Plan aims to make sustainable financial products transparent and comparable. It also requires the financial industry to redirect capital towards more environmentally sustainable investments. In a communication titled ‘Strategy for Financing the Transition to a Sustainable Economy’ from 6 July 2021, the European Commission stated: ‘Accordingly, environmental regulation must be complemented by a sustainable finance framework which channels finance to investment that reduces exposure to these climate and environmental risks.’
Insurance industry as a lever for sustainable transformation
This is where the insurance industry has a decisive role, because managing multi-billion-dollar investments provides the industry with an effective lever to drive the transition to a sustainable economy. The European insurance industry is Europe’s largest institutional investor, as highlighted by the Association of Insurance Companies “Insurance Europe” in its ‘European Insurance Key Facts 2020’. According to this report, the assets managed by European insurers amounted to almost 11 trillion euros in 2020.
In the same year, German insurance companies had invested a total just shy of 1.8 trillion euros on the capital markets. This corresponds to almost half of Germany’s gross domestic product of 3.4 trillion euros in 2020. According to the German Insurance Association GDV, German insurers invest new funds of around 300 billion euros each year. ‘Probably our strongest means of combating climate change and achieving further sustainability goals are investments in the insurance sector,’ said Wolfgang Weiler, president of the GDV, in March 2022.
A large proportion of the investments are made by German life insurers. At the end of 2021, life insurance (excluding pension funds) had investments amounting to around 1,032 billion euros as published in the GDV’s report on life insurance figures in June 2022.
What is a sustainable investment?
Yet, what is the true meaning of ‘sustainable’? How can green investments be defined and verified? To date, there has been a lack of common minimum standards for sustainable investments. In order to create transparency and to define common standards of comparison, the EU has developed several measures for a sustainable financial framework as part of the aforementioned Sustainable Finance Action Plan. The most important components are the Taxonomy for sustainable activities, the Sustainable Finance Disclosure Regulation (SFDR) and for brokers to consult on the sustainability of financial investments.
Standards for ecological management
The Taxonomy for sustainable activities is a classification system of economic activities that establishes a common definition of sustainability. It is also designed to address and combat greenwashing. The EU’s SFDR regulates sustainability-related disclosure obligations in the financial services sector. Furthermore, brokers will have to ask clients about their sustainability preferences. The EU also intends to develop standards and labels to help financial market participants develop sustainable investment solutions.
If you want to learn more about the EU’s Taxonomy, sustainability-related disclosure obligations and the current status of regulations, we recommend reading our next blog article titled ‘EU Taxonomy Regulation and the Sustainable Finance Disclosure Regulation: making green investments recognisable’.
