ESG principles and their role in the transition towards a sustainable socioeconomic model

Spain European Union

The concept of “sustainable or responsible investment” might seem relatively new. However, this approach to ethical investment has been around almost since the 1960s.

ESG principles and their role in the transition towards a sustainable socioeconomic model
May 18, 2021

During and after the Vietnam War, students in the United States protested, trying to force their universities to stop investing in military companies. Since then, there has been a growing interest in ethical investments. In the late 1990s, the significant demand for these investments led to the creation of the Dow Jones Sustainability Index, i.e., the first world index including sustainability criteria. The concept of “sustainable or responsible investment” has become increasingly important, to the point that, in 2020, sustainable debt was almost at the same level as high-yield debt (544 billion dollars versus 547 billion).

Currently, investors can hardly disregard these parameters, now called ESG, revolving around the following factors: (i) “E” stands for the environmental factor; (ii) “S” stands for the social factor; and (iii) “G” stands for the corporate governance factor.

Until the 2015 Paris Agreement, sustainable or responsible investment was a rather abstract concept, with little practical impact on the financial market. This changed after the Paris Agreement was adopted at the 2015 Paris Climate Conference (COP21). The Paris Agreement was the first universal, legally binding agreement on climate change, and thus a milestone in the fight against climate change, allowing to speed up and intensify the necessary actions and investments for decarbonizing the economy.

In March 2018, within the program to meet the Paris Agreement targets, the European Commission adopted an action plan on sustainable finance falling under the European Green Deal adopted in 2019. The action plan on sustainable finance is part of the Capital Markets Union’s (CMU) efforts to strengthen the financial market’s role in meeting these targets.

Based on their importance for the current economy, below are the three most remarkable EU legislative initiatives:

  • Regulation 2020/852 on the establishment of a framework to facilitate sustainable investment (also known as the Taxonomy Regulation), providing a classification system to determine which economic activities qualify as “green” or “sustainable” (thus focusing on the environmental factor of the ESG principles);
  • Regulation 2019/2088 on sustainability-related disclosures in the financial services sector, clarifying the requirements applicable to institutional investors and fund managers regarding sustainability factors; and
  • Regulation 2019/2089 providing two new sustainable benchmarks: (i) the EU climate transition benchmark (to determine if a portfolio is on a decarbonization trajectory); and (ii) the EU Paris-aligned benchmark (to determine if a portfolio’s carbon emissions are in line with the Paris Agreement targets).

The aforesaid European Green Deal will require major investments. In particular, according to the European Investment Bank (EIB), an annual investment of EUR 528 billion is needed to meet the sustainable development goals in the European Union. We consider it necessary to bring together public and private resources to meet those targets.

Meeting the climate goals requires significant investments. Therefore, there is no doubt that private investment will play a major role in this transition. There are two major instruments that have become increasingly important over recent years and will be key in the near future to meet the climate goals: (i) “green, social and sustainability bonds,” which have increased by 50% from 2019 (with a total value of EUR 15.02 billion); and (ii) “sustainable loans,” mobilizing investments worth EUR 18 billion in Spain during 2020 (i.e., a 38% increase from 2019).

In our view, this growing trend will continue.

  • First, due to the various existing incentives for sustainable financing (e.g., green loans have subsidized interest rates based on compliance with different key performance indicators, often linked to emission, waste or training coefficients), which can be appealing both for large corporations and small and medium enterprises that want to benefit from those incentives.
  • Second, due to the ever-increasing scope of regulations requiring compliance with sustainable targets. These regulations do not only cover large multinationals and listed companies like before, but also have an impact on other companies (approximately 50,000 EU companies are subject to binding regulations related to the European Green Deal).
  • Third, because the growing demand for these financing instruments will let new players into the market, thus further diversifying the available range of products fulfilling these benchmarks and criteria.

Finally, note that the Next Generation EU plan includes a recovery package worth EUR 750 billion to implement structural transformations and reforms for the Member States’ reconstruction and economic transformation. Spain is eligible to receive up to EUR 140 billion, which will most certainly contribute to maintain this growing trend, since one of the main focuses is energy transition and sustainability.

May 18, 2021