Green regulation amounts to a tide of red tape for financial services

Organisations are contending with a torrent of sustainability regulation, all aimed at directing investment to a greener economy. For the financial services sector it presents a sea of red tape.

“At European level there are many regulations, all evolving really rapidly,” says Elena Lillo, regulatory affairs executive at Ibec’s Financial Services Ireland group.

“The banking sector plays a pivotal role in allocating capital for greener initiatives and managing financial risks associated with the environment. While there has been progress in understanding climate impacts and improving governance and risk management, challenges remain, including data scarcity, methodological limitations and the need for comprehensive climate stress testing.”

Regulatory efforts are ongoing to integrate environmental risks into prudential regulations such as the EU’s Corporate Sustainability Due Diligence Directive and the Corporate Sustainability Reporting Directive.

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The latter aims to align sustainability reporting with financial reporting, while the Basel Committee on Banking Supervision, the primary global standard setter for the prudential regulation of banks, has included climate risks in its work, Lillo points out.

Then there are bank-specific approaches. “Banks are developing sustainability strategies, improving sustainability reporting and collaborating with clients to assess sustainability risks,” says Lillo.

The insurance sector is coming under the cosh too. “Sustainability risks are acknowledged to have a significant impact on insurance businesses, with potential investment losses and increased insured losses due to climate change,” Lillo explains.

The European Insurance and Occupational Pensions Authority has been assessing these risks and enhancing stress-test frameworks.

“Adapting to climate change is essential for the availability and affordability of non-life insurance products,” says Lillo. “The insurance sector is in the early stages of implementing climate-related adaptation measures.”

Solvency II, a risk-based framework which sets out the requirements applicable to insurance and reinsurance companies in the EU, is helping insurers manage sustainability risks.

Underpinning all of this activity is the European Green Deal, the EU strategy for a climate-neutral economy, which positions sustainable finance as a crucial pillar.

“Private investment is essential alongside public finance. The EU sustainable finance framework, including the EU taxonomy [for sustainable activities] and sustainability reporting standards, is among the world’s most advanced,” says Lillo.

“The EU taxonomy guides investors and companies toward sustainable transitions, supporting the decarbonisation of industries and attracting capital to emissions-reducing technologies. It recognises investments likely to align with taxonomy standards in the near future.”

There is now significant progress on this front, with many companies disclosing their taxonomy eligibility and alignment. That’s good, says Lillo, because “the EU wants to set a global standard in relation to this”.