Regulating Sustainable Finance in the Dark

Abstract

Analysing the revised EU Sustainable Finance Strategy disseminated in two steps in April and July 2021, we identify as core issues of any sustainability-oriented financial regulation a lack of data on profitability of sustainable investments, a lack of broadly acknowledged theoretical insights (typically laid down in standard models) into the co-relation and causation of sustainability factors with financial data, and a lack of a consistent application of recently adopted rules and standards. The three factors together hinder as of now a rational, calculated approach to allocating funds with a view to sustainability which we usually associate with ‘finance’.

These deficiencies will be addressed once (1) the EU’s sustainability taxonomy is implemented by most issuers of financial products, (2) several years of taxonomy-based reporting by issuers and originators of financial products is made available, and (3) these data have been used for validating emerging new sustainable finance benchmarks and models for investment and risk management. Until that day (which we expect to be at least five years from now), relying on Roberta Romano’s famous adage, regulators seeking to further sustainability by legal means, effectively ‘regulate in the dark.’

In order to avoid undesirable and unforeseeable effects of regulation, we argue against any regulation addressing capital requirements, mandating sustainability risk modelling or the inclusion of sustainability factors in investment or remuneration policies. Adopting such rules in the current premature state risks that Europe will not be able to rely on the capital markets to finance the sustainability transformation as planned.

Instead, regulators should focus on enhancing expertise on the side of intermediaries and supervisors alike. In particular, regulators shall introduce smart regulation tools, such as sandboxes, innovation hubs, and waiver programmes benefiting early adopters of sustainable finance modelling/models, utilizing approaches developed in other fields of experimental financial regulation (in particular Fintech and RegTech).

Keywords: Sustainable Finance, Financial Regulation, Sustainable Finance Strategy 2021, EU Green Deal, FinTech