The Current Column

Socio-ecological transformation

Sustainable financial market policy against the headwinds

Hilbrich, Sören
The Current Column (2025)

Bonn: German Institute of Development and Sustainability (IDOS), The Current Column of 12 February 2025

Bonn, 12 February 2025. Over the past 10 years or so, many initiatives have emerged to align financial markets more closely with sustainability goals. Now, there has been a strong countermovement for some time. But financial markets play a crucial role in the transformation of the real economy. At the same time, the climate catastrophe increases the risks to financial market stability. A profound transformation of the financial sector is therefore more urgent than ever. Regulations aimed at channelling capital into sustainable economic investment should therefore be progressively developed rather than them being weakened or even abolished.

The resistance to sustainable finance initiatives is evident, for example, in the anti-ESG (Environmental, Social, Governance) laws passed by many US states. These laws are intended to make it more difficult or even impossible for institutional investors to take sustainability criteria into account in their investment decisions. In addition, in early obedience to the new Trump administration, many US financial actors left the Net Zero Banking Alliance (NZBA) and the Net Zero Asset Managers Initiative (NZAMI), in which they had previously committed themselves to climate targets. It is also likely that the Trump administration will withdraw sustainable finance regulations. For example, the U.S. Securities and Exchange Commission (SEC) had planned to require companies to release their greenhouse gas emissions and other climate-related information. This will probably not happen now.

But the backlash against sustainable finance measures goes beyond the US. Scepticism is also growing in the EU, under the buzzword of reducing bureaucracy. The German government is now asking the EU Commission to postpone or suspend certain reporting obligations on sustainability aspects. However, reporting obligations for companies and financial market actors are a prerequisite for investors to have the necessary information to be able to redirect capital flows into more sustainable activities. In order to create more transparency, many countries have developed so-called sustainable finance taxonomies in recent years, for example. These classification systems define which economic activities are considered sustainable. As our research on the South African sustainable finance taxonomy shows, there is a risk that the introduction of such taxonomies will be hampered if they are not combined with mandatory reporting. In addition, many private actors have now adapted to the new rules and built up capacities to implement them. Even a number of companies are therefore opposed to efforts to roll back regulations.

During the limited window of opportunity for progressive environmental policy in the last legislative period, a whole series of regulations emerged in the EU within a short period of time. It is true that not all rules serve their purpose. For example, the specific design of the green asset ratio is repeatedly criticised. With this key figure, banks must indicate the proportion of their assets that are considered sustainable according to the EU taxonomy. Also, not all of the criteria of the taxonomy are meaningful and sufficiently clearly formulated. Some classifications, such as the classification of electricity generation from gas or nuclear power as sustainable (under certain conditions), reflect vested interests in a problematic way. In this respect, there is much to be said in favour of the further development of these regulations, as the EU Commission is currently planning as part of a so-called "omnibus package". However, this must entail increasing the coherence and user-friendliness of the regulations, rather than weakening them or even abolishing them again.

There are currently a large number of national and regional frameworks worldwide that need to be better coordinated. Mutual recognition of regulations can be a means of avoiding multiple reporting obligations for transnational actors and reducing transaction costs. In addition, it is important to ultimately go beyond transparency initiatives, and to modify incentives in the financial markets. This could be achieved, for example, through a different level of capital gains tax for sustainable and non-sustainable investments. Credit guidance policies, such as sustainable bank lending targets, could also modify incentives. In addition, many financial market actors need to set out in transition plans how they aim to achieve sustainability goals. These plans could, for example, be taken into account in financial market supervision in order to assess climate-related risks for financial market actors.

Hence much remains to be done to transform the financial sector from a drag into a driver of sustainability transformation. Anyone who is serious about the socio-ecological transformation must therefore decisively oppose the described headwinds, and advocate more sustainability on the financial markets. Cutting red tape and implementing competition policies must not lead to the abandonment of sustainability goals.