1. Instruments

1.1. Green Bonds

Green bonds are loans issued in the market by a public or private organization to finance environmentally friendly activities. They reached $170 billion in 2018 and are expected to reach $359 billions in 2021.^[1]

The Paris agreement on climate change highlighted a desire to standardize reporting practices related to green bonds, in order to avoid greenwashing.

From a legal point of view, green bonds are not really different from traditional bonds. The promises made to investors are not always included in the contract, and not often in a binding way. Issuers of green bonds usually follow standards and principles set by private-led organisations such as the International Capital Market Association (ICMA)'s Green Bond Principles^[2] or the label of the Climate bond initiative.^[1] To date, there are no regulations requiring the borrower to specify its "green" intentions in writing, however the EU is currently developing a green bond standard which will force issuers to fund activities aligned with the EU taxonomy for sustainable activities.^[3] This standard is expected to be a voluntary standard, operating alongside other voluntary standards, with academics and practitioners raising the policymakers' awareness to the dangers of imposing it as a mandatory standard.^[4][5]

1.2. Taxonomy of Sustainable Activities

Because energy transition is a broad concept and sustainability or green can apply to many projects (renewable energy, energy efficiency, waste management, water management, public transportation, reforestation...), several taxonomies are being established to evaluate and certify "green" investments (having no or very little impact on the environment).

In 2018, the European Commission created a working group of technical experts on sustainable finance (TEG: Technical Expert Group) to define a classification of economic activities (the "taxonomy"), in order to have a robust methodology defining whether an activity or company is sustainable or not. The aim of the taxonomy is to prevent greenwashing and to help investors make greener choices.^[6] Investments are judged by six objectives: climate change mitigation, climate change adaptation, the circular economy, pollution, effect on water, and biodiversity.^[7]

The taxonomy came into force in July 2020.^[6] The taxonomy is seen as the most comprehensive and sophisticated initiative of its type; it may inspire other countries to develop their own taxonomies or may indeed become the world's 'gold standard'. However when the disclosure regime comes into effect in January 2022 there will still be huge gaps in data and it may be several years before it becomes effective.

The classifications of fossil gas and nuclear energy are controversial.^[8] The European Commission asked its Joint Research Centre to assess the environmental sustainability of nuclear. The results will be investigated for three months by two expert groups before the Commission makes a decision on the classification.^[7] Natural gas is seen by some countries as the bridge between coal and renewable energy, and those countries argue for natural gas to be considered sustainable under a set of conditions.^[9] In response, various members of the expert group that advises the European Commission threatened to step down. They stated they see inclusion of gas as a contradiction to climate science, as methane emissions from natural gas form are a significant greenhouse gas.^[8][10]

The UK is working on its own separate taxonomy.^[11]

1.3. Mandatory and Voluntary Disclosure

In 2015, the Financial Stability Board (FSB) launched the Taskforce on Climate-related Financial Disclosures (TCFD) which is led by Michael Bloomberg. The TCFD's recommendations aim to encourage companies to better disclose the climate-related risks in their business, as well as their internal governance enabling the management of these risks. In the United Kingdom, the Governor of the Bank of England, Mark Carney, has actively supported the TCFD's recommendations, and has called on several occasions for the implementation of obligations for companies in the financial sector to be transparent and to take into account financial risks in their management, notably through climate stress tests.

In France, the 2015 Energy Transition Law requires institutional investors to be transparent about their integration of Environmental, Social and Governance Criteria into their investment strategy.^[12]

Nevertheless, empirical research has shown the limited effect of disclosure policies if they remain voluntary.^[13][14]

The European Commission is currently developing new rules (the CSRD directive) which will oblige most companies in the EU to disclose environmental-related data.^[15]

1.4. Green-Supporting Factor on Capital Requirements

To encourage banks to increase green lending, commercial banks^[16] have been proposing to introduce a "Green-supporting factor" on banks' capital requirements. This proposal is currently being considered by the European Commission and the European Banking Authority.^[17] However this approach is generally being opposed by central bankers^[18] and nonprofits organisations, which propose instead the adoption of higher capital requirements for assets linked with fossil fuels ("Brown-penalizing factor").^[19]

1.5. Green Loans and Mortgages

In 2022, the European Commission and the European Banking Authority will formulate proposals on the "definition and possible supporting tools for green retail loans and green mortgages." ^[20]

The industry is proposing to establish an energy-efficient mortgage label,^[21] while consumer associations^[22] and NGOs have proposed that central banks could support the issuance of green loans (in particular loans connected with home renovation) by introducing a lower interest rates on refinancing operations such as the ECB's TLTRO programme.^[23]

1.6. Green Monetary Policy

In 2018, under the leadership of Mark Carney, Frank Elderson, and Banque de France Governor Villeroy de Galhau, eight central banks created the Network for Greening the Financial System (NGFS), a network of central banks and financial supervisors wanting to explore the potential role of central banks to accompany the energy transition. This network has nearly 80 members and a dozen observers, including the IMF and the European Central Bank.

Several policy options for greening monetary policy instruments have been explored by the NGFS:^[24]

• Green refinancing operations: central banks can adopt green conditions when banks refinance themselves from central banks, for example by granting a lower interest rate if banks issue a certain volume of loans for green projects.
• Green collateral frameworks: central banks can restrict collateral eligibility rules by excluding polluting assets, or requiring banks to mobilize a pool of asset that is aligned with net zero trajectories.
• Green quantitative easing: central banks could restrict their asset purchases programmes to green bonds.

In July 2021, under the leadership of Christine Lagarde and after pressure from NGOs, the European Central Bank announced a detailed roadmap to incorporate climate change in its policy framework.^[25] The action plan includes measures to integrate climate-risks metrics in the ECB's collateral framework and corporate bond purchase programme (CSPP). Christine Lagarde said she was also in favour of developing "green lending facilities"^[26] like the Bank of Japan^[27] and People's Bank of China.