Lessons from Europe

29 Oct 21

The European Union needs to do more to ensure its resources are being directed to sustainable projects

FOUR YEARS AGO, together with my colleagues, I presented the European Court of Auditors’ (ECA) landscape review on energy and climate at a COP23 side event in Bonn.

When preparing for the event, we were more than once asked whether auditors had a role to play at the conference at all.

In the preparations for this year’s COP, I have noticed a change.

Supreme Audit Institutions (SAIs) have prepared for the event with confidence to demonstrate once more the important role that auditors can play in this area.

Still, when it comes to designing climate policy, or when journalists and citizens require information on whether taxpayers’ money is spent 'sustainably', it is perhaps not yet a reflex action for decision-makers to ask 'what have the auditors found?'.

However, when faced with the urgent need to mitigate and adopt, it is important to take into account the objective and independent views from auditors, not just for democratic scrutiny, but also sound financial management and effective decision-making.

The area of sustainable finance is no different and that is why the ECA carried out an audit.

The results will presented at a COP26 side event co-hosted with the European Investment Bank (EIB).

Here is a little taster.

Supporting the public sector to deliver a sustainable transition

In its role as the EU’s external auditor, the ECA aims to focus its performance audits where it can add most value.

With climate change being the key risk and challenge of our time, one of the priorities of the new ECA strategy 2021-2025 is on “climate change and the sustainable use of natural resources”.

The strategy defines sustainability as a cross-cutting issue for its work.

The audit on sustainable finance was decided before the current strategy came into force, but it is a prime example of such a cross-cutting issue.

It is not just about climate change but also affects our other priorities: the economy (namely the EU’s economic competitiveness), resilience, as well as sustainable public finances.

The EU’s spending on climate action is planned to be roughly €200bn (£170bn) each year until 2027. To achieve the 2050 net-zero emissions target, experts estimate that we need to invest almost €1trn (£0.85trn) each year in climate action – even without counting the cost of adaptation.

This already shows that public spending alone will not be enough. Private and institutional capital is needed to fill the investment gap.

Our audit therefore examined whether the European Commission has been taking the right action to redirect finance towards sustainable investments.

Our audit focused on whether the commission’s 2018 action plan on sustainable finance addressed the key issues for sustainable finance and was implemented on time.

We also looked into the role of the EIB and the EU budget’s support for sustainable investment.

Unsustainable business is still too profitable

The starting point for the audit was to ask why private finance is not flowing sufficiently into sustainable investments – most notably, what economists call 'negative externalities' and market failures.

This refers to the fact that the market does not sufficiently price in negative side effects of greenhouse gas emissions and other negative environmental and social effects of unsustainable economic activities.

As the member responsible for the audit, Ms Eva Lindström, put it, “unsustainable business is still too profitable”.

Additional barriers include the lack of sufficient transparency and disclosure on sustainable activities, the potentially higher risks and costs of financing for some sustainable investments, and the lack of clarity on sustainable investment needs and a lack of projects for investors to invest in.

These challenges had already been highlighted by the 2018 report of the high-level expert group on sustainable finance, which formed the basis for the commission’s action plan on sustainable finance.

More consistent action is needed

So what did we find?

We found that the commission’s action plan rightly focused on transparency.

The key measure of this is the EU taxonomy, with its 'do no significant harm' principle, as well as its detailed criteria to classify what is sustainable and what not.

During our audit, several new proposals and documents were published by the commission.

While this shows that much is going on in the area, auditing such a moving target was certainly challenging.

We also found that many actions, including the EU taxonomy, had suffered delays and require further steps to become applicable.

In addition, these actions have not been accompanied by measures to fully address the environmental and social cost of unsustainable economic activities.

Unless additional measures are taken to price these in, the EU’s actions on sustainable finance will not be fully effective. We therefore recommended that the commission identifies additional measures that aim to ensure the pricing of greenhouse gas emissions better reflects their environmental cost.

The commission responded in July with its Fit for 55 package. However, at the moment this is just a proposal under scrutiny and subject to negotiations with Member States in the European Council and the European Parliament.

As regards EU financial support, we found that the EIB has an important role to play in supporting sustainable investments and applying the EU taxonomy.

Between 2012 and 2021 the EIB financed nearly €200bn (£170bn) of sustainable investment. Only a small part of this can actually be audited by ECA, as our mandate is limited to what is guaranteed or financed by the EU budget.

This is why we focused our audit work on the European Fund for Strategic Investments (EFSI), which is guaranteed by the EU budget and managed by the EIB.

We found that EFSI did not focus on where sustainable investment is most needed.

Of the investment projects on climate action, only around 5% were being carried out in Central and Eastern Europe, where experts see the biggest need.

We also found that EFSI almost exclusively supported investments to mitigate climate change, with less than 4% going to adaptation projects.

While this might reflect the difficulty of getting bankable adaptation projects, the provisions of the latest Intergovernmental Panel on Climate Change (IPCC) report, or the deadly floods and fires this summer, underline the need for such projects.

Is the EU providing good practice?

In the final part of our audit, we looked at whether the EU is applying or plans to apply in its budget what it expects from the private sector.

We found that there is no consistent and binding requirement on all activities receiving EU financing to apply the 'do no significant harm' principle.

For example, this principle is not inserted in the relevant rules for the Common Agriculture Policy (CAP), an area that accounted for nearly 40% in the EU’s previous multi-annual financial framework and where emissions are not decreasing.

And while the principle is inserted into the EU’s recovery fund – the Recovery and Resilience Facility (RRF) – in practice the member states can implement this differently.

On a project level, we found that just one EU spending programme assesses individual investments against social and environmental standards comparable to those used by the EIB.

This means that insufficiently strict or differing criteria may be used to determine the environmental and social sustainability of the same activities funded by different EU programmes.

We also looked into how the EU labels its own 'green' investments.

We found that many of the criteria used for assessing and tracking the EU budget’s contribution to climate objectives are not as strict and science-based as those developed for the EU taxonomy.

The lack of consistent application of the EU taxonomy runs a risk that finance raised for the climate part of the RRF will not meet the EU taxonomy-based criteria that will apply for the EU green bond standard.

Audit as input for the decision-making process

Our recommendations are addressed to the commission and include completing the action plan; introducing additional measures to price greenhouse gas emissions; increasing efforts to generate a sustainable project pipeline; and applying the 'do no significant harm' principle and the EU taxonomy criteria consistently across the EU budget.

The report will be debated in the European Parliament and the council, who are the main stakeholders and can hold the commission to account.

I believe that COP26 will once again be a good opportunity to show what we as auditors can contribute and that we are forward-looking with our recommendations.

With more and more SAIs working in this area, we can show our added value. However, the increased activity of SAIs in the complex area of sustainability will also require new, in-depth competencies. It will be more challenging but also more interesting.

Image credit | Paddy-Mills

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  • Katherina Bryan

    is head of the private office of European Court of Auditors member Eva Lindström

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