Written by Liselotte Jensen and Stefano Spinaci.
|This paper is one of 11 policy responses set out in a new EPRS study which looks first at 15 risks facing the European Union, in the changed context of a world coming out of the coronavirus crisis, but one in which a war has been launched just outside the Union’s borders. The study then looks in greater detail at 11 policy responses the EU could take to address the risks outlined and to strengthen the Union’s resilience to them. It continues a series launched in spring 2020, which sought to identify means to strengthen the European Union’s long-term resilience in the context of recovery from the coronavirus crisis. Read the full study here.|
The issue in short: The challenge and the existing gaps
Human-induced climate change is happening, and the impacts are being felt around the globe. As presented in the risk section above, global warming is increasing the frequency and intensity of extreme weather events and altering standard seasonal climatic conditions in some regions. This results in multiple threats to people, property and society overall.
With current projections, the agreed goal of the universal Paris Agreement to limit global warming to well below 2, preferably to 1.5 degrees Celsius (˚C) compared with pre-industrial levels, will be missed. The difference between 1.5 ˚C and 2 ˚C is significant as it pertains to the threat of climate change impacts. An overshoot of the 2 ˚C goal is likely to result in long-lasting and irreversible risks, including loss of ecosystems and potentially tipping point events leading to a significant change in the world’s physical climate system.
In the sixth assessment report (2021) of the Intergovernmental Panel on Climate Change (IPCC), five emission scenarios are presented along with their associated warming projections over time. Only the low or very low emission scenarios are considered capable of keeping global warming within the 2 ˚C goal. All scenarios are expected to overshoot the 1.5 ˚C ambition in the 2041-2060 period. It is important to note that for the very low emission scenario, the overshoot is expected to be minimal and temporary, with global warming reverting below 1.5 ˚C towards the end of this century.
Considering the potential cascading effects on people, the economy and societal systems from changing climatic conditions and volatile climate phenomena, as presented in the risk scenarios on page 25, and supported by the February 2022 IPCC report on impacts, adaptation and vulnerability, the EU must ensure policy responses suitable for the challenges ahead.
Policy responses need to mitigate the root cause of the increased risks – climate change – and at the same time build resilience and preparedness at all levels of society, thereby reducing vulnerabilities.
The EU is a frontrunner when it comes to climate action and is increasingly stepping up its efforts in the field of sustainable finance; on both accounts, international cooperation is however crucial. In an interconnected global system of different players and agendas, driving forward a transition while attempting to build resilience to systemic risks is an ever-evolving challenge. The scale of the task to increase overall systemic resilience becomes evident when reading also the chapters on ‘greater strategic autonomy for European industry‘ and ‘consolidating strategic ties with democracies‘.
The turn of events currently witnessed with Russia’s 2022 invasion of Ukraine leaves the EU at a critical junction. The security risk associated with EU’s dependence on Russian energy sources has become all too evident. Many call for an immediate stop of energy imports from Russia, but how fast is it feasible to divert into other sources, and what will they be?
In a world where inaction and prolonged policy processes on climate change have been environmentalists’ main critique for years, will this sudden push to change Europe’s energy dependence fuel a green transition, or undermine it?
Existing policy responses
The types of risks that policy responses need to address can be divided into three groups: first, the physical risks connected to loss of life or property because of extreme weather events; second, the transition risk to the value held in various types of assets in an economy under transformation; and third, potential systemic risks to the economic and financial systems. As seen in the extreme weather events scenarios, physical risks can induce further transition risks and accumulate impacts that can ultimately pose a threat at the systemic level.
Climate action is established in Article 191 of the Treaty on the Functioning of the European Union (TFEU) as one of the objectives of EU environment policy. The EU and its Member States are signatories to the 2015 Paris Agreement, and major parts of the EU climate and energy legislative framework towards 2030 were revised between 2015 and 2018. As part of the European Green Deal (EGD), the EU Climate Law was adopted in July 2021, setting a new 2030 target on emissions reduction, and making climate neutrality by 2050 legally binding.
To align the climate and energy acquis to the now binding ‘at least’ net 55 % emissions reduction by 2030 compared with 1990 levels, the European Commission put forward 18 legislative proposals in its ‘fit for 55‘ package in July and December 2021. The package includes, among other things, proposals to raise 2030 renewable energy as well as energy efficiency targets across the EU, to which the co-legislators – the European Parliament and Member States through the Council – would need to agree.
In terms of mitigating climate change, the EU Climate Law Article 4 further obliges the Commission to propose in a legislative initiative, following the global stocktake on climate action planned to finalise in 2023 (see below), a binding emission-reduction target for 2040. The proposal must be accompanied by a carbon budget report indicating the total volume of net greenhouse gas (GHG) emissions expected to be emitted in the 2030-2050 period, without jeopardising European commitments in the Paris Agreement.
The climate challenge poses risks to both natural and human systems at varying levels. Natural hazards mainly pose physical risks to people’s health and security as well as to property and assets. Civil protection cooperation is enshrined in TFEU Article 196 and the solidarity clause in Article 222, under which the Union and its Member States act in a spirit of solidarity if a Member State is the victim of a disaster. The EU’s civil protection mechanism (UCPM) is a key part of Europe’s efforts in disaster preparedness and response. The Copernicus Emergency Management Service lends support, via satellite imagery and geospatial data, to civil protection interventions. Recently the Council concluded that disaster preparedness and prevention measures needed to be strengthened in view of the threat of increased extreme events due to climate change.
Increasing the resilience of the EU’s economy and society to climate change requires large investments and improved risk management. This in turn demands a financial system resilient to climate change impacts. The EU has taken significant action in the field of green and sustainable finance. Before the 2020 European Green Deal investment plan, the 2018 action plan on financing sustainable growth, integrated by the 2021 strategy for financing the transition to a sustainable economy, laid down the foundations of the EU sustainable finance framework. The framework is based on three building blocks: the EU taxonomy; disclosures; and a toolbox including benchmarks, standards and labels.
The July 2020 EU Taxonomy Regulation, is the centrepiece of the EU sustainable finance architecture; its classification system helps to both channel investment into climate action, and guide the integration of climate risks into the management of financial institutions such as banks, insurance companies and pension funds. It plays a pivotal role for legislative and non-legislative initiatives in areas such as labelling, disclosures and prudential rules. The EU taxonomy is established through delegated acts, determining which activities should be considered as sustainable and contributing to the fight against climate change, and be reported as such. The European Parliament is currently scrutinising a delegated act in which the Commission proposes to consider as eligible certain activities in the nuclear and gas sectors.
EU regulatory and non-regulatory initiatives on disclosures aim to improve transparency on risk factors, including climate risks and their effects on financial stability. In this domain, the Sustainable Finance Disclosure Regulation came into effect in March 2021, while the Corporate Sustainability Reporting Directive (CSRD), presented by the Commission in April 2021, is at an advanced stage of negotiations between the co-legislators. In the meantime, sustainability reporting is regulated by the Non-financial Reporting Directive, which entered into force in December 2014, supported by the guidelines on reporting climate-related information, published in June 2019. In the toolbox, the EU Climate Benchmarks Regulation has applied since April 2020, and the July 2021 proposal on an EU green bond standard is with the co-legislators. Both aim to ease the development of sustainable investments, while preventing greenwashing.
EU action to improve the financial sector’s resilience to climate risks also includes the review of EU banking rules (the Capital Requirements Regulation (CRR) and Directive (CRD IV)), and the review of the EU insurance rules (the Solvency II review), both proposed by the Commission in autumn 2021. The Commission proposals, currently examined by the co-legislators, ask banks and insurance companies to systematically identify, disclose and manage sustainability risks, i.e. environmental, social and governance (ESG) risks, as part of their risk management. While larger EU insurers have already had to conduct climate scenario and stress tests, the new proposal is set to embed climate risk analysis in most insurers. In April 2021, the Commission amended existing delegated regulations under Solvency II and the Insurance Distribution Directive to ensure integration of sustainability factors and risks in (re-)insurance undertaking’s management, products and services.
In the banking sector, the European Central Bank (ECB) is increasingly considering climate change in its activities of banking supervision and monetary policy. After publishing a guide on climate-related and environmental risks for banks in November 2020, and the state of climate and environmental risk management in the banking sector in November 2021, the ECB launched in January 2022 a supervisory climate risk stress test to assess how prepared banks are for dealing with financial and economic shocks stemming from climate risk. In July 2021, the ECB presented its action plan to include climate change considerations in its monetary policy strategy, which should deliver macroeconomic modelling and assessment of implications for monetary policy transmission, and statistical data for climate change risk analyses.
Given the key role played by the insurance sector for financial stability and resilience to climate risks, the European Insurance and Occupational Pensions Authority (EIOPA) has made sustainable finance a strategic priority in its 2022-2024 work-programme. Its aim is to increase the insurance sector’s climate resilience by acting in key areas of activity: prudential framework, risk assessment, disclosures, supervision, climate protection gap, use of open source modelling and data, and international convergence. In addition, EIOPA will conduct centralised climate stress tests in the (re‑)insurance sector, as tasked by the Commission.
National level initiatives
In the EU, several Member States had adopted national climate laws before the adoption of the EU Climate Law. Some have set higher 2030 targets or aim to reach climate neutrality sooner than 2050.
Member States and the sub-national levels play a key role in building resilience to climate change impacts, whether it concerns urban planning, public expenditure, construction and industrial permissions, nature conservation, or disaster preparedness and response capacities and training. To foresee risks and ensure resilience adequately requires know-how and the latest data on risk assessments, considering future climate projections. In the EU, Member States and institutions share these kinds of insights on the Climate-ADAPT platform and collaborate through the UCPM’s knowledge network and joint exercises to support national-level preparedness. Research and innovation for resilient cities and implementation of nature-based solutions often occur at national and sub-national levels, while key climate partnerships in various sectors are driven by countries in which the sectors are most prevalent. Russia’s war on Ukraine has highlighted the vulnerability of the EU’s energy supply dependency on Russia, with Denmark being the first Member State to announce its ambition to phase out Russian gas supply completely as soon as possible. On 8 March 2022, the Commission adopted the RePowerEU communication presenting the aim to wean Europe off Russian gas. It includes measures to be implemented at the national and citizen levels, such as energy savings, rooftop solar panels, and heat pump installation. Accelerating renewables, in particular hydrogen for industry, and strengthening the internal energy market interconnections while increasing gas storage are other key measures. The national level will play a pivotal role, as under TFEU Article 194(2), Member States have the right to decide on their own energy mix and supply structures, which only unanimity among Member States in the Council can affect (Article 192(2c)). Key projects would not only include accelerated renewables roll-out, but also seek to increase resilience through cross-border connections, such as from the Iberian peninsula to the continent, or gas pipeline connections for example to Poland.
EU action with external partners/international organisations
The United Nations Framework Convention on Climate Change (UNFCCC) was established in 1992 to prevent dangerous climate change. Continued climate negotiations have so far not been successful in halting global GHG emissions or the associated global warming. The 2015 universal Paris Agreement – with its specific targets to limit global warming, and sections on mitigation, adaptation, and financial support and mechanisms to support the work – was a breakthrough in UNFCCC negotiations. However, only at the 26th Conference of Parties (COP26) to the UNFCCC, held in Glasgow in November 2021, was the Paris rulebook for implementation finalised.
The EU has taken significant steps to influence the transition not only internally but also externally, and actively negotiates for increased climate ambitions globally. The February 2022 Council conclusions called on EU climate diplomacy to support third countries in developing carbon markets and further step up its work to turn intentions into implementation through green partnerships and alliances. The Council repeated the EU’s intention to provide further climate finance, including through the Global Gateway initiative, to build resilience and stability in vulnerable third countries, urging partners to contribute.
Against the backdrop of the latest IPCC warnings, COP26 in the Glasgow Climate Pact named this decade the ‘critical decade’ during which accelerated action must be ensured. Under Article 14 of the Paris Agreement, a first global stocktake will be undertaken in 2023 to assess collective progress to achieving the agreement’s purpose and deliver on its targets.
In October 2019, the EU and seven third countries launched the International Platform on Sustainable Finance (IPSF) with the aim to exchange best practices, compare initiatives and enhance international cooperation. Together, the current 18 IPSF members represent 55 % of GHG emissions and global gross domestic product (GDP), and 50 % of the world population. The EU is also present in the Network for Greening the Financial System (NGFS), a group of more than 100 central banks and supervisors worldwide working to share best practices on climate risk management in the financial sector. EIOPA is also member of the International Association of Insurance Supervisors (IAIS), and of the Sustainable Insurance Forum (SIF), international networks of insurance supervisors and regulators working to integrate climate risks into their activities and into the insurance sector.
Obstacles to implementation
Geopolitical events can reframe the assessment of risks and their impacts, and may thus significantly redirect certain policies. Russia’s invasion of Ukraine has led to the RePowerEU communication, which aims to accelerate renewables, but will also heavily invest in energy security measures (see Chapter 18 on energy security). This risks further lock-ins to new gas supplies or investment to increase new pipeline capacities, or postponement of coal’s phase out, potentially creating further lock-ins, ultimately slowing the green transition. EU leaders and co-legislators will need to balance the desire to cut energy dependence from Russia with the risk of undermining the business case for future energy autonomy through renewables.
Furthermore, climate change’s threat to global food security is exacerbated by the war between two countries that together supply 29 % of global wheat exports. Disrupted food and fertiliser supply chains could weaken the environmental integrity of the expected EU taxonomy delegated act on agriculture because of food security concerns raised, while other world events could affect future delegated acts.
The EU has been a consistent actor on mitigating climate change, delivering well beyond its 20 % GHG emissions-reduction target for 2020 compared with 1990. The efficacy of the Union’s climate policies internally may however weaken its climate-diplomacy position externally. Over the past 30-year period, the EU has gone from a 15 % share of global emissions to around 8 % in 2018. Only significant global action will change the current global warming trajectory.
The EU’s share of global emissions is production-based; this does not take import-related emissions from trade into account. The need to address also consumption-based emissions becomes evident when looking at the difference in emissions reduction achieved depending on the variable chosen. Beyond the multilateral level in the UNFCCC, the EU has taken steps through its trade agreements, but also in legislative proposals such as the ‘fit for 55’ package, the carbon border adjustment mechanism (CBAM), and the proposal to limit EU-driven deforestation so as to address the overseas emissions and negative climate impacts of trade to the EU.
Energy-related investments, including transport, will need an estimated additional annual € 350 billion to meet the EU’s 2030 emission-reduction target, alongside the €130 billion needed for other environmental goals. These amounts are too big to be covered by public funding; a flow of private capital is needed to close the gap. The EU has taken significant action to facilitate this, and it is considered a global leader in mainstreaming climate factors in the financial system, thanks also to innovative sustainable finance regulations. The future success of the EU in this field will depend to a great extent on the EU taxonomy’s fate. Any possible obstacle to its development can jeopardise the implementation of many other sustainable finance instruments, strictly dependent on its pivotal role. As the European Court of Auditors has noted, the effectiveness of the EU taxonomy and labelling schemes will largely depend on their voluntary take-up, and whether their credibility is backed up by adequate verification. This may prove challenging given the number and complexity of taxonomy criteria. Competing taxonomies or other jurisdiction standards pose a risk to the EU taxonomy’s impact on global investment trends. In this, the taxonomy’s complex structure, and the need to update it continuously according to the scientific and technological evolution, could affect its usability and become its Achilles’ heel. Other challenges could come from the need to ensure alignment with sectoral regulations, and from the risk of greenwashing or potentially pursuing other policy objectives.
|In focus: The role of data in climate-proofing|
Data are crucial to improve climate resilience and crisis preparedness, as they enable better accuracy of climate risk assessment, forecasting and modelling, and are key to early warning systems. Some datasets provide insights on extreme climate events, shedding light on direct and indirect causes, behavioural trends and consequences, such as loss of life, damage to infrastructure, and costs of emergency response and recovery. Others can help analyse the protection gap by measuring hazard (intensity and frequency of events), exposure (assets that are present at the location involved), vulnerability (susceptibility of the objects to the impact) and insurance coverage.
The 2021 EU climate adaptation strategy announced a series of initiatives to collect more and better climate intelligence data, and to make them available to policy-makers, supervisory authorities, and financial and economic actors (including citizens). The aim is to make any new investment and policy decision climate-informed and future-proof. Among other things, the Commission will extend the scope of public access to environmental information in the INSPIRE Directive to include climate-related risk and losses data. It will promote and support the use of its risk data hub to harmonise data recording and collection, and promote national-level public-private partnership.
Insurance companies have been collecting data and developing risk-zoning mapping systems for decades, and so the Commission has tasked EIOPA with exploring – alongside the industry – how best to improve the collection of uniform and comprehensive insured loss data, not least through its catastrophe risk expert network. EIOPA aims to provide open access through a data hub for the European level.
Digitalisation and technological innovation, such as big data, artificial intelligence, machine learning, high-performance computing, geospatial mapping and the internet of things, can help to enrich the variety and quality of data available and their analysis, including through capturing and developing continuous data flows and information. The Commission is delivering on this by means of initiatives under its priority ‘A Europe fit for the digital age‘ and through financing research projects, as for example on climate intelligence. Among others, the EU data act, which the Commission proposed in February 2022, aims to provide means for public-sector bodies to access and use data held by the private sector that are necessary for specific public-interest purposes, for instance to develop insights with a view to responding quickly and securely to a public emergency.
Policy proposals by experts and stakeholders
To build resilience against ‘green swan’ events as presented in the risk paper on page 26, Finance Watch proposes to use the Prudential Regulation’s pillar I – capital requirements with regard to capital reserves as the most effective tool among the three prudential pillars. More specifically, Finance Watch proposes to increase the risk weight for exposures to fossil fuels both in the banking (CRR II) and the insurance sectors (Solvency II). Finance Watch asks the Commission to promote the adoption of similar prudential requirements globally, as well.
When it comes to addressing the protection gap in the insurance sector, Insurance Europe considers it necessary to make tackling under-insurance of natural climate risks a priority for Member States. Insurance Europe suggests establishing more public-private partnerships to share insights, and having Member States actively promote insurance as a way to providing cover for natural perils.
A 2021 collaboration between Carnegie Europe and the Open Society European Policy Institute produced an in-depth report on EU climate security in a global world, exploring how the EGD’s multiple strands should link more directly with EU external action to deliver on the EU’s commitment to be a stronger geopolitical player. The report identifies various shortcoming in the EU’s approach to climate security and climate action through its external relations, and proposes ecological diplomacy adjustments in four areas, ultimately referring to the need for – and the EU’s responsibility in – bringing this about and resetting the global architecture for international cooperation.
The combined threat to food security from climate change and the war in Ukraine have led Copa-Cogeca to suggest crop cultivation on all available land as part of an EU food shield. The aim is to prevent disruptions in the food supply chain, although this would likely undermine carbon sequestration, while the increased production would increase GHG emissions from agriculture. On 23 March 2022, the Commission decided to derogate from greening obligations temporarily and allow for food crop production on fallow land that is part of the 2022 ecological focus areas.
Position of the European Parliament
The European Parliament has spoken out on the need to fight and contain the threat of global warming before it is too late. Across various resolutions, the Parliament has consistently highlighted the need for strong climate diplomacy, calling for increased global ambitions faced with the ongoing climate and environment emergency. As co-legislator, the European Parliament will have a key role in ensuring a legal framework fit to deliver the climate targets set in the Climate Law, and build resilience through other related files from the EGD. In its 2018 resolution on the Commission action plan on sustainable finance, the Parliament agreed on the financial sector’s essential role as regards sustainability, and on the need for policies to correct market failures. It pointed out that the inaccurate assessment or misleading presentation of climate and other environmental risks of financial products can constitute a risk to market stability. The Parliament also emphasised that the identification, management and disclosure of these risks are an integral part of consumer protection and financial stability, and should therefore fall under the mandate and supervisory duties of the European supervisory authorities. In its climate diplomacy resolution, the Parliament said it was ‘convinced that an EU financial system which contributes to climate mitigation and incentivises investments in clean technologies and sustainable solutions will be a role model for other countries and could help them to implement similar systems’.
Through a legislative own-initiative resolution adopted in October 2020, the European Parliament called on the Commission to propose an EU legal framework to halt and reverse EU-driven global deforestation. The legislative proposal has in the meantime been tabled, as mentioned above, and contains several of Parliament’s recommendations. In March 2021, the Parliament adopted an own-initiative resolution on the CBAM, ahead of the Commission proposal. Parliament stressed the role of the CBAM in helping to reach climate objectives and finance the delivery of EGD ambitions.