Mandatory transition plans are the key to Europe’s competitiveness

Europe is now legally committed to reaching climate neutrality by 2050. But the European economy can’t transition to net zero if its companies do not.

This is why EU lawmakers are contemplating new legislation that would oblige all companies operating in Europe, including financial companies, to implement a transition plan and evaluate their progress towards climate goals.

In the financial industry, such mandatory transition plans would mirror the flurry of commitments made by voluntary net-zero initiatives such as the Glasgow Financial Alliance for Net Zero. These have committed trillions to climate virtue, even though their objectives are in doubt following an exodus of members.

However, mandatory transition plans would level the playing field instead of costing more to the virtuous. They would make net-zero claims credible at a time when fragmented methodologies across different alliances feed concerns around greenwashing. Moreover, they would remove the risk of “stop and start” progress (which tends to accompany voluntary initiatives) from the EU’s climate trajectory. 

The recent failure of a major net-zero voluntary initiative in the face of adverse conditions is a good indicator of the actual capacity of market forces to spontaneously overcome the tragedy of the horizon and steer our economies towards sustainability.

Obstacles to EU regulations

A new threat to Europe’s climate ambition comes from its closest economic partners. The US Treasury secretary Janet Yellen criticised the new European directive on due diligence – which looks at companies’ responsibility regarding environmental and human rights in their value chains – for its supposed extra-territoriality. This plants seeds of doubt in the EU and could result in fresh attempts to further water down ambition in a game of reciprocal regulatory dumping in which no one wins.

Will Europe bow to the lowest bidder at the expense of its hard-won and rare competitive advantage which is the readiness of its companies for greater sustainability? Or will policymakers ignore this provocation, resolutely positioning its industry for the future markets of the transition? Strategically speaking, the case for the latter is compelling.

Fragmented requirements are another danger to the future of European mandatory transition plans. Governments are responsible for reducing greenhouse gas emissions, and so need transition plans to organise the effective decarbonisation of financial companies and their financial asset portfolios.

Meanwhile, authorities in charge of financial supervision will also need transition plans to organise the reduction of institutional exposure to sustainability risk – in other words, demanding that supervised institutions anticipate the financial consequences of sustainability considerations.

Diving further into the details, one transition plan would be required for outside-in sustainability (financial materiality) and a second would be required for inside-out sustainability (impact materiality). At the moment, these two regulatory approaches co-exist on the policymaking table. The banking package and the solvency rules for insurance may include sustainability risk management transition plans, while the corporate sustainability due diligence directive may impose impact-related transition plans.

It’s crucial that both ambitions are maintained, but they should not have overlapping requirements as this risks increasing the administrative burden and creating legal uncertainty. There is still time for policymakers to harmonise these into one unique requirement, explicitly embracing the double materiality approach to ensure consistency with the rest of the EU sustainable finance regulatory framework. This is also key to the operationality and effectiveness of mandatory transition plans.

If EU lawmakers dodge the myths of market efficiency, resist the temptation of a race to the bottom, and avoid bureaucratic complexity, they can make the sustainable finance agenda the key to European competitiveness. With  early adoption of higher sustainability standards, European companies can have a competitive advantage in the emerging transition markets.

Now is not the moment to water down requirements to align with international competition. Rather, it’s time to reinforce the position of EU economic actors in the new markets.

Europe must resist the temptation of a race to the bottom by making its industries win the race to zero.