Green Financial Products in the EU – A Critical Review of the Status Quo

The ﬁ nancial sector plays an important role in supporting the green transformation of the European economy. A critical assessment of the current regulatory framework for sustainable ﬁ nance in Europe leads to ambiguous results. Although the level of transparency on environmental, social and governance aspects of ﬁ nancial products has improved signiﬁ cantly, it is questionable whether the complex, mainly disclosure-oriented architecture is suffi cient to mobilise more private capital into sustainable investments. It should be discussed whether a minimum taxonomy ratio or Green Asset Ratio has to be fulﬁ lled to market a ﬁ nancial product as “green”. Furthermore, because of the high complexity of the regulation, it could be helpful for private investors to establish a simpliﬁ ed green rating, based on the taxonomy ratio, to facilitate the selection of green ﬁ nancial products.

The EU has developed a Sustainable Finance Strategy to enhance transparency for investors, avoid greenwashing and channel more capital into sustainable economic activities. The European Action Plan on Sustainable Finance (European Commission, 2018), which has been refi ned through the Renewed Sustainable Finance Strategy (European Commission, 2021a) and amended by the "April package" in 2021 (European Commission, 2021b), provides the regulatory framework for sustainable fi nance in the EU.
This paper provides a detailed analysis on the conditions fi nancial products have to meet in order to be classifi ed as sustainable as well as the disclosure requirements for such products. It is suggested that a simplifi ed "green rating" based on the taxonomy ratio could be useful in terms of avoiding greenwashing and fostering additional capital fl ows into green investments.

Economic rationale for sustainable corporate fi nance
In general, sustainable fi nance refers to the process of taking environmental, social and governance (ESG) considerations into account when making investment decisions in the fi nancial sector. This paper defi nes green fi nance as a subset of sustainable fi nance, i.e. the fi nancing of investments that contribute to the attainment of one or more environmental objectives, which include climate change mitigation and adaptation (Berrou et al., 2019;Brühl, 2021;Brühl, 2020;Hong et al., 2020;European Commission, 2017).
Initiatives to generate more capital for ESG investments implicitly rest upon the assumption that investors prefer fi nancial products with a given fi nancial risk-return profi le that perform better on ESG criteria. Financial products could directly fi nance specifi c investment projects to achieve certain sustainability objectives, or they could provide general fi nancing to companies whose business profi le meets certain sustainability characteristics. In either case, it is essential for investors that fi nancial market participants disclose reliable and transparent information about the sustainability characteristics and impacts of fi nancial products they off er. This will improve both the comparability of investment products and the information basis for portfolio decisions. Moreover, information asymmetries among fi nancial market participants, advisors and investors will be reduced.
ESG investment products have been marketed for many years by large asset managers and investment fi rms, as demand for ESG products is on the rise. Several institutional investors have excluded problematic sectors from their investment universe if they are associated with major environmental hazards or if they do not comply with fundamental principles of good corporate governance (e.g. anti-corruption, anti-money laundering). The same applies to important social aspects such as the respect Climate Policy for human rights and the assurance of fair labour conditions. Overall, investment fi rms today are tending to put more pressure on the fi rms they invest in to actively address ESG risks due to the increased sensitivity of end investors. Rating agencies specialising in developing ESG risk scores and profi les already play an important role in marketing fi nancial products that claim to be sustainable. Based on complex scoring methods, they include many diff erent ESG factors and condense them into an ESG rating. If ESG ratings reach a level of market relevance and acceptance comparable to credit ratings, such scores could become a key performance indicator (KPI) for capital market-oriented companies. Hence, fi nancing costs for sustainable investments may decrease if investors are willing to pay a premium for green securities (e.g. green bonds) with a given risk-return profi le. However, there is so far no clear empirical evidence as to whether such a "greenium" can be observed (Deutsche Bundesbank, 2021).
Companies operating in a business with a high ESG risk score may have to pay a higher spread in fi nancing transactions or -in extreme cases -might fi nd it very diffi cult or even impossible to fi nance their business at all. Furthermore, companies with a poor ESG rating could face negative impacts on their company valuations due to higher costs of capital. Such impacts could create incentives for the management team to adjust their business model and incorporate ESG aspects into their corporate strategy. Whether such an eff ect materialises depends, inter alia, on investor preferences, i.e. whether investors are willing to sacrifi ce fi nancial return for improved ESG compliance or vice versa. Clearly, there is not always a trade-off between the ESG score and the fi nancial performance. This could be the case in industries where heavy investments in new technologies are needed to transform greenhouse gas (GHG) intensive industries such as steel, aluminium or cement production. On the other hand, there are several examples in sectors such as renewable energy or green tech where a high degree of sustainability can go along with strong fi nancial performance.
However, due to the lack of a consistent regulatory framework ensuring a high level of transparency and data quality, cases of "greenwashing" have been detected in the recent past. For instance, fi nancial products have been positioned as sustainable, yet a closer inspection of the investment portfolio revealed that they fulfi l only some sustainability criteria, while they simultaneously cause negative impacts on other sustainability objectives. Transparency of the sustainability of economic activities is an essential precondition for equity and debt investors as well as investors in portfolio-based fi nancial products such as mutual funds or exchange-traded funds (ETFs) to make informed investment decisions. Conversely, a lack of transparency, com-parability and data reliability may lead to unintended consequences of investor decisions, potentially even harming sustainability objectives. The meaningfulness of ESG ratings may also be negatively aff ected.
In order to mobilise the capital necessary for the green transformation, sustainability objectives must be clearly formulated. Furthermore, detailed ESG criteria need to be established according to which economic activities to be fi nanced through the fi nancial product can be classifi ed as sustainable. Such a classifi cation system (taxonomy), including science-based indicators and metrics, provides the basis for characterising fi nancial products as being more or less sustainable with regard to one or more ESG criteria.
However, there is usually no direct relationship between the sources of capital and the business activities for which the fi nancing is used. A direct link between sources and uses of funds can only be identifi ed in certain cases. In project fi nance, for instance, the dedicated fi nancing of e.g. a wind park or a solar park must be repaid based on the cash fl ow of the respective project. Another example could be a green bond issued under the European Green Bond Standard, which requires that funds raised be fully allocated to economic activities that are sustainable according to the Taxonomy Regulation. On the other hand, investment funds or ETFs investing in a diversifi ed portfolio of stocks and bonds usually have neither an infl uence on the governance of the companies nor a direct link to investment or operational activities conducted by the investee companies. Besides, these funds normally do not inject new cash into those companies; they usually buy the securities on the secondary market.

Green (sustainable) fi nancial products in the EU
In the EU, the regulatory framework for sustainable fi nancial products consists of diff erent legislative components that are closely interconnected ( Figure 1). Firstly, the Sustainable Finance Disclosure Regulation (SFDR) provides the disclosure framework for sustainability information to be reported by fi nancial market participants and fi nancial advisors. The SFDR itself is closely related to the Taxonomy Regulation (TR), which has established a classifi cation scheme allowing economic activities to be categorised in terms of their environmental sustainability. The TR is so far supplemented by the Climate Delegated Act, specifying the technical screening criteria of taxonomy-aligned activities, and the Disclosure Regulation, which defi nes the KPIs for non-fi nancial and fi nancial undertakings. The corresponding Regulatory Technical Standards (RTS) provide the detailed requirements in terms of methodology, indicators, metrics and reporting templates. Due to the close link between the SFDR and the TR, a "single rulebook", i.e. a set of RTS for both regulations is envisaged (SFDR RTS). Finally, it must be ensured that the required sustainability information is generated by the non-fi nancial reporting standards for corporates. The Corporate Sustainability Reporting Directive (CSRD) is currently in the legislative process and is intended to broaden the scope and the level of detail of sustainability information disclosed so that the reporting needs -according to SFDR, TR and SFDR RTS -are taken into account.

The role of the Taxonomy Regulation
The TR has been adopted to establish a comprehensive, transparent and consistent framework that allows for a classifi cation of economic activities as to their environmental sustainability. The taxonomy distinguishes between six environmental objectives. An economic activity has to contribute substantially to at least one of them in order to be categorised as sustainable. These sustainability objectives comprise "climate change mitigation" (e.g. investments in renewable energies) and "climate change adaptation" (e.g. fl ood protection). Other objectives include the protection of water and maritime resources, the transition to a circular economy, the prevention of pollution and the protection of biodiversity and ecosystems. An economic activity can only be classifi ed as sustainable according to the Taxonomy Regulation, if • it contributes substantially to one or more environmentally sustainable objectives (Article 9 TR) and • at the same time the activity does not cause a significant negative impact on the other sustainability objectives (do no signifi cant harm (DNSH) principle) (Article 17 TR) and • it is carried out in compliance with the minimum safeguards laid down in Article 18 TR and • it complies with the technical screening criteria applicable to the respective activity.
In addition, the TR distinguishes between economic activities that directly contribute to one of the defi ned objectives, activities that serve as an "enabler" (Article 16 TR) for such direct contributions, and activities that are needed as "transitional" technologies (Article 10(2) TR) as long as a sustainable alternative is not available. Moreover, the TR, together with the corresponding delegated acts and the RTS, defi ne exactly the scope of the respective environmental objectives as well as the defi nition of "substantial" in that regard.
For instance, "climate change mitigation" (Article 2(5) TR) refers to the process of limiting the increase in the global average temperature to well below 2°C and pursuing eff orts to limit it to 1.5°C above pre-industrial levels, as laid down in the Paris Agreement. The TR covers all activities that substantially contribute to the stabilisation or reduction of GHG emissions through avoidance, reduction or removal of GHG (Article 10(1) TR). In par-  (2021) 4987) KPIs for financial/non-financial undertakings • Environmental Delegated Act Climate Policy ticular, it is considered that the following activities fulfi l these requirements: • generating, transmitting, storing, distributing or using renewable energy • improving energy effi ciency • increasing clean or climate-neutral mobility • switching to the use of sustainably sourced renewable materials • increasing the use of environmentally safe carbon capture and utilisation and carbon capture and storage technologies • strengthening land carbon sinks, including through avoiding deforestation and forest degradation, restoration of forests, sustainable management and restoration of croplands, grasslands and wetlands, aff orestation, and regenerative agriculture • establishing energy infrastructure required for enabling the decarbonisation of energy systems • producing clean and effi cient fuels from renewable or carbon-neutral sources.
The defi nition of "signifi cant harm" is laid out in Article 17 TR. For instance, all activities that lead to signifi cant GHG emissions are detrimental to the objective "climate change mitigation". The TR has been amended by three delegated acts so far. Apart from the Climate Delegated Act establishing the technical screening criteria for the environmental objectives "climate change mitigation" and "climate change adaptation", the corresponding technical criteria for the remaining environmental objectives will be set forth in the upcoming Environmental Delegated Act. In addition, the Disclosure Delegated Act concretises the disclosure obligations according to Article 8 TR, which requires increased transparency in non-fi nancial statements on how and to what extent the undertaking's activities are associated with economic activities that qualify as environmentally sustainable under the TR. In particular, non-fi nancial undertakings shall disclose the proportion of their turnover derived from products or services associated with economic activities that qualify as environmentally sustainable under Articles 3 and 9 TR. The proportion of their capital expenditures and of their operating expenditures related to assets or processes associated with sustainable economic activities need to be reported accordingly.
How the taxonomy works in practice is illustrated by way of three examples, the fi rst of which is electricity generation using concentrated solar power (CSP) technology. The second is the manufacturing of iron or steel and the third is coal mining as a typical example of a non-sustainable activity (Table 1). The sector categorisation is achieved Note: *The activity assesses availability and, where feasible, uses equipment and components of high durability and recyclability and that are easy to dismantle and refurbish. Appendix A = Performance of cimate risk asessment. Appendix B = Risk assessment regarding protection of water and marine resources. Appendix C = Risk assessment regarding pollution and use of chemicals. Appendix D = Risk assessment regarding biodiversity and ecosystems. C(2021) 2800 fi nal (Annex I).
Source: Own illustration.
Climate Policy by using the NACE codes, which is the statistical classification system of economic activities in the EU. While the economic activity CSP is taxonomy-aligned by defi nition, as it contributes to climate change mitigation by using carbon-neutral technologies, manufacturing of iron and steel is categorised as transitional technology as long as an alternative carbon-neutral technology is not available.
In order to qualify nevertheless as a taxonomy-aligned activity, certain technological criteria defi ned as upper limits of CO 2 emissions have to be met. These criteria refl ect the average emission intensity of the top 10% most efficient installations of the existing steel manufacturing operations, depending on the value chain. Hence, other steel operations exceeding these emission criteria are taxonomy-eligible, as they are covered by the taxonomy, but not taxonomy-aligned. Other activities, such as coal mining, are excluded from the taxonomy by defi nition. In order to consider the potential adverse impacts of the economic activities fi nanced by the respective fi nancial product, fi nancial market participants need to publish, for each product, a Principal Adverse Impacts (PAI) statement. With regard to taxonomy-aligned activities, the strict criteria of DNSH have to be applied. Adverse sustainability indicators associated with climate change mitigation could be the level of GHG emissions, the carbon footprint and the GHG intensity of investee companies. The supplier of a fi nancial product promoting ESG criteria (Article 8 SFDR products) or even pursuing specifi c investment objectives (Article 9 SFDR products) therefore needs to disclose potential negative impacts on GHG emissions using these indicators.
The GHG emissions of a fi nancial product (GHG FP ) are calculated as the total GHG emissions of the investee companies weighted by the relative value of the investments compared to the enterprise value of the investee company. The resulting fi gure is the GHG emission volume attributable to the investment portfolio measured in tonnes of CO 2 equivalent (tCO 2 e). The GHG intensity (GHGI) of the fi nancial product refers to the GHG emissions in tCO 2 e per million euro of revenues. After a controversial political discussion, the Climate Delegated Act and the Disclosure Delegated Act of the TR will possibly be amended by a Complementary Climate Delegated Act (C(2022) 631/3), which classifi es certain gas and nuclear energy activities as transitional activities that could contribute to a faster transition to a climate-neutral energy sector. It is argued that nuclear energy is a low-carbon technology and that best-available existing technologies ("Generation III+" nuclear plants) will be used. However, it is possible that the DNSH principle of the taxonomy will be violated, as the fi nal disposal of high-level radioactive waste has yet to be resolved. Gas-based energy activities are also viewed as transitional technology if they meet the strict technical screening criteria. Highly effi cient gas-fi red power plants can be temporarily helpful to decarbonise the energy sector by replacing coal-fi red plants, for example, which have higher carbon emissions. Furthermore, specifi c disclosure requirements apply to nuclearand gas-related activities, e.g. the amount and proportion of activities linked to natural gas and nuclear energy.
Although the basic approach of the taxonomy is understandable and reasonable, the currently envisaged implementation is rather complex, requires large amounts of granular data and the technical screening criteria have to be regularly updated due to technological advances. It is questionable whether the required data can be collected in a reliable way, especially with regard to the value chain of manufacturing industries. Furthermore, ways to simplify compliance for smaller and medium-sized companies should be considered.

The role of the Sustainable Finance Disclosure Regulation
The SFDR covers fi nancial market participants (FMP) such as investment fi rms, alternative investment funds, Climate Policy venture capital funds, insurance companies, security brokers, pension funds as well as insurance fi rms and banks off ering portfolio management services. The regulated financial products are investment funds (e.g. UCITS, ETF), alternative funds, insurance-based investment products (IBIP), pension funds as well as pan-European personal pension products (PEPP). Detailed and harmonised disclosure obligations regarding the integration of ESG aspects in the investment process, the characteristics of the fi nancial product and pursued ESG objectives shall improve transparency and comparability for investors.
FMP have to publish information about their general policies on the integration of sustainability risks into their investment decision-making process. They have to disclose how they consider PAI of investment decisions on sustainability factors including their due diligence policies and any actions taken to mitigate them. In order to facilitate sustainable investment decisions, FMP have to comply with extensive pre-contractual and periodic disclosure requirements for each fi nancial product they make available by 30 December 2022.
The SFDR distinguishes between "light green" fi nancial products (Article 8 SFDR, "Article 8 products") that just promote environmental or social characteristics and "dark green" fi nancial products (Article 9 SFDR, "Article 9 products") that pursue specifi c sustainable investment objectives. The Taxonomy Regulation (Article 5 TR) has amended the disclosure obligations for Article 9 products by requiring information about the environmental objective(s) to which the investments underlying the financial product contribute. Furthermore, it has to be described how and to what extent these investments are in economic activities that qualify as environmentally sustainable in line with the strict criteria of the TR. Similarly, the disclosure requirements of Article 8 products that are promoting environmental characteristics have been amended by Article 6 TR.
It should be noted that the defi ned scope of sustainable activities pursuant to §2(17) SFDR is broader than the precise defi nition of environmentally sustainable activities according to the TR. For instance, the SFDR also covers activities contributing to a social objective, e.g. by addressing equal access to healthcare and education systems or by fostering social integration of economically or socially disadvantaged communities. The TR is also more restrictive in terms of environmental sustainability. If all TR-related criteria are met, the respective activity is said to be taxonomy-aligned; if the activity per se could be eligible under the TR but violates e.g. the technical screening criteria, the activity may be called taxonomy-eligible but not taxonomy-aligned.
As the SFDR and TR regulations are closely interlinked, they have been combined in the amending RTS in a "single rulebook" (SFDR RTS) for sustainability-related disclosures in order to avoid inconsistencies or duplications. Therefore, the European Supervisory Authorities (ESA) have developed draft SFDR RTS that establish detailed requirements regarding the content, methodologies, metrics, indicators and reporting templates for both regulations. There are many communalities in terms of disclosure requirements between the two diff erent types of sustainable fi nancial products (Article 8, Article 9 SFDR), including information on the investment strategy, integration of ESG criteria, the planned asset allocation including the selection criteria applied and the consideration of principal adverse impacts of investment decisions on sustainability objectives. Figure 2 illustrates the pre-contractual disclosure requirements for Article 9 SFDR ("dark green") products in more detail. Information about the respective investment objectives, the indicators used to measure the attainment of such targets and information about the avoidance of signifi cant harm to other sustainability objectives (DNSH) needs to be disclosed. Furthermore, the planned minimum investments in sustainable activities and certain KPIs such as the minimum ratio of taxonomy-aligned investments (including and excluding investments in sovereign issuers) have to be published. If a fi nancial product pursues the reduction of CO 2 emissions, it has to be disclosed whether and how such emissions will be reduced in alignment with the Paris Agreement.
For both types of sustainable fi nancial products, periodic reporting of ESG performance parameters is mandatory ( §11 SFDR) and is closely aligned with the pre-contractual disclosure obligations. Periodic reporting is an important prerequisite for a fair pricing of ESG fi nancial products. This provides incentives to fi nancial market participants to deal with unintended impacts and gives investors the chance to dispose of fi nancial products that are underperforming in terms of ESG. Therefore, it has to be reported if and to what extent the objectives (Article 9 products) or characteristics (Article 8 products) have been attained. Possible deviations and their major drivers have to be addressed. Furthermore, the performance of the fi nancial products compared to the selected reference index has to be explained. A core element of the periodic reporting is the actual versus the planned asset allocation, which includes, inter alia, a list of the 15 largest investments as well as information about the actual ESG performance indicators (taxonomy ratio, Green Asset Ratio). Other periodic reporting obligations for Article 9 SFDR products concern the contribution to taxonomy-based environmental ob-jectives and the achievement of CO 2 reduction targets. Information about the purpose and proportion of investments with a social objective and the proportion of investments in enabling/transitional activities needs to be provided as well.

Key performance indicators and Green Asset Ratio
In order to enable investors to evaluate the degree of sustainability of economic activities of large undertakings, the proportion of turnover, capital expenditures and operating expenditures have to be disclosed that are taxonomy-aligned, only taxonomy-eligible or not taxonomy-eligible (Article 8 TR, C(2021)4987). However, companies are expected to disclose not only the overall ratios, but also the allocation to the diff erent sustainability objectives and the compliance with the DNSH criteria.
The calculation of corresponding KPIs for fi nancial undertakings measuring the degree of taxonomy alignment of their activities depends on the respective business model (e.g. asset managers, investment fi rms, credit institutions or insurance companies).
For credit institutions, the Green Asset Ratio (GAR) plays an important role, which refl ects the proportion of taxonomy-aligned assets compared to the total assets covered. The GAR has to be calculated both using the proportion of taxonomy-aligned turnover and taxonomyaligned capital expenditures of the underlying assets. The fi nancial instruments considered include loans, advances, debt securities, equity instruments and certain off -balance sheet instruments.
Credit institutions are expected to periodically report not only the aggregated GAR, but also disaggregated fi gures diff erentiating between environmental objectives and types of counterparty. Similar KPIs have been established for asset management companies and other fi nancial institutions. Due to the complexity of the data generation and technical requirements for the reporting, the Disclosure Delegated Act applies with a limited scope as of 1 January 2022, the remaining obligations

Figure 2
Pre-contractual disclosure for fi nancial products referred to in Article 9 SFDR and Article 5 TR Climate Policy for non-fi nancial and fi nancial undertakings will have to be applied successively until 1 January 2024.
The detailed disclosure obligations introduced by the SFDR in connection with the TR, the delegated acts and the RTS are certainly useful for supporting investment decisions of institutional investors. However, it is questionable whether retail investors being addressed by ETFs or UCITS are able to fully understand the ESG information provided by suppliers of fi nancial products. Therefore, it could make sense to introduce a kind of mandatory "green rating", especially for fi nancial products supporting environmental objectives such as climate change mitigation and climate change adaptation. The metric applied to such a rating could be the taxonomy ratio based on the proportion of taxonomy-aligned turnover. Consequently, the "green rating" of fi nancial products would improve with a higher taxonomy ratio and vice versa. Table 2 illustrates a simplifi ed example with rating intervals of 20% mapped to fi ve green scores from A to E.

Conclusions
The European regulatory framework for Sustainable Finance consisting mainly of the SFRD, TR and CSRD, including the corresponding delegated acts, ensures a much higher level of transparency on ESG aspects of fi nancial products and thus improves the information basis for investor decisions. The complex design of the disclosure obligations will create signifi cant additional costs of collecting, evaluating and reporting sustainability data for both fi nancial and non-fi nancial undertakings, including for fi nancial market participants. A taxonomy precisely defi ning sustainability objectives, the categories and technical criteria for sustainable activities is essential to raise more capital for sustainable investments. However, what the current architecture of the regulatory framework for sustainable fi nance lacks are minimum quantitative criteria measuring the degree of sustainability of fi nancial products. For instance, the taxonomy ratio or the GAR are per se meaningful indicators, but so far fi nancial market participants are only obliged to report these fi gures within the planned and realised asset allo-cation. In order to provide stronger incentives to achieve a high taxonomy ratio, it should be discussed whether a minimum taxonomy ratio (e.g. 25% or even 50%) has to be achieved to market a fi nancial product as "green". A similar approach to "social" fi nancial products could be taken as soon as a "social taxonomy" is in place. Based on such green and social ratings of fi nancial products, a combined ESG rating could be established that also requires compliance with good corporate governance practices. Furthermore, it is questionable whether the complex reporting requirements will really impact the investment decisions of end investors. Especially for retail investors, a simplifi ed "green rating" based on the taxonomy ratio could facilitate a target-oriented selection of sustainable fi nancial products.