Impact vs. EU Green Deal: On the lack of consideration of "investor impact" in the EU Green Deal

The origin of the EU Green Deal lies in the ambition to transform the European Union into a climate-neutral area by 2050 and to play an ecological pioneering role in the world. Since its publication in 2019, the primary goal of the Green Deal has been to steer the global and European economy in such a way that business is more sustainable and resource-efficient. By promoting "sustainable investments" (within the meaning of Article 2(17) of the EU Disclosure Regulation), such as renewable energy investments or a more sustainable real estate industry, the framework aims to redirect finance to address the problems described.

Many staunch product providers of ESG or impact funds welcome the EU Green Deal, as the previously largely unregulated market segment has been given the necessary credibility and attention since its introduction. Thus, the introduction of the EU Green Deal made it much easier to detect green washing, which led to a sharp increase in disclosed green washing incidents since the SFDR came into force in 2021.
Despite the extensive attention paid to sustainable investment products, there is no mention of "impact investing" in the current cosmos of the EU Green Deal. A possible explanation for this circumstance could be the lack of agreement on an EU-wide definition of impact investing at the time of the introduction of the EU Green Deal and the lack of relevance of the market segment at the time.

Given the high amount of assets under management in the impact segment, it is regrettable that impact investing is not considered in either the EU Disclosure Regulation or the EU Taxonomy.

Due to the lack of official definitions of impact investing by national or European institutions, various definitions have been established through initiatives such as the Global Impact Investing Network (GIIN). The Federal Initiative Impact Investing (BIII) substantiated this position in its position paper of December 2022 and was thus able to promote the significant reallocation and mobilization of capital in the direction of impact investing and establish a new attitude in the German-speaking economic and financial world. The BIII definition of impact investing is as follows:

"Impact investing encompasses an investment approach that aims to achieve a measurable environmental and/or social impact in addition to a financial return." The BIII further divides "genuine" impact investing into four core criteria:

These criteria allow a clear distinction to be made from conventional ESG approaches. Investments that do not meet all four criteria are defined as "impact-compatible" or "impact-effective" investing.

Despite the positive response to the GIIN and BIII definitions, impact investors note that combining the requirements of the EU Green Deal and the Impact frameworks is difficult to implement.

Impact investors are faced with the challenge of meeting both the core criteria of the impact definitions (e.g. from the BIII) and the strict regulatory requirements of the EU in order to meet the highest sustainability standards. The criterion "investor impact" is particularly crucial, as a net-positive, significant impact must be proven by the asset manager. Many investors have become accustomed to the SFDR product classifications (Article 6/8/9), even though they were not intended by the EU as a classification framework.

Impact investors aim for the highest sustainability ambitions and should therefore be classified as Article 9 funds. However, this is often not feasible, especially for impact products in the social real estate industry. The binary structure of the EU taxonomy requires that investments meet the strict requirements at the time of purchase, which does not take into account planned environmental improvements.

The dilemma arising from this circumstance can be illustrated by an example from the German building stock:

The German building stock is responsible for around 40% of CO₂ emissions in the country, and fossil fuels such as gas and oil still account for almost 80% of the heat used in existing buildings. Despite the efforts made so far, fossil fuels continue to dominate heat generation. It is therefore urgently needed and widely demanded by scientific experts to take measures to reduce CO₂ emissions in the real estate sector. [1] Consequently, CO₂ reduction pathways have established themselves as a useful and descriptive investment objective for combating climate change in the case of ecological investment objectives at fund level. Since CO₂ emissions are closely linked to the energy consumption of real estate, the European Commission has set ambitious targets for the primary energy demand of real estate in the EU taxonomy. Primary energy demand refers to the total amount of energy that must be generated to cover the energy demand of a property.

In order to achieve an ecological investor impact and to demonstrate an improved CO₂ reduction pathway, the properties must therefore be upgraded in terms of energy efficiency. The worse the energy condition of the property is at the time of purchase, the more potential it offers for ecological investor impact. In contrast, in order to meet the requirements of the EU taxonomy, the best energy efficiency class (class A) must already be proven at the time of purchase. Article 9 funds with a taxonomy ratio of 100%, i.e. those funds with the highest level of ecological ambition, would only be allowed to buy energy-related "lighthouse projects". This raises fundamental questions for both impact investors and investors.

From the point of view of impact investors, this circumstance leads on the one hand to the fact that they often have to do without Article 9 classification and taxonomy compliance requirements. On the other hand, the dilemma makes it particularly difficult to market impact funds and causes reluctance among investors who have already become accustomed to the supposed product classes under Article 6/8/9. A regulatory framework would not only help product providers, but also the EU's overarching goal of greater transparency and the shift of capital towards greater sustainability.

[1] https://www.dena.de/newsroom/meldungen/2023/dena-gebaeudereport-2024-klimaschutz-im-gebaeudebestand

The EU Green Deal is an ambitious project with the enormous potential to shape a sustainable and climate-friendly future. However, the lack of regulatory consideration of one of the core criteria of impact investing, investor impact, represents a gaping gap in the framework that urgently needs to be closed by the European Commission. Impact investors play a crucial role in the implementation of the global and European sustainability goals that have been set out - their activities should be taken into account much more strongly and adequately within the framework of the EU Green Deal.

Due to the growing criticism, the European institutions are now aware of the problem described and so the European Securities and Markets Authority (ESMA) published its guidelines for fund names using ESG or sustainability-related terms in May 2024. [1] The guidelines aim to protect investors from the risk of greenwashing and to set minimum standards for funds offered for sale in the EU that use certain ESG terms on their behalf. In this context, the definition of products that use "impact" in their name is particularly interesting, because it is here that impact investing is defined for the first time, five years after the publication of the EU Green Deal. Affected funds must either meet the new portfolio requirements set out in the guidelines and comply with a minimum ratio of 80% sustainable investments, or change their name. Even though it is very welcome for the impact market that the EU has finally addressed the impact issue, it does not do justice to the dynamic market segment that the definition of the term was very closely adhered to the first, very vague definition of the impact term by the Rockefeller Foundation from 2007. However, the impact market has evolved tremendously since that first definition, as illustrated above.

Despite the justified criticism, ESMA's guidelines represent an important rapprochement between the two regulatory universes. However, further alignment of the definition used by the EU with more modern, internationally recognised impact frameworks, such as the GIIN or the BIII, is still needed.

By looking at international regulations, such as the requirements of the British Sustainability Disclosure Requirements (SDR) or the "Basic Guidelines on Impact Investment (Impact Finance)" from Japan, alignment could be intensified. This is because more and more legislators in international countries are also following the European model and integrating impact investing into regulation. For example, in parallel with the EU's presentations, SDR introduced a new labelling system for sustainable products to help investors navigate the market for sustainable investment products. The product category with the highest sustainable requirements is the "Sustainable Impact" category. Products bearing this label are expected to meet the core criteria for impact investing: They must demonstrate a net-positive, significant impact on societal, environmental challenges. However, with full implementation of the SDR not expected to begin until 2026, it is unlikely that the more detailed, UK product categories will make their way into the EU Green Deal in the coming months.

In addition, the EU has already published a final report on "The Extended Environmental Taxonomy" in March 2022. The existing EU taxonomy is to be significantly expanded and, among other things, leave room for "transitional activities". These activities, such as energy upgrades to real estate, would equalise the binary structure of the existing EU taxonomy described above and offer impact investors the opportunity to meet an investor impact and thus meet both the highest regulatory and the strictest impact frameworks. Since the publication of the final report, however, there has unfortunately been no discernible effort on the part of the EU as to when and whether the "Extended Taxonomy" will come into force in this form.

Impact investing has proven to be a powerful tool for transforming the financial system in recent years. With the right regulatory support, it can play a central role in shaping a more sustainable and equitable future. The dynamic development of the impact market shows that investors are willing to take responsibility and actively contribute to solving global challenges. Only through continuous adaptation and further development of the regulatory framework can the EU achieve the ambitious goals of the EU Green Deal. A look at international preparatory work and the expansion of the existing EU taxonomy are practical instruments for considering impact investments in the European context. The implementation of these measures is not only crucial for impact investors and asset managers, but also a significant step towards meeting the European and global sustainability goals.

[1] https://www.esma.europa.eu/sites/default/files/2024-05/ESMA34-472-440_Final_Report_Guidelines_on_funds_names.pdf