The EU’s ESG Strategy and Global Competition: Environmental, Social, Geopolitical?

By David Henry Doyle, Vice President, Head of Government Affairs & Public Policy at S&P Global

Sustainability risk has become a priority for policy makers, regulators, and business leaders. The integration of Environmental, Social, and Governance (ESG) factors into decision making has migrated from a niche concept to the mainstream. Europe has played a leading role in driving this revolution. A complex ESG governance system has been codified into EU law and is likely to have significant international implications. However, the rapid deterioration of the global geopolitical environment increasingly poses challenges to the EU’s sustainability strategy and competitiveness. To deliver on its ESG ambitions, the EU and its financial system will need to account for geopolitical as well as sustainability risk. The Capital Markets Union represents a potential strategic tool to manage both.

The ESG of the EU Green Deal

Despite its complex policy agenda, the ESG components of the EU’s Green Deal are simple to identify. First, the EU has committed to minimise environmental impacts and to transition to a climate neutral economy. Second, it has pledged to pursue a ‘just’ transition which mitigates the social impact of transformational economic change. Third, it has enacted a regulatory governance system to embed sustainability into the management of the EU industrial base, supply chains, and financial markets. Yet, while the EU’s ESG policy measures have been hotly debated, their geopolitical impact has received less attention.  

 The Geopolitics of ESG

The consequences of the world’s largest trade bloc pursuing what amounts to a sustainability-based industrial revolution should not be underestimated. When launched in 2019, the European Commission’s Green Deal Communication noted that ‘the ecological transition will reshape geopolitics, including global economic, trade, and security interests’.

While this remains accurate, a radically different geopolitical and economic context now exists compared to when the EU Green Deal launched.

A succession of shocks has shaken the established geopolitical order. States and financial markets have discovered that rapid tectonic shifts in the international system can result in severe vulnerability. External dependencies can be (and have been) weaponised. The prevailing dynamic in the international system is now one of intense competition for strategic capabilities, critical raw materials, technology, supply chains, and investment. Europe, however, still relies heavily on its trade partners for the resources needed to ensure its economic security and to implement its green transition.

The ‘Paradigm Shift’ of Open Strategic Autonomy

 To address this challenge the EU has pursued ‘Open Strategic Autonomy’, a new operating model which targets ‘the capacity to cope alone if necessary but without ruling out cooperation whenever possible’. The EU High Representative for Foreign Affairs and Security Policy heralded this model as a ‘paradigm shift’ in the EU’s approach to international affairs.

 The significance of this paradigm shift is remarkable since the EU has long championed a multilateral and rule-based trade, finance, and economic system. The impact of this model on the global financial architecture remains to be seen.

However, the combination of the EU’s ambitious ESG strategy and the new imperative of strategic autonomy raises questions about the future role, governance, and geometry of EU capital markets as well as their relationship with the international financial system.

 Fortunately, the EU High Representative has also warned of the need to avoid dependency reduction resulting in ‘green protectionism’ or ‘regulatory imperialism’. Instead, he has declared that the EU’s objective should be ‘to create new opportunities to develop our trade relations with many partners’ and ‘maximise mutual benefits’.

The International Potential of the Capital Markets Union

To maintain and grow its industrial base, Europe must compete with other economies pursuing similar transformational objectives. While the EU has primarily focused on ESG requirements through regulation, other jurisdictions have chosen to stimulate capital formation through financial subsidies which incentivise sustainable investment.

In this context, Europe’s financial markets should be recognised as a strategic tool. The EU’s Capital Markets Union (CMU) project represents a major opportunity to pursue mutually beneficial financing arrangements for Europe and its partners. Many have pointed to slow progress on CMU being an obstacle to mobilising the necessary risk capital to fund Europe’s sustainability transition. However, as Europe comes to terms with its strategic vulnerability in the new geopolitical context, CMU has been propelled to the top of the political agenda.

The untapped potential of Europe’s capital markets could be a powerful mechanism to channel investments towards the objectives of the EU Green Deal.

However, a CMU which not only integrates ESG but is also open to global partners could become an attractive forum to build strategic and mutually beneficial investment links. The funding potential of deeper EU capital markets and expertise in sustainable finance could be shared with international partners to maximise the attractiveness of forging closer ties with the EU.

To conclude, the integration of ESG into regulation, trade relationships, and financial markets can have a transformative effect on the ecological footprint of the EU and its partners. However, an elaborate governance system alone will not mobilise the capital needed to fuel Europe’s transformation. Increased geopolitical competition means that the EU needs strategic partners for its Green Deal. Strengthening, deepening, and opening the EU’s capital markets represents a major opportunity to build the future investment partnerships needed to navigate the EU’s ESG and geopolitical challenges.