Europe is a leader, again in regulations, this time/again in the financial sector, specifically the insurance sector 🤷♂️
The EIOPA (European Insurance and Occupational Pensions Authority) website features proposals for new regulations concerning sustainable development risks. In this regard, the Solvency II Directive would be amended, and new Regulatory Technical Standards would be introduced (link in the comments).
This position is consistent with actions taken by banking regulators. On January 9 of this year, the European Banking Authority (EBA) published Guidelines on ESG Risk Management. It is worth noting that these guidelines were released just a few days after several major overseas banks announced their withdrawal from the Net Zero Banking Alliance (NZBA). The departure of these institutions led to a decline of approximately 22% in NZBA’s total assets, while these “exiting” banks account for around 12% of the entire global banking system.
Returning to the regulations published on the EIOPA website, it is difficult to agree with their core arguments, and I believe a broader assessment of their implications is lacking.
The authors of the EIOPA document cite the potential failure of insurers to identify material risks as the main cost of not implementing the proposed regulations, which would consequently pose a risk to customers. For the insurers themselves, the stated cost would be the lack of supervisory guidance on minimum expectations (sic!).
It is overlooked that—on the cost side—implementation will likely introduce new requirements for the ORSA document or recovery plans, in which ESG risks may have previously been excluded due to their immateriality. Moreover, regulation may also entail other typical costs associated with new regulatory frameworks, such as personnel expenses or system adaptation costs.
The most critical omission, however, is the lack of reference to the impact of these regulations on investment risk. Under ESG regulations, insurance and reinsurance companies are required to ensure that sustainable development risks related to their investment portfolios are properly identified, assessed, and managed (including compliance with the prudent person investment principle). To me, this weakens the competitive position of entities subject to these obligations compared to institutions that are not regulated. It effectively limits or even excludes them from projects that do not fit the definition of “green/clean energy.”
Such projects will still be financed and insured—most likely by entities not subject to EU regulations, such as American or Chinese institutions. This results in lower profits and returns for shareholders of European companies in the immediate term (meaning that, at least in this timeframe, the regulation effectively favors other institutions). On the other hand, the supposed benefits of these rules remain potential and uncertain in a distant future.
What should be done?
Given the challenges Europe faces—whether geopolitical or the already widening gap with the U.S.—it cannot afford to sacrifice near-term benefits in the name of uncertain future gains.
The author of the text is a member of the Foundation’s Council.
