Can the EU get into shape with its “Fit for 55” green package?

• The European Union’s recent legislative package, called “Fit for 55”, aims to cut pollution in the region by at least 55% by 2030
• The reforms are expected to affect many industries – such as renewables, cars, aviation and even imports
• And while the changes may take some time before they are approved and implemented, investors might consider positioning investment portfolios now before market movements and sentiment force the issue.

With climate breakdown becoming more apparent, in July the EU set out an ambitious sustainability plan. What do investors need to know to manage risks and spot opportunities on the continent?

At the United Nations' High-Level Political Forum in July, the European Union stated “The global recovery must be sustainable, green, digital, circular, inclusive and just.”¹

At the same time, it was proposing a legislative package designed to deliver on this global aspiration for its own jurisdiction. It further backed its words with action by linking its fiscal stimulus to fight climate change (see Will Europe’s ambitious recovery fund plan work?).

The proposal has significant implications for investors, pointing to a wide range of industries likely to be affected as the EU transitions to a sustainable economy.

The next step in the journey

With its announcement, the EC sets a blueprint for how the bloc aims to cut greenhouse gas emissions by at least 55% by 2030 from 1990 levels, hence calling the plan “Fit for 55”.

This next step follows the release the European Green Deal in December 2019, which has the goal of making Europe the first climate neutral continent by 2050. Followed, in January 2020, with the European Green Deal’s Investment Plan (EGDIP)² (also called the Sustainable Europe Investment Plan) which aims to support the transition by mobilising at least €1tn in sustainable investments over the next decade.

In addition, the approved Next Generation EU (NGEU) recovery funding has minimum green requirements within its €800m spending commitments.

The proposed “Fit for 55” legislative package aims “to make all sectors of the EU’s economy fit to meet this [sustainability] challenge” and “to reach its climate targets by 2030 in a fair, cost effective and competitive way”³. Realistically, before the legislation comes into force, negotiation may take years to gain approval by the European Parliament and national governments. However, even given timeframes and potential changes, there are significant implications ahead for European citizens and industry.

Accelerating transformation across industries

When reviewing the plans, the breadth and scale of the ambitions is remarkable. Along with the NGEU budget, which is targeting 30% of its spending to fight climate change, the result would accelerate a reconfiguration of the European economy, including how people live and travel, how key industries operate and even how the EU trades with partners.

Notable sectors affected by the plans

Renewables will be boosted with the proposal to increase the binding target of renewable sources in the EU’s energy mix to 40% by the end of the decade. Having overtaken fossil fuels for European energy generation in 2020⁴, producers of renewable energy, as well as adjacent sectors, will continue to have support to aid growth.

In transport, particularly passenger cars, emissions from new cars would drop by 55% from 2030 and to zero from 2035 under the proposals. The result implies significant pressure for hybrid and fully electric vehicles in the EU. It also suggests increased demand for underlying technologies and materials, as well as the required charging infrastructure.

Similarly, aviation and shipping, previously partially or fully exempt from the requirement, would pay for their greenhouse gas pollution by coming into the scope of the EU’s Emissions Trading System. This will force these industries to account for their externalities, generating higher input costs. This is likely to affect industry dynamics and prices, as well as spur innovation in alternative fuels and more efficient (or electric) planes and ships.

Wider implications

Beyond the European industries affected, the Carbon Border Adjustment Mechanism seeks to provide relief for home companies who will face higher regulations relative to their foreign competitors. By introducing a levy for imports on goods such as steel, cement or aluminium produced in countries with lower environmental standards, it will afford some pricing protection to European companies.

Finally, the plan sets aside funding to support disadvantaged or vulnerable citizens and workers faced with increased costs from the transition. In addition, the legislation incorporates support for biodiversity both as a carbon sink and a critical foundation to our food systems.

Portfolio positioning

As we’ve noted previously, investors should be expecting these, and further, policy and fiscal responses to address climate breakdown. To review their portfolios, two lens can be useful.

First, assessing the environmental practices of all companies they hold. Even where sectors are not directly in scope for legislative change, they may still face implications. For example, given that companies require energy, European requirements for greater renewable energy will affect power costs and consumption. This is where assessment of the “E” of ESG considerations, notably carbon intensity, is valuable.

Second, legislation may open up new opportunities for new entrants and disruptors in specific sectors. The industries noted earlier in the article, and in the rest of the legislation, will need to evolve. Companies providing solutions to their issues and wider climate mitigation or adaptation will be attractive for their long-term growth potential, as we reviewed in Greening the Economy last November.

Starting now, not later

As noted, the proposed EU legislation will take time to be approved and then implemented. As such it might appeal to wait to take action until final changes are in law.

However, like addressing climate change itself, making smaller portfolio changes earlier can have disproportionate benefit and provide more flexibility over timing and selecting investments. It may pay for investors to consider current portfolio positioning before market movements and sentiment force the issue.