Make EU Economic Governance fit for climate neutrality: Time to reform the European Semester

Brussels/Berlin, March 2022

Make EU Economic Governance fit for climate neutrality:

Time to reform the European Semester HOW TO MAKE THE EU’S ECONOMIC SURVEILLANCE & COORDINATION MECHANISM A KEY LEVER FOR THE EU’S GREEN TRANSITION

Authors Louise Simon Dr Oliver Herrmann Ingmar Juergens Stefanie Berendsen Laura Kaspar

The authors would like to express their sincere gratitude to Hans Naudts, Helene Banner, David Bartle and Emma Gervasi for their valuable comments and insightful contributions.

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EXECUTIVE SUMMARY If the European Union wants to "green” its economy, it also needs to “green” its main coordination instrument for the macroeconomic and budgetary policies of its Member States: the European Semester.

By adopting, in 2019, the Green Deal as its new economic paradigm, the European Union has committed itself to transforming its economy to achieve climate-neutrality and halt environmental degradation. Yet, a multitude of governance structures are in place and the various policy objectives are not consistent. This situation has hampered more significant progress in the battle against climate change (and environmental degradation more broadly). In acknowledgement of this challenge, the European Commission was tasked in the EU Climate Law to propose how to align EU policies and measures to the Union’s climate objective. This paper takes a closer look at an area of policy misalignment which could, if reformed, be a key lever: the European Semester, which is the EU’s core mechanism to monitor and coordinate the Member States’ economic policies and required structural reforms The European Semester, initially set up to mitigate the financial and debt crisis more than a decade ago, can become a powerful tool to stimulate the green transition by systematically integrating its most important economic, fiscal and labour market implications in the processes of monitoring, economic policy coordination, country specific recommendations and support services corresponding with the challenges specific to the successful implementation of the Green Deal and the EU’s climate policy objectives in every EU Member State.

Based on our own experience in this field, a thorough review of the available evidence and the intensive consultation of other experts in economic and climate governance, we identified a set of opportunities where economic and climate and energy objectives can and should be linked more strongly and systematically in the European Semester: Understanding the investment challenge - monitoring the sustainable investment gap. We recommend that the European Commission monitors the Member States’ progress on delivering their climate and energy investment needs in the European Semester, including the financial dimension of the National Energy and Climate Plans. The Commission should issue clear guidance to Member States on how to correctly assess, monitor and report their climate and energy investment needs.

Understanding the environmental sustainability of national budgets – using a common green budgeting tool. We recommend that the European Commission and Member States agree on a common green budgeting framework. The common framework should then be used to assess the greenness of their national budgetary plans submitted in October every year as part of the European Semester. Member States need to transparently disclose the extent to which their overall budgets are contributing to these targets or to the further deterioration of the climate (and environment more broadly).

From fiscal footprint to fiscal space - monitoring environmentally harmful government support. The European Semester should introduce a surveillance mechanism for environmentally harmful government support to ensure the monitoring and evaluation of the cumulative fiscal environmental footprint. This will help build the (much needed) additional fiscal space for an active role of governments in facilitating a green transition.

Skills for sustainable labour markets - monitoring employment policies for a just transition. The Semester needs to monitor that Member States’ employment policies are fit for the necessary shift of the labour force from carbon-intensive to sustainable sectors. The green transition will have important effects on required skills and unemployment - which will vary across the EU. The Semester has a key role to play in ensuring that the transition is “just” for European workers and the necessary skills to work in a green economy are developed.

Using the European Central Bank’s climate stress tests to understand the exposure of Member States’ economies to physical and transition risks. We recommend that the European Commission uses the European Central Bank’s climate stress test as input for the assessment of macroeconomic imbalances of Member States, contributing to a more comprehensive observatory of Member States’ financial market stability (risks).

With the relaunch of the EU economic governance review in October 2021, the European Commission and the Member States have started to take action on rethinking and reforming the economic governance framework. This paper could serve as a reference document for decision-makers at national and EU level, contributing with some concrete ideas to the dialogue between and within national governments and Commission services, to feed and facilitate this vital process of reforming the European Semester.

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TERMS AND CONCEPTS Annual Sustainable Growth Survey

Strategic guidelines outlining the EU’s economic and employment policy priorities at an annual basis.

In 2021, it was focused on implementing the Recovery and Resilience Facility. In 2022, the Survey structured the policy priorities for the EU and Member States around the dimensions of competitive sustainability, namely environmental sustainability, productivity, fairness and macroeconomic stability.

EU Climate Law

Sets a legally binding target of net zero greenhouse gas emissions by 2050. The EU Institutions and the Member States are bound to take the necessary measures at EU and national level to meet the target, taking into account the importance of promoting fairness and solidarity among Member States

European Semester

An annual cycle of coordination and monitoring of the EU’s economic policies and national budgets.

For a more detailed discussion, please see here and here.

European Green Deal

Adopted in 2019 by all EU Member States, the Green Deal proposes to tackle the climate change and environmental degradation challenges. Regarding climate change, this includes for the EU to reduce greenhouse gases emissions by at least 50% and towards 55% by 2030 and to be climate neutral by 2050.

Fit for 55 Package

A set of inter-connected proposals across a range policy areas and economic sectors: climate, energy and fuels, transport, buildings, land use and forestry, aiming to achieve the carbon emission reduction target of 55% by 2030.

Just Transition Fund

Fund designed with the purpose of investing €17.5 billion between 2021-2027 in territories most affected by the transition to the objectives of the European Green Deal. Entered into force in July 2021.

Territorial Just Transition Plans

Documents currently being written by EU Member States, which will serve as a basis for national government to decide how to allocate their part of the Just Transition Fund across regions. They should contain an assessment of the socio-economic impacts and challenges of the green transition.

Member States are also asked to report the types of measures planned and how these contribute to the objectives of the Just Transition Fund.

Long-Term Strategies

All Parties to the Paris Agreement were invited to communicate, by 2020, their mid-century, long-term low greenhouse gas emission development strategies with the target of holding the increase in the global average temperature to well below 2°C above pre-industrial levels and pursuing efforts to limit the temperature increase to 1.5°C.

National Reform Programmes

As part of the European Semester cycle, countries report on the specific policies they are implementing, prevent or correct macroeconomic imbalances, and on their concrete plans to ensure compliance with EU’s fiscal rules and with any CSRs.

National Energy and Climate Plans

EU countries needed to establish a 10-year integrated National Energy and Climate Plan for the period from 2021 to 2030 to show how they plan to meet the 2030 energy and climate targets (within the Energy Union governance).

Renewed Sustainable Finance Strategy

Adopted in in July 2021, the renewed Strategy aims to support the financing of the transition to a sustainable economy through four key action areas: transition finance, inclusiveness, resilience and contribution of the financial system and global ambition.

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Recovery and Resilience Facility

€672.5 billion in loans and grants available to support reforms and investments undertaken by EU countries with the aim to mitigate the economic and social impact of the COVID-19 pandemic and declared objective to make economies and societies more sustainable, resilient and better prepared for the challenges and opportunities of the green and digital transition. More details on its implementation in the European Semester here.

Recovery and Resilience Plans

Proposal prepared by MS outlining spending and reform plans in order to access recovery funding under the RRF.

Structural Reforms

An action or process of making changes and improvements with significant impact and long-lasting effects on the functioning of a market or policy, the functioning or structures of an institution or administration, or on progress to relevant policy objectives, such as growth and jobs, resilience and the climate and digital transition.

EU Taxonomy Regulation

Entered into force in July 2020, it is an EU regulation aiming at the development (through delegated acts) of a concrete criteria-based classification system of “sustainable” economic activities, thereby providing a basis for and increasing transparency in relation to green financial products. The taxonomy is explicitly referred to in the EU’s legal disclosure framework (namely, the SFDR and the CSRD), but also in the EU green bonds standard.

ABBREVIATIONS ASGS: Annual Sustainable Growth Strategy

LTS: Long-Term Strategy

CSRs: Country-Specific Recommendations

MFF: Multiannual Financial Framework

EAP: Environmental Action Programme

MIP: Macroeconomic Imbalance Procedure

ECA: European Court of Auditors

NECP: National Energy and Climate Plan

ECB: European Central Bank

NGEU: Next Generation EU fund

EEA: European Environmental Agency

RRF: Recovery and Resilience Facility

EU: European Union

RRP: Recovery and Resilience Plan

GDP: Gross Domestic Product

SDGs: Sustainable Development Goals

GHG: Greenhouse gases

SGP: Stability and Growth Pact

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TABLE OF CONTENTS EXECUTIVE SUMMARY

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TERMS AND CONCEPTS

3

ABBREVIATIONS

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TABLE OF CONTENTS

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1 INTRODUCTION

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2 A GOVERNANCE FRAMEWORK FIT FOR DEALING WITH CLIMATE RISKS

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2.1

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2.2

Risks for Member States’ economies due to climate change and the transition 2.1.1

Economic risks associated with climate change

8

2.1.2

The need for an adequate governance framework

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Key ingredients of an integrated climate and economic governance framework 2.2.1

Assessing the sustainable investment gap

2.2.2

Identifying environmentally harmful government support

10

2.2.3

Matching labour supply and demand of the green transition

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3 A MULTITUDE OF PARALLEL GOVERNANCE STRUCTURES 3.1

3.2

3.3

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The climate and energy governance structure

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3.1.1

The Governance Regulation of the Energy Union

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3.1.2

The European Climate Law

12

3.1.3

Fit for 55 Package

12

3.1.4

Renewed Sustainable Finance Strategy

12

3.1.5

Insights from the analysis of the climate and energy governance framework

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The economic governance framework

13

3.2.1

Purpose and structure of the European Semester

13

3.2.2

The Recovery and Resilience Facility as response to the Covid crisis

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3.2.3

Why can the European Semester be useful for delivering the European Green Deal?

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3.2.4

Conclusive notes on Chapter 3.2

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Interlinkages between EU economic and climate and energy governance frameworks 3.3.1

The Energy Union and the European Semester

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3.3.2

The Energy Union and the Recovery and Resilience Facility

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3.3.3

The European Climate Law and the European Semester

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3.3.4

The Fit for 55 Package and the European Semester

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3.3.5

The Renewed Sustainable Finance Strategy and the European Semester

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3.3.6

Conclusive notes on Chapter 3.3

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4 A REFORMED EUROPEAN SEMESTER - MAKING BUDGETARY SURVEILLANCE AND THE MACROECONOMIC IMBALANCES PROCEDURE WORK FOR THE CLIMATE TRANSFORMATION 22 4.1

4.2

Reforming the economic and climate governance frameworks in the short term 4.1.1

Aligning monitoring frameworks of different economic and governance structures

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4.1.2

Improving the implementation of Country-Specific Recommendations (CSRs)

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Reforming the economic and climate governance frameworks in the medium- to long-term

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4.2.1

Monitoring the sustainable investment gap

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4.2.2

Greening national budgets

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4.2.3

Monitoring environmentally harmful government support

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4.2.4

Monitoring the employment effects of the green transition

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4.2.5

Using climate stress tests to understand the exposure and resilience of the economy

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5 THE WAY FORWARD – NEXT STEPS FOR DECISION-MAKERS 5.1

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Actors: who needs to do what in order to make the European Semester fit for the EU Green Deal?

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5.1.1

European Commission services

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5.1.2

European Parliament

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5.1.3

Member States

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5.1.4

Ongoing French and upcoming Czech EU Presidencies

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6 ANNEX: DETAILS ON TIMELINES OF GOVERNANCE FRAMEWORKS

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6.1

The Governance Regulation of the Energy Union

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6.2

The European Semester

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6.3

The Recovery and Resilience Facility

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7 REFERENCES

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1 INTRODUCTION Achieving the European Green Deal’s climate and sustainability targets requires a transformation of our economies. The EU’s current economic governance does not yet reflect the shift of economic paradigm that is needed to deliver the European Green Deal and to support the green transition. This transition, and achieving the 2030 climate targets and climate neutrality by 2050, is a shared European responsibility. Accordingly, delivering these targets will require a coordinated effort across the EU to implement structural reforms that channel public and private resources into sustainable investments. National budgets need to make strides towards achieving the goals in the Green Deal as much as possible and abolish harmful practices such as investing in and subsidizing fossil-fuels. Economic policy coordination and monitoring at the EU level is crucial, as none of the Green Deal’s objectives can be achieved by individual Member States alone.

This paper first highlights the fiscal and macroeconomic risks Member States are facing in relation to climate change and the transition (Chapter 2.1). Drawing on this analysis, the paper describes the key ingredients of an integrated climate and economic governance framework (Chapter 2.2).

Chapter 3 highlights the different mechanisms under the EU’s current environmental and economic governance frameworks, their interlinkages, as well as what is missing in terms of an integrated governance framework for delivering the Green Deal. Particularly, the focus of this analysis is on the European Semester, which is the European monitoring and coordination framework for Member States’ economic and budgetary policies and structural reforms, whose different processes will be essential to accelerate the green transition.

A European Semester aligned to the challenge of climate neutrality should be considered as a fundamental component of an effective EU economic governance framework to deliver this objective, because it will play a crucial role in better aligning budgetary and economic policies in Member States into an environmentally and economically sustainable path.

The Commission and Member States admit 2 that there is a need to discuss how to adapt the Semester and overall economic governance framework to the new climate and energy challenges. This would go beyond the Recovery and Resilience Facility (RRF), the EU post-pandemic financial instrument currently monitored in the Semester. In fact, the Commission had relaunched a consultation on the review of EU economic governance until the end of 2021; further discussions with Member States are planned to follow throughout 2022.

Drawing on the analysis of the shortcomings of the current provides governance frameworks, Chapter 4 recommendations on how to strengthen the European Semester, and the climate and energy governance framework, with regards to achieving the climate and energy targets. The fundamental changes introduced by the Green Deal, the adoption of the RRF as well as the European Climate Law and the re-opening of the EU Economic Governance Review create an opportunity to assess and rethink the governance mechanisms at the European and national levels, in particular the European Semester.

Finally, in Chapter 5, the paper provides an overview of the next required steps for decision-makers at the European and national level.

The economic and environmental context has changed considerably since the European Semester was first introduced in 2011. Meanwhile, Europe is aiming to become the world's first climate-neutral continent and to seize new opportunities of the digital age, as set out in the 2021 Annual Sustainable Growth Strategy 1 of the Semester.

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2 A GOVERNANCE FRAMEWORK FIT FOR DEALING WITH CLIMATE RISKS 2.1 Risks for Member States’ economies due to climate change and the transition The following sub-chapters highlight various fiscal and macroeconomic problems that the EU and its Member States face if national budgets do not sufficiently reflect the need to reconcile economic and environmental concerns. In fact, the world’s economies and financial actors are facing two types of risks from inaction or insufficient action towards climate change: physical risks and transition risks 3. These risks need to be closely monitored, analysed and relevant actions be identified and taken before imbalances affect the overall financial and macroeconomic stability of Member States and the EU.

2.1.1

Economic risks associated with climate change

Physical risks and the costs of climate change - impact and adaptation The first type of risks, physical risks, relates to the impacts of climate change, the resulting weather and climate-related hazards, and the need to adapt to them 4. The costs of climate change impacts in Europe were illustrated in the summer of 2021, when e.g. extraordinarily heavy rainfalls in Belgium and Germany and apocalyptic forest fires in Greece led to the tragic loss of many lives and the destruction of significant economic value.

Adapting to physical risks will require significant investments in infrastructures to prepare for sea level rise and changes in weather patterns, amongst numerous other environmental consequences 5. Climate adaptation measures usually require large sums of up-front funds and usually do not provide very steady revenues 6. In fact, the benefits of this type of measures are mostly non-financial and thus complex to assess economically 7. This is reflected by the fact that many climate adaptation investments represent a problem of market failure,

meaning that the environmental and social benefits of climate adaptation investments are not depicted in the market costs of climate adaptation activities and investments, leading to an undersupply of many climate adaptation goods by the private sector. 8 Climate impacts affect public budgets immediately, while adaptation costs can impact public finances more in the medium- to long-term 9.

Transition risks and “stranded” assets The second type of risk resulting from climate change are transition risks, which are the risks of economic dislocation and financial losses associated with the transition to a lowcarbon economy 10. It relates to indirect economic effects that can be caused by market trends, changes in consumer preferences, technological developments, international policy agreements or national policy reforms (for example pricing externalities like carbon emissions) for reaching climate and sustainability goals, which lead to, for example, a ban on certain unsustainable practices, a drop in demand for fossil fuels (and associated drop in income from fossil fuel exports and associated changes in a country’s current account balance), etc 11.

A less disruptive transition to a low-carbon economy is possible if the expectation of, say, a future policy tightening on carbon emissions induces an early and orderly shift of public and private investments towards low-carbon technologies. Not making the transition globally means that the physical risks from climate change are certain to increase over time. In addition to higher physical risks, a late and abrupt policy tightening on carbon emissions could lead to a loss in value of carbon-intensive investments, resulting in “stranded” assets 12.

Investors and supervisory authorities in the financial sector still lack information on the exposure of different entities to sustainability risks, and of the environmental and social impacts of investments. This is a problem of an informational market failure 13. A further type of market failure relevant in this context is that the market still does not fully internalize the environmental costs of polluting activities and infrastructures,

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such as the costs of emitting greenhouse gases (GHG), and this leads to an oversupply and consumption of high-emissions goods 14 . These market failures both inhibit efficient capital allocation and expose some existing asset classes (and their investors) to the risk of massive and potentially rapid devaluation and hence becoming “stranded assets” 15.

2.1.2

The need for an adequate governance framework

Both physical and transition risks affect public budgets in the EU, at all levels of governance, now and even more so in the coming years. Environmental sustainability is interconnected with long-term fiscal sustainability: imbalances related to the transition to carbon neutrality have a significant impact on future economic development and (future) national budgets.

An integrated governance process, that is fit to deal with these risks and recognises that key macroeconomic factors cannot be evaluated independently of climate action and investments, is urgently needed.

By neglecting environmental risks, even otherwise balanced macroeconomic conditions can slide into severe imbalances.

So, we see a need for reforms in the governance of the financial and economic aspects of achieving the 2030 and 2050 targets. In fact, we have identified three key elements that, if incorporated into an economic governance framework coherent with climate-related financial impacts, would support to alleviate this challenge. The three elements are presented in the following sub-chapter.

2.2 Key ingredients of an integrated climate and economic governance framework 2.2.1

Assessing the sustainable investment gap

Identifying sustainable investment needs is crucial for making long-term investment-related decisions, both for the public and private sector, particularly when public goods and the associated market failures require policy reforms to attain the most efficient allocation of capital 16.

Highlighted in various Commission report 17 as well as by experts and academia 18, the investment gap for a successful green transition needs to be tackled with both private and public funds. In fact, public funds represent only a small, yet very important share of total finance needed, so the majority will need to be supplied by private sources. Public sources, together with the right policy instruments, needs to reliably leverage private investments i , 19 . Every year, the remaining sustainable investment gap not addressed by Member States is carried forward to the next year, which adds on to the financial burden to already high annual investment needs and leads to ever higher physical and transition risks.

Estimating the relative investment needs of each Member State is a complex, yet very important step in defining the pathway for reforms and finance strategies. Currently, there is no comprehensive assessment of the scale of investments needed to reach net zero by 2050. Various “headline figures”, exist, such as the Commission estimate of €520 billion per year until 2030 the meet the EU’s environmental objectives of the green transition 20. McKinsey & Company have estimated that reaching net-zero emissions by 2050 in the EU27 would require total capital expenditure of around €1 trillion per year in the period 2021-2050 21. Worldwide estimates vary between $500 million and $1 trillion as calculated by the United Nations Environment Programme 22, between $1-2 trillion according to the Energy Transitions Commission 23, between $4-5 trillion by the International Energy Agency 24 and between $5-11 trillion as measured by the Climate Policy Initiative 25. Such “order of magnitude” figures are important to highlight the scale of the challenge, but ultimately, the assessment of investment needs and gaps needs to be done on a sectoral level and as granular as possible in order to support the allocation of the necessary resources towards the investment gaps.

Without a granular assessment of investment and the role of different investors needed to reach the climate and sustainability targets, Member States and the Commission risk missing the efficient and successful allocation of resources on adapting to and mitigating climate effects. With the steady rise of investment needs for climate action, fiscal sustainability incurs the risk of significant additional pressure. This needs to be addressed in a governance framework for budgetary planning and related structural policy reforms.

i

See our publication in partnership with Agora Energiewende for more details: Agora Energiewende, Climate & Company (2021), Matching money with green ideas - A guide to the 2021–2027 EU budget.

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2.2.2

Identifying environmentally harmful government support

Both on EU and Member States level, support is still flowing into unsustainable activities. For example, most Member States still provide so-called “fossil fuel subsidies” and give out investment support for carbon intensive activities. The EEA 26 highlights the importance to phase out all direct and indirect fossil fuel subsidies by 2025 and all subsidies which fund environmentally harmful activities by 2027. Phasing out these subsidies is an agreed objective in the Governance Regulation of the Energy Union 27 (described on the next page).

As agreed on by all Member States, phasing out harmful subsidies is essential to achieve one of the key goals of the Paris Agreement, namely to “make finance flows consistent with a pathway towards low greenhouse gas emissions and climate resilient development” 28 . Support for unsustainable activities includes, for example, the provision of subsidies for the production of fossil fuels; Member States spent on average €55 billion per year between 2014 and 2016 subsidising oil, gas and coal production and also consumptio 29 . Another challenge is to correctly reallocate the funds previously serving as harmful subsidies towards the just transition.

Numerous (social) implications can emerge from the reallocation of subsidies, such as making fuel more expensive to already financially disadvantaged societies, and these need to be considered during policy decision-making to avoid creating further socio-economic problems 30.

Considering the limited and shrinking fiscal space for supporting the climate transition (against the backdrop of massive recovery spending and on top of that recent announcements of significant increases in defence spending in many EU Member States 31 ), an integrated governance framework should clearly monitor the remaining supports from Member States’ governments to any environmentally harmful activities. The emerging EU Taxonomy framework 32, including the proposal of the EU Sustainable Finance Platform 33 for a “significant harm taxonomy”, could inform and help harmonise such a monitoring effort. Disclosing data on the amount of funds disbursed to such activities creates transparency which is useful for all Member States, as well as any investors exposed to sovereign assets. As delivering the 2030 and 2050 targets requires a coordinated effort across the

EU, more transparency regarding environmentally harmful activities amongst Member States will help identify counterproductive (fiscal) policy practice, as well as potential fiscal space for more sustainable public expenditure 34.

2.2.3

Matching labour supply and demand of the green transition

The green transition will have both positive and negative effects on employment in most industries. Depending on how the green transition is managed, it will create new work opportunities across the economy and in sectors such as in renewable energy, energy efficiency or circular economy related activities, but inevitably lead to job losses in, for example, carbon-intensive, ecosystem destroying, water polluting, or fossil-fuel orientated extractive industries. To alleviate consequences of job losses in certain industries and create the right skills to meet the challenges of the green transition there is a great need to focus on reskilling and upskilling of the labour force 35. In the 2020 Renovation Wave Strategy, a strategy to improve the energy performance of buildings in Europe, the Commission stated that “already before the COVID-19 crisis, there was a shortage of qualified workers to carry out sustainable building renovation and modernisation” 36. A ‘just transition’ approach on the shift of economic paradigm reflects this need by focusing on mitigating the possible negative social consequences that may result from transitioning our economies. Similarly, social policies should match the work force with the skills demanded by a low-carbon economy 37 . So, the overall amount of expenditures needed for a green and just transition needs to consider areas broader than investments in the mere sense of gross fixed capital formation.

Labour market reforms have traditionally played an important role in the context of the EU economic policy coordination and represent a horizontal challenge across EU Member States, particularly in fossil fuel and heavy industry-dependent regions. Due to the importance of the Territorial Just Transition Plans 38 and other public investments in financing the required labour market measures, there is a direct link between budgetary surveillance and monitoring of climate expenditures, which an integrated governance framework should consider.

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3 A MULTITUDE OF PARALLEL GOVERNANCE STRUCTURES

To deliver the objectives of the Green Deal, two EU governance regimes are highly relevant: the economic governance and the climate and energy governance regimes. The three points described in the previous chapter need to be fully integrated in a climate and energy governance framework: 1.

The assessment and monitoring sustainable investment gap,

2.

The identification of environmentally harmful government support, and

3.

The match between labour force and the green transition.

of

the

However, as discussed in the next sub-chapters, these three factors for an economically sustainable green transition are currently not adequately addressed in the relevant processes of the above-mentioned frameworks.

3.1 The climate and energy governance structure 3.1.1

The Governance Regulation of the Energy Union

The Governance Regulation of the Energy Union 39 establishes the (i) Integrated National Energy and Climate Plans (NECPs) and the (ii) Long-Term Strategies (LTSs).

The NECPs form the framework for Member States to outline their climate and energy targets for 2030, and the policies and measures they plan to undertake between 2021 and 2030 in order to reach these targets.

The LTSs, on the other hand, address the long-term dimension of climate neutrality by 2050. Member States were required to

ii

develop these LTSs for the next 30 years and submit them at the same time as the NECPs, in 2019. However, to date, not all Member States ii have submitted their LTS 40.

The Governance Regulation stipulates that NECPs should be consistent with LTSs, but the Commission did not set up a process to ensure that the Member States actually follow through 41 . In 2020, the Commission (rather superficially) assessed the NECPs and concluded that collectively, they achieve the EU binding target for renewable energy. 42 However, many of the aspects of like energy efficiency and research & innovation in energy are not met and cast doubts if the long-term goals will be achieved. The assessment of the individual plans led to the issuance of specific recommendations to the Member States. However, a majority of Member States (17 out of 27) did not really address these recommendations in the final NECP which add further criticism of the effectiveness of the NECPs. The Commission can, if need be, propose further Union level measures to ensure targets are collectively achieved.

Member States must report every two years on the progress made in implementing their NECP, by providing information on their progress towards the targets set in their NECP and towards financing the necessary measures to deliver those targets (more details and informaiton on timelines in the Annex: Details on timelines of governance frameworks).

As part of their NECPs, Member States were asked to include a chapter describing their investment needs to achieve the relevant climate and energy targets. This requirement reflects parts of the first element for an integrated governance framework explained earlier, namely, to assess the sustainable investment gap. However, one of the latest audits from the European Court of Auditors (ECA) 43 states that the information on investment needs included in the NECPs was

Bulgaria, Cyprus, Ireland, Poland and Romania still missing.

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incomplete, inconsistent, and showed large disparities iii .

Although the Commission provided some support to Member States, it did not develop a common framework for Member States to apply when assessing their needs and identifying flagship sustainable projects 44 . Thus, the ECA 45 and other experts 46 conclude that there is a risk that some NECPs will not contribute to a credible sustainable project pipeline in sectors and areas where it is currently lacking. Moreover, the current NECPs do not yet reflect the raised climate and energy 2030 ambitions iv . Consequently, it is necessary to recalculate investment needs according to the EU’s new climate targets in a comparable, reliable, and verifiable way and to more clearly indicate in what areas investments are most needed and by whom and with which instruments the investment challenges will be met.

The Commission requested Member States to present measures to phase-out fossil fuel subsidies in their NECP. According to the Commission 47 , thirteen Member States 48 communicated their intentions to introduce plans to phase out fossil fuel subsidies, but only six (Austria, France, Germany, Latvia, Lithuania and Spain) have set a timeline for doing so.

One problem is the lack of common definition across the EU regarding what harmful subsidies are, which is reflected directly in the NECP guidance document from the Commission which states that “Member States may choose to base themselves on existing definitions for fossil fuel subsidies used internationally” 49.

3.1.2

The European Climate Law

The European Climate Law 50 entered into force in July 2021 and establishes the legal framework for achieving the 55% GHG emission reduction target by 2030 and climate neutrality by 2050. It transforms these targets from aspirations or ambitions to obligations. However, the European Climate Law appears to lack sufficient powers (and some more concrete and binding levers) to achieve its objectives. It does not address the necessary improvements for economic coordination on green transition aspects between Member States. For example, the shortcomings of the Governance Regulation described above have not been revised by the adoption of the Law. The Commission was not given the legal authority to take meaningful actions to address national lack of progress on delivering the targets, particularly where levels

of key investments are too low. The Climate Law only gives the Commission the ability to issue recommendations to those Member States whose measures are inconsistent with the climate-neutrality objective (Article 7.2). The Law as it currently stands is a missed opportunity to require Member States to address their sustainable investment needs and allow the Commission to act if a country is not designing suitable investment programmes to achieve their climate targets.

3.1.3

Fit for 55 Package

In July 2021, the Commission published the Fit for 55 Package 51, which is a set of interconnected proposals, aiming to achieve the carbon emission reduction target of 55% by 2030. It consists of eight existing legislations, adjusted to meet this target as well as five new proposals. The Communication on the Package briefly mentions that some measures will help identify the scale of needs, such as reskilling, investment or technology needs for the ‘industrial transition to 2030’ (p.7). It however does not set up a framework for keeping an eye on those needs and the progress towards funding them.

3.1.4

Renewed Sustainable Finance Strategy

Also in July 2021, the Commission presented the Renewed Sustainable Finance Strategy 52. While aiming at a more or less comprehensive approach to filling the regulatory gaps in the emerging sustainable finance framework, the strategy remains often vague v and lacks coherence and integration with other key policies under the Green Deal. Although it contains several instruments and policies to address the climate and energy targets, the strategy barely refers to the Fit for 55 Package and does not contain a link to the abovementioned mechanisms. In the Strategy, the Commission highlights that to monitor progress and achieve the EU climate objectives, collaborative action among Member States, financial supervisors and relevant public authorities is required. Therefore, the Commission plans to develop, together with the European Platform on Sustainable Finance 53, a robust monitoring framework to measure capital flows to sustainable investments. The Strategy also states the Commission’s mandate will be to assist Member States in assessing their investment gap. However, it does not explain

iii

A few Member States, such as Austria and Denmark, have still managed to provide a more meaningful presentation of the investment challenge in their NECP. iv See our publication for more details: Climate & Company (2021), Assessment and monitoring of the Recovery and Resilience Facility – how does it work and how can it deliver the Green Deal? v See for example Juergens et al 2021 for a critical assessment of the Strategy by the Sustainable Finance Research Platform.

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the framework in which this support will take place and does not mention anything about monitoring this gap on a regular basis.

3.1.5

Insights from the analysis of the climate and energy governance framework

When considering the processes of the NECPs, the LTSs, the EU Climate Law, the Fit for 55 package and the Renewed Sustainable Finance Strategy, it becomes clear that they differ significantly. Member States have to submit a large number of planning and progress reports as well as evaluations of them to the Commission, which often have overlapping timelines.

There is an overall lack of coherence and integration of the different relevant processes to deliver climate and energy targets. This constraints effective dialogue on how policy frameworks at the national level 54 can best address the climate challenge.

More importantly, none of these processes contains a robust decision mechanism that includes one or more of the elements necessary for an integrated governance framework as explained in chapter 2.2. While the NECPs and the LTSs are currently the only frameworks where investment needs are reflected, the guidance given by the Commission in that regard is too vague. This is reflected in the very heterogenous, rather uncoherent, poorly detailed, and superficial investment needs estimates that are provided by Member States.

3.2 The economic governance framework

importance of the EU budget, and particularly the Multiannual Financial Framework (MFF) which is the total EU budget to implement internal and external policies for a seven-year period. This budget plays a substantial role for Member States, some particularly more than others 55, and civil society 56. The overall EU budget available from 2021-2027 is the largest one ever, totaling €1.824 trillion. It consists of the new MFF and a new instrument, the Next Generation EU Fund (NGEU) 57 , a financial instrument introduced by the Commission in response to the economic fallout of the Covid19 crisis, mainly consisting of the Recovery and Resilience Facility (RRF) vi.

3.2.1

Purpose and structure of the European Semester

The EU has an economic governance framework, made of three main branches: to monitor, to prevent and to correct potential economic problems, before they can affect other Member States and the EU overall. These three lines of action are implemented through the European Semester. This is a tool created by the Commission in 2011 to address the consequences of the economic and financial crisis of 20082009. It focuses on coordinating the economic, financial and employment policies of Member States and monitoring their budgetary plans on a yearly basis, with the help of two main sets of regulations: the Stability and Growth Pact (SGP) and the Macroeconomic Imbalance Procedure (MIP) vii (more details on the history of the European Semester and its different processes in the Annex: Details on timelines of governance frameworks).

While the climate and energy governance framework is not yet well adapted to appropriately consider the financial and economic dimension of the green transition, the economic governance framework, on the other hand, has an established coordination and monitoring mechanism in place, with a track record of assessing and facilitating policy action (at EU and national level) on investment-related challenges: the European Semester. The following sub-chapters and the Annex: Details on timelines of governance frameworks” describe in detail what the European Semester is and clarify its functioning by presenting the different processes that make up the Semester cycle. This chapter establishes the

vi

See our publication for more details: Climate & Company (2021), Assessment and monitoring of the Recovery and Resilience Facility – how does it work and how can it deliver the Green Deal? vii The Semester also contains other ad-hoc regulations, such as on crisis management which sets the legal basis for programmes such as in Greece.

However, these regulations were put in place as a consequence of the financial crisis of 2009 and so are not of use anymore.

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Figure 1: Purpose of the European Semester

Although the Semester was initially mainly focused on economic reforms, it has evolved. It now integrates fiscal, labour and social policy coordination within the EU. In December 2019, the Communication from the Commission on the Green Deal 58 announced the intention to refocus the European Semester process to integrate the UN SDGs and to put sustainability and the well-being of citizens at the centre of economic policy. The SDGs’ indicators were integrated in an Annex to the 2020 Country Reports, but the resulting Country-

Specific Recommendations (CSRs) did not consider Member States’ performances on these indicators 59.

Figure 2 shows the European Semester cycle as it ran up to 2020. The next sub-chapter introduces the Recovery and Resilience Facility (RRF), an instrument which brought temporarily changes to the Semester structure.

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Figure 2: The European Semester cycle until 2020

3.2.2

The Recovery and Resilience Facility as response to the Covid crisis

The Recovery and Resilience Facility (RRF) 60 is a temporary recovery instrument of €672.5 billion of loans and grants launched by the European Commission to allow Member States to economically recover from the Covid pandemic while delivering the EU’s objective of a green transition. The European Semester is explicitly considered as the reporting mechanism under the RRF regulation (Article 27) viii (more details and information in the Annex: Details on timelines of governance frameworks). Under the RRF, Member States were required to submit a national Recovery and Resilience Plan

(RRP) if they wished to receive support from the EU instrument. These plans needed to highlight, inter alia, the investments and reforms that Member States will implement with the funds of the RRF until 2026.

Member States are asked to design their RRP in a way that at least 37% of the plans contribute to the green transition, which the Commission and the Council assessed before approving each national RRP. For their assessment, the Commission and the Council used so-called ‘EU climate markers’ 61, inspired by the OECD Rio markers. Under the EU Climate markers, an activity can then

viii

See our publication for more details: Climate & Company (2021), Assessment and monitoring of the Recovery and Resilience Facility – how does it work and how can it deliver the Green Deal?

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‘significantly’, ‘moderately’ or ‘insignificantly’ contribute to climate objectives, represented by markers of 100%, 40% or 0% respectively. The two think-tanks Wuppertal Institute and E3G have created what they call the ‘Green Recovery Tracker’ 62, which identifies the RRPs’ contribution to the green transition, particularly assessing if Member States will deliver the 37% threshold imposed by the Commission. Their methodology largely mirrors the EU climate markers used by the Commission in the context of the RRF, but also contains more stringent and detailed criteria. Under the Green Recovery Tracker, many RRPs do not meet their 37% of green plans requirement, while these same plans have been approved by the Commission and the Council. This suggests that the definition of the “green share” of the RRF is weak and should be made more precise.

From our experience analysing Czechia’s RRP ix, we found that the proposed measures and reforms simply do not go far enough to drive a transformative green transition needed to meet EU climate goals. Even though the Commission approved the Czech Recovery Plan and confirmed a climate share of 41.6%, it also stated that the allocation attributed to climate-related actions appeared only partially satisfactory 63.

The Green Recovery Tracker’s assessment of the Czech Recovery Plan 64 claimed that shortcomings from Czechia’s NECP filters through in the RRP, which is likely the case in other countries whose NECP lacks the necessary details to cause change. In our exercise to determine which investments could strongly accelerate Czechia’s green transition, we read the Czech RRP; analysed investment barriers and opportunities in Czech sectors of buildings, district heating, vehicle transport, renewable energy, grids, and industry; estimated the investment needs and gaps in each sector; and proposed reforms and finance instruments needed to implement a more transformative change. This practice led us to propose country-specific recommendations at the sectoral level, indicating a gap in what was proposed in the Recovery Plans and what is needed to drive transformative change.

There is currently no planned process to fully evaluate ex-post if the measures and policies implemented by Member States delivered on its “green transition” goals as planned in the RRPs. To monitor the implementation of the RRF, the Recovery and Resilience Scoreboard 65 entered into force in December 2021. Its aim is to display EU countries’ progress in implementing their RRPs and to depict common indicators to

report on progress and evaluate the RRF and the national plans. This tool aims to transparently convey information on the implementation of the RRF to European citizens and will be used to prepare the Commission’s annual report on the implementation of the RRF to the European Parliament and the Council. It will also serve as a basis for the Recovery and Resilience Dialogue between the Parliament and the Commission. The first reporting of the common indicators by Member States will take place in February 2022 and will then take place twice a year, by the end of February and the end of August 66 . While the RRF Scoreboard is a good initiative to increase transparency and visibility or the implementation of such an important financial tool, its indicators will not sufficiently shed light on the exact impact of the activities in the RRPs 67 . This is a missed opportunity to evaluate how coherent and correct the Commission’s climate markers are, and to reform and strengthen them accordingly. So, while the introduction of a ‘green transition contribution threshold’ through the RRF and thus the Semester is an important step towards the creation of a concrete link between financial and climate considerations, the current initiatives are insufficient to achieve this.

In 2021, the Semester was adapted to incorporate the RRF and the assessment of RRPs x . The 2021 Country Reports were replaced by the Commission’s assessment of the RRPs 68. We welcome that the whole in-depth analysis of the Country Reports will be taken up again in the 2022 Semester cycle 69.

This is a decision we fully endorse because the creation of these reports is a useful usual exercise to discover which financial and macroeconomic issues Member States may face.

The Country Reports represent the whole essence of the Semester and its country-specific monitoring framework.

The introduction of the RRF has opportunistically turned the European Semester into a tool for steering financial EU level resources to Members States and to encourage Member States to identify more or less specific spending categories. This represents an opportunity to make recommendations (including those related to the achievement of the Green Deal objectives) more binding, by linking them to the financial resources, beyond mere macro-economic conditionality. In the past, because of the non-binding character of most of its policy processes, the Semester was considered “merely technocratic” 70. Member States had lacked the willingness to thoroughly implement the CSRs, as there was no legal basis

ix

See our website for more details : Climate & Company (2021), Financing the European Green Recovery; Climate & Company (2021), 6 sector-specific ideas for Czechia’s green transition. x See our publication for more details: Climate & Company (2021), Assessment and monitoring of the Recovery and Resilience Facility – how does it work and how can it deliver the Green Deal?

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and enforcement mechanism to ensure compliance of Member States with the recommendations they receive. This prompted some scholars to question the usefulness of this tool 71.

However, with the emergence of the RRF, Member States’ access to EU funds is made conditional on the implementation of their RRP, which transforms the Semester from a mostly soft monitoring tool to an integrated political process for economic policy and budgetary planning, including the access to EU funds x, 72.

Before the adoption of the RRF, the European Semester coordinated and monitored the structural reforms and the budgetary policies of Member States. In the 2021 cycle, the assessment of RRPs replaced the assessment of NRPs as well as the 2021 CSRs otherwise given by the Commission and Council.

The 2019 CSRs are still valid and long-term issues of structural reforms are still the essential purpose of the European Semester. Indeed, Member States were required to address all

or a significant share of the 2019 CSRs in their RRPs. While some countries have only partially considered the 2019 CSRs in their economic reform plans for the green and just transition 73 , the RRF remains an important tool for the Commission to request Member States to specifically address certain recommendations and only grant EU funds once they are fulfilled 74.

While the Semester cycle was adapted to coordinate and monitor the rollout of the RRF, the Commission and Member States recognize that there is now a need to review the EU economic governance in light of new climate and energy challenges beyond the RRF 75.

3.2.3

Why can the European Semester be useful for delivering the European Green Deal?

The European Semester’s unique structure can benefit the EU environmental governance in multiple ways.

Figure 3: Six elements of the European Semester useful for delivering EU Green Deal objectives

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First, the Semester process makes economic policies of Member States and the Commission’s assessments highly visible because the Semester documents xi are made public.

The mechanism brings together finance ministers from all Member States and key European policy makers on a regular basis, ensuring that ownership is held at the highest level and in the finance and economic affairs ministries, which are in positions of relative power compared to other ministries, in most Member States. The annual consultation process of the Semester, along with the thorough annual country reports from the Commission increase awareness, transparency, and legitimacy of key economic policy challenges and creates the structure for a permanent iterative process or ‘policy conversation’ between Member States and EU institutions.

Issues of transparency still exist within and between Member States, and the Semester can be an opportune process to raise awareness about Member States’ performances in terms of sustainable finances.

Increased transparency and consultation of civil society organisations usually leads to better policies, and within an economic union transparency of national policies is necessary for better coordinated policy reforms.

Second, the Semester has long-standing experience in supporting and assisting Member States with their structural reforms, notably through DG Reform 76, whose functions were already in the hands of the Commission long before.

Investment programs for EU funds need to be embedded into structural reforms for a green and resilient EU, so the Semester can play an important role in this regard.

Third, the European Semester provides in-depth countryspecific expertise through different country teams and a network of European Semester officers (see Box 1). These country-specific analyses and advice consider the different geographic, economic, and social contexts across Member States, which is necessary for follow-up policy actions to be effective and efficient.

Fourth, the European Semester also comprises an important surveillance arm, which represents a unique instrument to monitor economic, as well as environmental imbalances of Member States. The budgetary surveillance regime under the Semester is an important mechanism which requires Member States to declare budgetary priorities and coherence with key

EU economic and fiscal policy objectives. This regime has an important impact on ensuring that budgetary positions of Member States are coherent with and even prioritise EU sustainability targets.

Fifth, the Commission has an important soft instrument: the Country-Specific Recommendations (CSRs). While their usefulness has been debated because of their low implementation rates over the years xii, CSRs remain valuable.

Through the CSRs, the Commission has the opportunity to support Member States with concrete policy recommendations. The CSRs are an instrument used by the Commission to inform Member States that they might face ‘inaction risks’, even though not explicitly described. The wider public, national think-tanks, opposition parties and civil society organisations have access to this information; and the relevant ministers (finance, employment, etc) are exposed to a scrutiny. This instrument exposes shortcomings and affects a Member State’s reputation, especially when challenges are not addressed over multiple annual cycles.

Sixth, the National Reform Programmes form an essential tool for the Commission to assess if Member States are taking the necessary measures to comply with the objectives of the Europe 2020 Strategy and the CSRs. The Europe 2020 Strategy 77 is considered the Commission’s previous equivalent of the EU Green Deal and is the EU’s ten-year strategy for smart, sustainable and inclusive growth, whose targets cover employment, climate change and energy sustainability and education, amongst others. The long-term targets of the Europe 2020 Strategy were only partially achieved and the European Environmental Agency (EEA) argued that the efforts of Member States in improving energy efficiency have not gone far enough. 78 However, the European Semester did not issue enough warnings or provide concrete recommendations on how to improve policies to deliver the Strategy’s targets xiii. This could be explained by the fact that the Commission does not require Member States to evaluate the undertaken measures to deliver the different targets, and to report of these evaluations in their NRP xiv . As result, the Commission and Member States are unable to differentiate between successful and unsuccessful measures and policies.

If the Commission required Member States to provide an expost evaluation of their measures, the NRPs could become a more effective tool to monitor the cause of progress (or

xi

Such as national budgetary plans, Country Reports, Country-Specific Recommendations, National Reform Programmes, etc.

See our recent publication for more details : Climate & Company (2021), Insights from the Country-Specific Recommendations of the European Semester. xiii The 2019 CSRs for Ireland seems to be the only ones clearly indicating that the Member State will not be able to achieve the climate goals of the Europe 2020 Strategy. xiv See our recent publication for more details: Climate & Company (2021), Anecdotal insights from a quick comparative analysis of National Reform Programmes of the European Semester. xii

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deterioration) ahead of time and to then promote best practices in the whole EU.

3.2.4

Conclusive notes on Chapter 3.2

Currently, the mechanisms within the European Semester lack the three necessary elements to ensure a coordinated, efficient, and socially just green transition, namely (1) a consistent sustainable investment gap assessment, (2) a surveillance mechanism for environmentally harmful government support, and (3) employment policies reflecting the impact of the green transition on the labour force. The Semester does not yet adequately address the challenges Member States’ economies are facing to achieve the 2030 and 2050 targets.

This gap may lead to greater and irreversible economic consequences resulting from physical and transition risks, whereas a Semester “fit” to deliver the Green Deal could strengthen the Member States ability to achieve the Paris Agreement Commitments and the European Green Deal.

The Semester repeatedly received criticism 79 regarding the poor implementation of its CSRs by Member States and thus the lack of national ownership, and the lack of enforcement power of the Commission xv. However, the Semester has very important and useful processes which can be adjusted to reflect the need for a new economic paradigm. While the embedment of the RRF in the Semester is a first step in aligning environmental and economic sustainability requirements, these capabilities can be largely improved.

Box 1: Who works on the European Semester at the European Commission Country teams are economists and policy officers working in the European Commission in the various DGs according to their policy focus. The main ones in charge of the European Semester are: •

SG (Secretariat General) coordinates the core group

Core group: • DG ECFIN (economic and financial affairs); • DG EMPL (employment, social affairs and inclusion).

• DG GROW (internal market, industry, entrepreneurship and SMEs); • [DG FISMA (financial stability, financial services and capital markets union)] Other DGs are also in charge of the Semester for more specific areas such as: • • • •

DG RTD (research and innovation), DG CLIMA (climate action) DG ENER (energy); DG MOVE (mobility and transports).

To steer the implementation of the RRF, the European Commission established within its Secretariat-General the Recovery and Resilience Task Force (SG RECOVER). They work closely with DG ECFIN to coordinate the European Semester and the elaboration and progress on the RRPs, amongst other things.

European Semester Officers (ESOs) are located in the Commission Representation in each Member State. A link is thus created between the Commission and the Member States’ governments on how to make policies and ensure a smooth policy coordination. ESOs are part of the so-called country teams, which comprises desk officers from each core DG and most other DGs.

xv The Excessive Deficit Procedure was never used, even though all conditions for sanctions were met, e.g. for Portugal. The Excessive Imbalance Procedure has also never been activated.

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3.3 Interlinkages between EU economic and climate and energy governance frameworks This chapter explains how the previously described elements of the economic and climate and energy governance framework are interlinked.

up in the NECPs xvi. Moreover, the NECPs and the RRPs do not have the same timeline, as the RRPs are running for the next 6 or 7 years and the NECPs are covering the period until 2030, which can raise confusion amongst Member States. The RRF Regulation does not mention that RRPs should be consistent with national LTSs, so Member States were not required to embed their RRPs in the long-term perspective of the 2050 target.

3.3.1

3.3.3

The Energy Union and the European Semester

The Governance Regulation of the Energy Union 80 explicitly mentions the European Semester (Chapter 2, Article 14 (5)), stating that the NECPs updates shall take into consideration the latest CSRs issued in the context of the European Semester.

However, the Commission only has some power with regard to renewable energy. Until 2015, the Semester had an energy and climate outlook in its Country Reports. The Juncker Commission removed most climate and energy considerations from the Semester cycle to be taken up via the Energy Union governance processes. 81 What was left in the Semester was the monitoring of progress made towards the Europe 2020 objectives. However, the Commission and the Council usually omit to include climate and energy considerations into their CSRs over the years. Only the 2019 CSRs contained short recommendations related to energy effiency and renewable energy for a limited number of Member States. So, it is very unclear and uncertain to what extent the 2020 NECPs were based on energy recommendations from the Semester, as the latter did not provide some for each Member State, or they were not very extensive.

3.3.2

The Energy Union and the Recovery and Resilience Facility

The Commission required Member States to make their RRP consistent with their 2019 NECPs. However, as explained, the 2019 NECPs did not consider the raised climate and energy ambitions and are, especially when it comes to assessing investment needs and gaps and financing mechanisms, mostly rather vague, thus failed to deliver a sustainable investment pipeline 82. The RRPs would have benefitted from being based on a thorough analysis of investment needs and gaps as well as concrete strategies of how to close them drawn

The European Climate Law and the European Semester

The European Climate Law 83 only mentions the Semester in one sentence by saying that, when assessing national measures and giving recommendations to Member States: “the recommendations shall be complementary to the latest CSRs issued in the context of the European Semester” (Article 7.2.c). However, as explained earlier, since 2015, the Semester recommendations do not adequately consider energy and climate challenges, so the role of the Semester in the European Climate Law remains focused on economic and financial stability. The Law would have the potential to be a helpful means to establish a clear division of roles between the NECPs, the LTSs, the Semester and other relevant policy mechanisms.

3.3.4

The Fit for 55 Package and the European Semester

The European Semester is not mentioned in any of the proposals of the Fit for 55 Package 84. We see this as a missed opportunity, as the Semester can play an important role in monitoring how the different funds under the Fit for 55 legislations are disbursed and if they are in line with climate objectives.

3.3.5

The Renewed Sustainable Finance Strategy and the European Semester

The Strategy 85 does not mention the European Semester, which is a missed opportunity as its monitoring and coordination tools have the potential to stimulate sustainable investments from private and public sources.

xvi

See our publications for more details: Climate & Company (2021), Assessment and monitoring of the Recovery and Resilience Facility – how does it work and how can it deliver the Green Deal? ; Agora Energiewende, Climate & Company (2021), Matching money with green ideas - A guide to the 2021–2027 EU budget.

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3.3.6

Conclusive notes on Chapter 3.3

Figure 4 depicts the different mechanisms under the current economic and environmental governance framework and

their explicit link with the European Semester, in cases where one exists.

Figure 4: Governance structures and their interlinkage with the European Semester

Currently, the links between the economic and energy and climate governance regimes are weak, and the different processes clearly lack much needed coherence. This incoherence has a negative impact on the overall progress towards energy and climate targets. This is partly due to the complexity of the numerous tools put in place to deliver the different targets, which leads to uncertainty around what is required from under each instrument 86. A lack of coherence also means that synergies and trade-offs are not considered across the different frameworks, which may impact Member

States’ progress towards sustainability targets negatively. One of the central roles of the Semester has always been the coordination of policies, but the current governance structure is not sufficiently coordinated to achieve the climate and energy targets. The Semester could play a significant role in leading a coordinated move towards the climate and energy targets. Not using the European Semester to its full potential is a missed opportunity in the different strategies and policy frameworks, as highlighted above.

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4 A REFORMED EUROPEAN SEMESTER MAKING BUDGETARY SURVEILLANCE AND THE MACROECONOMIC IMBALANCES PROCEDURE WORK FOR THE CLIMATE TRANSFORMATION

The EU economic governance framework needs to be strengthened in order to be fit to rise to the challenge of transitioning economies towards a climate-neutral EU. This can be achieved by suggested changes that are outlined in this chapter. Some of these adjustments are already evident in the RRF Regulation, while others still need to be fleshed out. Our proposals aim to address the three elements we see missing in an integrated governance framework, namely (1) a consistent sustainable investment gap assessment, (2) a surveillance mechanism for environmentally harmful government support, and (3) employment policies reflecting the impact of the green transition on the labour force. Our proposals are based on the principle of linking fiscal and budgetary planning with the financial aspects of progressing towards achieving climate targets. By focusing on the financial aspects of the climate and energy targets, the primary focus of the Semester is kept, while acknowledging the need to transform our economies to reflect the shift in economic paradigm introduced by the Green Deal.

The first sub-chapter below presents ideas that can be readily implemented in the short-term. The next sub-chapter presents reform ideas that would require more long-term and legislative changes, but are crucial to ensuring that economies can respond to the massive sustainability transformation that is underway.

4.1 Reforming the economic and climate governance frameworks in the short term This chapter covers reform ideas that would either not require legal changes in relevant legislations and regulations and/or that have a high potential for being politically feasible. These ideas are ready to be incorporated in th near term (up to 2023).

4.1.1

Aligning monitoring frameworks of different economic and governance structures

As explained in chapter 3, there are various economic and climate governance structures, yet their interlinkages are weak and inadequately support Member States with the green transition. This has effects on the different monitoring frameworks under each governance structure. For example, the frameworks include various different scoreboards such as the RRF Scoreboard, the NECP indicators, the Social Scoreboard and the MIP Scoreboard, but the scoreboards lack coherence. As each considers sometimes similar fields but with different indicators, collectively they miss the opportunity to make use of possible synergies between them.

For example, the Governance Regulation contains various indicators on energy, climate and related investment needs which Member States can make use of when reporting on the progress made on their NECP. However, the RRF Scoreboard,

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which should measure Member States’ progress on using recovery finance to achieve the green transition, does not align with them. This could be a missed opportunity to make the reporting mechanisms of the RRF and NECP more coherent, as these two processes should, from the RRF Regulation, be consistent 87 . Therefore, we recommend that a future integrated scoreboard should address these shortcomings 88.

As with the EU 2020 Strategy until 2020, we propose to have a limited subset of key targets which the EU and Member States need to reach which makes it easier to create a narrative and to communicate on progress. Finally, there is also a need to enable these convergences by changing the internal governance and process within the European Commission.

4.1.2

Improving the implementation of Country-Specific Recommendations (CSRs)

The Semester’s Country-Specific Recommendations’ (CSRs) implementation rate is low as briefly stated in chapter 3.2.3, partly due to their non-binding nature, the fact that almost each CSR now contains multiple issues and the challenging timeframe for implementation Member States are facing xvii .

National progress towards climate and energy targets requires extensive tracking of Member States’ budgetary planning and structural reforms. Thus, monitoring Member States’ economic policies in more depth through the Semester would allow for the formulation of more specific CSRs. We see two points where the CSRs could be improved to increase their implementation rate without changing their legal basis. The RRF implementation in the coming years is a unique opportunity to move into this direction.

First, the Commission should draft differentiated CSRs according to a clear timeline, separating between short-, medium- and long-term recommendations. In addition, CSRs should be differentiated according to annual or multiannual CSRs, while keeping the annual cycle of assessment.

Therefore, CSRs should outline the policy recommendations and the expected timeframe for achieving them. The addition of a timeline will improve the consistency of CSRs and avoid the repetition of certain CSRs every year. It will also help Member States understand for which recommendations they should expect results shortly after the implementation of measures and for which recommendations they should expect the results to be taking more time and which require measures to be taken with a long-term vision.

xvii

Second, CSRs would be more effective if they focused on measurable and quantitative targets, where applicable. They should further highlight different levels of urgency for recommendations, so priorities are clear. Recommendations should stay in place until they are implemented by the respected Member State. The status of the recommendations could be displayed publicly by using the following categories: closed-implemented,-open-not-implemented, reendorsed-until-implemented. To give more concrete and meaningful guidance, the recommendations could be linked to best-practice examples of actions that Member States can choose to follow or not. To follow the implementation of the CSRs, the Semester could introduce an action tracker, which could be inspired by the RRF milestones and targets mechanism, in which Member States highlighted which targets they would follow by which dates.

While these two points do not have a direct climate dimension, their incorporation in the overall European Semester’s structure will indirectly have a positive impact on climate and energy issues through enhanced implementation of the CSRs which could highlight climate-related macroeconomic and fiscal issues.

4.2 Reforming the economic and climate governance frameworks in the medium- to long-term Addressing the different issues highlighted in chapter 2.2 requires reforms that would involve changes in legislations and regulations, and which would thus need to be endorsed by the European Commission, the Council and the European Parliament over the medium- and long-term. This chapter presents five key reforms which in our opinion should be prioritized. Of course, implementing all five of these reforms will represent quite some work for the European Commission services. So, the Commission should assess the feasibility of each recommended reform and choose which ones are preferable to implement, or in which order these reforms should be implemented.

4.2.1

Monitoring the sustainable investment gap

A closer monitoring of carbon emissions, energy efficiency, energy renewables and other climate and energy targets is a

See our recent publication for more details : Climate & Company (2021), Insights from the Country-Specific Recommendations of the European Semester.

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legitimate part of the Energy Union governance, such as within the National Energy and Climate Plans (NECPs). On the other hand, the financial aspects of delivering these targets, namely through making progress on closing the sustainable investment gap, would be strengthened by being part of both the Energy Union and the Semester cycle. In principle, the NECPs have the mandate to serve as the overall strategy documents for a country when it comes to climate an energy targets. However, as explained in chapter 3.1.1, the quality of the climate and energy investment needs assessments and strategies in NECPs had severe shortcomings. So, the financial dimension of the NECPs will first need to be improved. In addition, investment needs and gaps also need to be assessed for objectives not included in the Governance Regulation of the Energy Union.

The NECPs and the Semester should both play different but complementary roles in reporting/monitoring data on investment plans/gaps. We suggest that NECPs remain the place for setting out the broader plan of measures and setting out the investment plan. The European Semester, on the other hand, should act as the mechanism for: 1.

Mainstreaming the investment plan into Member States’ fiscal policies;

2.

Monitoring the investment gap deliver the Green Deal and reach the EU’s energy and climate targets;

3.

Engaging with Member States finance ministries on the role of public finance in closing this gap.

Without a thorough understanding of investment needs and gaps per sector, drawing up suitable policies to close the gap is impossible. The Commission will be in a position where it is unable to provide concrete guidance and support to Member States. With a thorough analysis of investment needs and a close monitoring of progress on closing the investment gap, Member States are in a position to assess in which sectors they are on track or where corrective action has to be taken. The inclusion of the monitoring of sustainable investment needs and gaps in the European Semester sets a supporting and guiding role for the European Commission, which would be able to use tools such as the CSRs to govern Member States’ progress on closing their sustainable investment gap.

Another argument to involve the Semester in the monitoring of the investment gap part of the NECPs is that the NECP reporting cycle is currently biennial, and while energy and climate targets might be less sensitive to policy changes and financial reforms, there is a need to identify now whether Member States are on track with investments plans and to assess their progress regularly. The biennial reporting under the NECPs is too slow to enable the Commission to properly track and influence national financing arrangements. We

highly recommend that reporting should be annual to enable sufficiently timely monitoring and influencing of national financing located in the NECPs. This could be achieved through linking it to the Semester.

How can the European Commission support and monitor investments needs and gaps assessments?

Member States previously received very limited guidance on how to track their investment needs under the NECPs. The Renewed Sustainable Finance Strategy already states that, through a robust monitoring framework, the Commission will support Member States in assessing their sustainable investment gap and measuring the progress made by financial sectors to achieve the EU’s climate and environmental targets 89 . Supporting and monitoring Member States with regard to finances falls under the competences of the Semester. The Commission has set up the EU Platform on Sustainable Finance 90 as an advisory body for matters related to the development of sustainable finance policies.

One of the Platform’s mandates is to monitor and regularly report to the Commission on trends regarding capital flows towards sustainable investments. The Platform could play an essential role in advising the Commission on a common methodology for assessing investment needs. This will ensure that investment and the likely gap for reaching the climate and energy targets will be consistently identified and measured (see Box 2 for more details on our work on investment needs assessment methodologies). Then, the Semester would promote such methodology and require Member States to use it in the Semester cycle when drafting their budgetary plans and composing their NRPs. One way to do so is by introducing a new indicator in an extended Semester Scoreboard, additionally to what currently constitutes the MIP Scoreboard. This indicator could take a “progress-to-target” approach, highlighting the progress on closing the sustainable investment gap 91 . This indicator could be used in the MIP or in another “early alert mechanism” which would highlight the risks of macroeconomic imbalances due to the lack of sustainable project pipelines and the risk of not reaching the climate and energy target in due time. The Commission, depending on the performance of Member States on closing their sustainable investment gap, would then be able to draft CSRs and give guidance on where and how to increase capital flows.

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Box 2: Assessing sustainable investment needs There are different types of models that can be used to assess the investment needs in relation to climate and energy targets. Juergens et al (2019) present multiple models to identify investment needs and note that, “estimates of investment needs depend on assumptions that are taken along the course of the modelling-process. Some are more important than others, some are more controversial than others and some may not be obvious in the face of the (necessarily) complex modelling framework required for sophisticated estimates”. They concluded that: •

the choice of scenarios influences the estimated investment needs,

•

the models differ in their assessment of investment, and

•

the investment needs assessments are sensitive to the underlying assumptions.

For those estimating investment needs, it will be important to have a sound understanding of the available (and suitable) analytical frameworks, as well as their key features and “what to pay attention to“ when planning such an assessment, when commissioning respective studies or when, as a last step, interpreting modelling outputs provided to them.

Source: Juergens et al. (2019) - How to Assess Investment Needs and Gaps in Relation to National Climate and Energy Policy Targets? A Manual - and a Case Study for Germany

Another channel to use this new indicator is in the context of the EU fiscal framework, particularly if reformed. Proposals have been made by experts 92 to exclude certain sustainable investments from the different fiscal rules of the SGP. The sustainable investment gap could serve as an indicator for the maximum amount of sustainable investments to be exempted from the deficit rules, or could be used for the design of country plans working in a similar manner as the RRPs.

4.2.2

Greening national budgets

The national budgetary plans submitted by Member States at the beginning of every Semester cycle are missing a climate and sustainability tracking methodology. There is currently no common practice for climate tracking of national budgets across Member States. As part of the budgetary plans that Member States must submit at the beginning of every Semester cycle, requiring Member States to assess the extent to which their budget is aligned with sustainability objectives would shed light on the national governments’ intention to implement their political ambitions. Furthermore, this is an opportunity to transparently report to what extent national budgets contribute to closing the sustainable investment gap.

On top of monitoring capital flows to sustainable investments as part of the investment gap assessment, we recommend that

the Semester takes the role of monitoring capital flows to unsustainable activities, contributing to observing the Member States’ financial market stability and examining the flow of private and public capital towards unsustainable development.

Certain tools already exist and aim to go in that direction, such as the EU Taxonomy 93 which contains criteria to classify an investment as contributing to climate mitigation or climate adaptation and will soon contain criteria for the other four environmental objectives. However, the Commission made, on 31 st December 2021, a proposal to include gas and nuclear energy as ‘sustainable investments’, which has triggered massive criticism by the investor community, the Commission’s own advisory group (the EU Sustainable Finance Platform), many Member States, NGOs, think tanks and civil society organisations 94.

France, the Netherlands, Ireland and Italy already have national climate investment tracking methodologies. France already uses a method that is aligned with the six objectives of the EU Taxonomy 95 . In Germany the pressure to monitor climate protection investments in the budget, using a climate tracking approach derived from the EU Taxonomy, is increasing 96. At EU level, the ECA, in one of its recent audits 97,

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and previous report co-authored by Climate & Company xviii analysed that the existing climate tracking approaches in EU funds (inspired by the “Rio Markers”) are imperfect and are shown, in some cases, to significantly overstate climate contributions, thus undermining the credibility of the EU’s climate action commitment. The Commission announced in the Renewed Sustainable Finance Strategy, published in July 2021, that it is committed to producing updated and strengthened tracking methodologies on both climate and biodiversity 98. It states that those tracking methodologies will be key to monitor that climate and biodiversity spending under the 2021-2027 MFF align with the EU’s ambition.

Furthermore, the Strategy explains that the Commission has developed a green budgeting reference framework and reports on the different green budgeting practices in the EU for any Member States who are interested in redirecting their national budgets to green priorities 99.

The implementation of the RRF showed that using different methodologies to determe the climate share of budgetary items can lead to relatively divergent results. The ‘Green Recovery Tracker’ 100 , established by the Wuppertal Institute and E3G to identify the RRPs’ support for the green transition, diverges from the Commission’s climate markers methodology used to assess the contribution of the RRPs to climate and energy targets. A comparison of the results from the Green Recovery Tracker’s assessments and the Commission and Council’s assessments proves that differences in methodologies play an important role in assessing how sustainable expenditures are.

There is currently no harmonized methodology to tag the “sustainability” of budgetary items across Member States. The approach to green budgeting should be designed with multiple factors being considered 101. First, an expenditure can have ‘hidden’ effects on the climate and the environment, meaning that the direct and indirect impacts of a spending should be measured. Second, expenditures can tackle a wide range of different environmental objectives, which also means that expenditures can have positive impacts on certain objectives but be harmful for others. Third, the level of contribution to environmental objectives can differ from one expenditure to another. Fourth, environmental targets and policies change over time, meaning that the definitions behind what is considered a ‘green’ expenditure may vary over time (e.g. activities that will help meeting the 2030 goal of 55% GHG emission reduction (such as mixing biofuels with fossil

xviii

fuels) but that will not be a solution to meet the 2050 target of net-zero emission).

Concretely we propose that the Economic and Finance Committee (EFC) in collaboration with the European Commission proposes a code of conduct on green budgeting to be implemented by all member states within their budgetary frameworks.

How can the European Commission implement a climate and sustainability tracking method for national budgets?

For Member States to report on the greenness of their national budget, a common tracking method would ensure comparability of results across Member States, lower the risk of green washing, and ensure that the reported information is accurate. In fact, a robust methodology needs to better assess the impact of the budget on the environment. The current Rio Markers are not adequate for a legitimate understanding of the contribution of budgets to sustainability objectives. The Commission and the EFC should develop this common methodology with the help of advisory platforms such as the Platform for Sustainable Finance.

The Semester has the potential to serve as a support mechanism for Member States to use green budgeting tools and as the reporting mechanism for the usage of green budgeting methodologies.

Furthermore, with the introduction of the RRF, Member States’ access to funding is made conditional on achieving certain milestones and targets outlined in the RRPs. The link between the European Semester process and the EU budget should remain even once the RRF is concluded, in particular where there is a strong link between EU funds and the implementation of climate policies and climate-related investments. The Commission and the Member States who have welcomed the linkage between Member States’ access to EU funds and achieved reforms will likely keep the same opinion for the future 102.

4.2.3

Monitoring environmentally harmful government support

As explained earlier, national governments of Member States are still giving support to unsustainable activities, such as subsidies for the production and consumption of fossil fuels.

This kind of financial support needs to be urgently phased out, a process which could be supported by the Commission being in a position to monitor the progress of Member States in this

Climate Strategy, Climate & Company (2020): Applying the EU Taxonomy: Lessons from the Front Line.

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regard. The Commission and all Member States would benefit from having a clear understanding on what the state of play of environmentally harmful support is, as to be in a better position to draft recommendations on how to phase it out and how to better allocate resources towards sustainable projects.

There is currently no standard definition across the EU of what an environmentally harmful subsidy is, and no institution is currently collecting data on these kind of subsidies for all Member States. The same goes for other government support to environmentally harmful activities, such as harmful tax advantages. Coordinating Member States’ understanding and reporting of such harmful government support would reduce administrative work for monitoring entities and ensure that all Member States are heading in the same direction. There is thus a need for the design of a common definition of environmentally harmful subsidies and overall support from the government and a common methodology to track them throughout the EU. The 8th Environmental Action Programme 103 (8th EAP) xix , which will serve as a guide for EU environmental climate policymaking and implementation until 2030, states that the Commission is tasked to set out by 2023 a methodology to identify all environmentally harmful subsidies, on the basis of which Member States shall report their progress made on phasing them out (Article 3.1.e). The 8th EAP does not set a legally binding deadline for phasing out environmentally harmful subsidies, which is a missed opportunity to enhance pressure to phase out the subsidies 104 . The 8th EAP furthermore does not shed light on the particular monitoring framework to use to report harmful subsidies. As outlined before, the Semester could be a suitable framework to take on this monitoring role.

supports out. This procedure would then put th Commission in a position to give detailed and targeted CSRs to the Member States.

4.2.4

Monitoring the employment effects of the green transition

The green transition has significant impacts on the European labour market, for example job losses in certain industries.

There is a strong need to make the transition “just” for European citizens, which is highlighted in the EU Green Deal by the “Just Transition Mechanism“ 105. Members States’ labour policies are currently fairly general and do not sufficiently address the requirement of more specific analyses on employment guidelines and the impact of current policies on the labour market. Yet, such analyses would identify necessary actions to be taken to ensure that, for example, enough skilled labour force is available to build and maintain renewable energy systems. Moreover, the Commission needs to understand the order of magnitude of the amount of workers and types of skills needed in each industry to realize the green transition. Without this information, Member States risk facing large shortages of qualified workers, such as for sustainable building renovations as highlighted by the Commission in the Renovation Wave Strategy of 2020. 106 The European Semester already contains a branch dedicated to monitoring employment policies, as within the Employment guidelines, common priorities for national employment and social areas are presented and provide the legal basis for CSRs. The employment branch of the European Semester should thus be expanded to include better employment guidelines to make the green transition just.

How can the Commission monitor the labour market impact of the green transition?

How can the Commission monitor environmental harmful government support?

The Semester is a suitable framework to introduce an environmentally harmful subsidy and investment support surveillance program to make sure to monitor the extend of these subsidies and support. A requirement for Member States to report on their support for harmful activities when drafting their budgetary plans every year would help to understand where tax revenues are spent and where corrective actions are needed. In their National Reform Programmes (NRPs), Member States would thus be required to convincingly provide information on the measures taken to phase these

xix

The Semester needs to take a forward-looking perspective on the employment effect of the green transition, as there will be strong fiscal and social implications. Member States need to improve and report in the European Semester their impact assessment of two elements: First, Member States should assess and report the effect of their current employment policies on their macroeconomic stability to assure that new sustainable investments can, in the case of renewable energy systems and other sustainable innovations, be built and maintained by a skilled labour force.

Re- and upskilling of the work force needs to accelerate to

The 8th EAP was provisionally approved on 10th December 2021 by the European Parliament and the Council.

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avoid a massive shortage of workers for new sustainable and innovative infrastructure.

How can the European Commission utilize climate stress tests?

Second, Member States should assess and report the effect of economic policies, climate change and financial stability on employment. The green transition will lead to massive unemployment in carbon intensive sectors, so Member States will need to provide extensive training facilities to mitigate this, and to provide adequate support for workers transitioning to green jobs and to those experiencing (temporary) unemployment. Member States need to estimate the quantity and type of workers needed to to implement the Green Deal. This analysis would in turn allow the Member States to understand the investment challenge of re- and upskilling of the workforce.

We recommend that the Commission, during the Semester cycle, bases its assessment of macroeconomic imbalances on the information given by Member States, as well as the information provided by relevant sources such as the ECB 111 on climate risks to the financial system and the broader economy. So, the European Semester should not conduct its own climate stress test but should take up information already available. This assessment can be used through the MIP or related processes that would be forward-looking. Having this information directly in the hands of the Commission and as common knowledge for all Member States will help raise the importance of climate change and the consequential physical and transition risks to the economy. It is vital to know how climate resistant Member States’ economies, and the EU as a whole, are.

4.2.5

Using climate stress tests to understand the exposure and resilience of the economy

The European Central Bank (ECB) monitors Member States’ financial systems’ exposures to climate change from both physical and transition risks. 107 In doing so, it considers possible future paths of, for example, real GDP, carbon emissions and energy prices, both with and without successful climate policy action and assesses the resilience of the national financial systems to different economic and climate scenarios. More specifically, the Financial Stability Institute 108 recommends developing macroeconomic variables on the basis of the results of climate stress tests. This step is essential to translate climate risk into economic and financial impacts and risks for the financial system.

A stress test examines the potential impact of a hypothetical adverse scenario on the health of the financial system and individual institutions within it. Stress tests allow policymakers to assess the resilience of the financial system and individual institutions to a range of adverse shocks and, if needed, take measures to ensure that financial institutions are resilient and can continue to supply credit to the real economy even under stress. 109 Climate stress tests are a starting point to better understand and mitigate physical and transitions risks. The ECB’s economy-wide climate stress test shows that the impact of climate risks on companies and banks could in some scenarios initiate a collapse of the financial market 110.

Currently, the European Semester does not systematically consider climate risks to the economy, but the MIP would greatly benefit from an inclusion of impact from transition and physical risks; climate stress testing would be a suitable for doing this.

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5 THE WAY FORWARD – NEXT STEPS FOR DECISION-MAKERS

The launch of the RRF and the consequential adjustment of the European Semester offers a new window of opportunity to rethink the European Semester and, instead of returning to “business as usual”, and to structurally adjust the annual macroeconomic surveillance by: •

including core determinants of a successful “Green Deal” implementation; and

•

explicitly linking it with National Energy and Climate Plans (NECPs) and the Multiannual Financial Framework (MFF).

With the relaunched EU Economic Governance Review 112, the European Commission re-opened the debate on how to improve the current economic governance framework.

Stakeholders have voiced their concerns and have provided clear recommendations on how the Semester can serve as a mechanism to create and enhance the link between climate and economic policies, fiscal policy and structural reforms.

The Commission expects to have respective discussions with Member States, and we encourage them to come to a fruitful agreement as soon as possible. The reform of the fiscal framework has gained a lot, if not most, of the attention in the consultation. However, the other mechanisms are of high importance as well and should not be overlooked.

The following sub-chapters highlight different actors and what they can do next for a successful revision of the EU economic governance framework, particularly regarding the coordination and monitoring mechanisms of the European Semester.

5.1 Actors: who needs to do what in order to make the European Semester fit for the EU Green Deal?

5.1.1

European Commission services

Implementing the recommendations described in this report will require concrete proposals from the European Commission, based on input from the relevant DirectorateGenerals (DGs) and the Secretariat-General (SG). In the context of the European Semester, DG ECFIN and the SG are coordinating and leading the work of the Commission services; yet, to reflect a more holistic perspective on climate change and sustainability, other relevant DGs need to be fully on board and develop, with DG ECFIN and the SG, proposals for an integrated governance framework. Alternatively, the Commission could choose to have specific senior civil servants that are full-time member of the leading group – while currently the DGs and cabinets do this on top of their other duties - akin to the structure in place for the impact assessment board.

Making the European Semester fit for the EU Green Deal We support that Commission services should play an important role in the development of EU Green Deal specific monitoring, support and guidance provisions to Member States, for example: •

Developing guidance on how to use green budgeting tools, particularly in the context of the European Semester: this could include concrete proposals about what the draft budgetary plans should look like when incorporating green budgeting considerations.

•

Developing a harmonized methodology, or officially mandating an entity (such as the EU Sustainable

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Finance Platform) to develop such a methodology, to assess the sustainable investment needs and gaps.

•

Concretely reflecting the climate perspective in the CSRs.

•

Systematically monitoring the labour market effect of the green transition; and preparing a proposal about how Member States shall assess and report the emerging skills needs and gaps and the effects of the green transition on the labour force, i.e. in terms of unemployment in carbon intensive or economic activities and sectors associated with significant harm, as e.g. defined in the Taxonomy Regulation.

•

Regarding the monitoring of environmentally harmful government support and the incorporation of ECB’s climate stress test in the assessment of macroeconomic imbalances in Member States, by providing guidance on how to define and measure harmful government support, e.g. fossil fuel subsidies, and how to take the ECB’s stress tests into considerations during the MIP.

Naturally, for this top-down approach to reforming the European Semester to be successful, the European Semester country teams need to be on board. The DGs need to gather bottom-up views from each team on the overall economic governance reform required for the monitoring and implementation of the Green Deal and on each particular reform proposal made. Having country teams, which are closely in contact with national governments, thoroughly involved in the process has proven valuable in the past and will help guarantee that reform proposals are coherent, relevant and feasible.

Making the Governance Regulation coherent with an improved European Semester The idea to monitor the sustainable investment gap will require changes in the Governance Regulation of the Energy Union. DG CLIMA and DG ENER, in charge of the Governance Regulation, will have to take the lead in developing and proposing the required changes in the Regulation.

to be changed in Article 26 of the Governance Regulation xx to an annual progress report in the European Semester. The Governance regulation stipulates that recommendations given by the Commission should be complementary with those issues under the Semester. However, the Regulation does not further explain what this actually means in practice, and there is no mechanism to ensure that these recommendations are in fact complementary. The link between the Governance Regulation and the European Semester needs to be strengthened and made clearer, for example by amending Article 34.2.c of the Governance Regulation xxi . Indeed, the consistency between recommendations should also be made the other way: the recommendations provided by the Commission related to the financial planning of the NECPs and LTSs should be reenforced in the Semester cycle, though the CSRs. Member States would then have to include in their NRP the following year, and every year after that, the measures undertaken to comply with these recommendations.

5.1.2

European Parliament

The European Parliament plays a role on the employment dimensions of the European Semester by releasing an opinion on the Council’s employment guidelines. Its main role in the EU economic governance framework is in scrutinizing the implementation of it, mainly through its involvement in the economic dialogues with the European Commission, the Council, the Eurogroup and Member States. However, the Parliament now plays a more empowered role in the scrutiny of the RRF 113 . The Regulation of the RRF states different instances, e.g. Recovery and Resilience Dialogues, where the European Parliament is to receive information necessary to effectively scrutinize the implementation of the RRF. This more extensive role of the European Parliament should be continued in the long-term of the overall broader implementation of the European Semester; such dialogues between the Parliament, the Commission, Council and Member States should include broader discussions on the green transition and its incorporation in the economic governance framework.

As such, transforming the biennial reporting of the financial aspect of the NECPs (and simultaneously the LTSs) will have

xx For example by adding an Article 26.5.a: “By 30 September 2024 and every year thereafter, each Member State shall provide a report to the Commission detailing the status of implementation of the financing measures engaged for the decarbonisation of each economic sector, including Union support and the use of Union funds, of its integrated national energy and climate plan by means of a report covering all sectors covered by the plan.” xxi Example of change to Article 34.2.c : “The recommendations should be consistent with the latest country-specific recommendations issued in the context of the European Semester. Where applicable, the Commission’s recommendations shall be considered in the context of the European Semester and addressed in Member States’ National Reform Programmes.”

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5.1.3

Member States

This paper has important messages for individual Member States’ governments. Decision makers on the national level are the main actors of the green transition since they are the ones implementing reforms and policies in their country.

Applying our suggestions regarding national budgeting and policy monitoring mechanisms for the green transition would support them in focusing their strategy and reaching relevant taregts. This will empower Member States and prepare them (1) for the financial risks associated with climate change, and (2) for probable future amendments to the economic governance framework. By already considering our five key suggestions, Member States’ governments will be able to understand early which challenges and difficulties they face, e.g. when assessing their investment needs, when defining and measuring their government support to harmful activities or applying a green budgeting tool to their national budgetary plans. Moreover, it is important that the Economic and Finance Committee takes ownership of the newly created framework by adopting corresponding codes of conducts.

5.1.4

initial conclusions drawn by the Commission, but the agenda was also adjusted to reflect the sanctions imposed on Russia.

Against the backdrop of the invasion of Ukraine, it is currently uncertain how the policy agenda might change over the coming weeks and months.

We support the initiatives of the French Presidency, to put some of the reform issues identified above on the agenda. We hope and trust that the upcoming Czech Presidency will be willing and able to continue and expand this work. The EU Economic Governance review addresses many important aspects, not limited to the fiscal rules of the Stability and Growth Pact, which is why we encourage a broader reform perspective. The Czech EU Presidency could build on the inputs of the consultation on the EU economic governance review and the work of Commission services, working toward the actual adoption of concrete reform proposals for the EU’s economic governance regime and the European Semester.

Ongoing French and upcoming Czech EU Presidencies

As part of the current French EU-Presidency’s work programme 114 , discussions about the review of the EU economic governance framework will be taken forward, including on the consequences of and lessons learned from the COVID-19 pandemic, the review of fiscal rules and the MIP of the European Semester for the purpose of enabling the needed investments towards the green transition. Particularly, the French Presidency has planned to discuss an economic model for growth aligned with climate targets which offers an improved framework for suitable jobs, and to endorse work on green budgeting 115.

During their informal meeting on March 10th and 11th, Heads of State and Government had planned to discuss the topics of growth, investment and employment. However, the invasion of Ukraine by the Russian military on February 24 changed the priorities in the EU and thus the agenda points of the informal meeting 116.

The Commission published on March 2nd a Communication 117 setting out key principles that will guide the Commission's assessment of Member States' Stability and Convergence Programmes. However, these principles reflect the Commission's 2022 winter forecast, which did not factor in the invasion of Ukraine and the resulting geopolitical tensions.

On March 15th , parts of the Economic and Financial Affairs Council 118 meeting’s discussions were informed by these

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6 ANNEX: DETAILS ON TIMELINES OF GOVERNANCE FRAMEWORKS 6.1 The Governance Regulation of the Energy Union Article 17.2.e of the Governance Regulation specifies the reporting requirement for Member States’ biennial progress reports: “The integrated national energy and climate progress report shall cover […] information on the progress accomplished towards reaching the objectives, targets and contributions set out in the integrated national energy and climate plan, and towards financing and implementing the policies and measures necessary to meet them, including a review of actual investment against initial investment assumptions” and “as far as possible quantification of the impact of the policies and measures in the integrated national energy and climate plan on air quality and on emissions of air pollutant”.

By 30 June 2023, Member States must notify the Commission of their draft updates of their NECP, with the final updates due on 30 June 2024 (Article 14.1-2). Member States are also required to prepare and submit new LTSs by January 2029 and every 10 years thereafter (Article 15.1). The Governance Regulation also gives the Commission some weak tools, such as opinions and recommendations in order to articulate their concerns about ‘ambition’ and ‘delivery’ gaps.

The Governance Regulation does not contain a mandatory common template for LTSs like it does for NECPs; the Commission only provided an indication of the elements that could be included in the strategies for 2050. The LTSs submitted by Member States, when there is one, have serious shortcomings, notably regarding the assessment of investment needs for climate neutrality. The lax emphasis on the LTSs in both the Regulation and the application by Member States shows the prioritisation of the outlook until 2030, despite the growing importance of the climate neutrality objective 119.

6.2 The European Semester The SGP was introduced in 1997; it is a set of financial rules that Member States need to follow to ensure financial stability and sustainable economic growth. In the preventive arm of the SGP, Member States update every third year their budgetary targets, called medium-term budgetary objectives (MTOs).

Member States have to present the measures they will take to achieve their MTO, which is done annually through a stability programme (for Member States in the Euro area) or through a convergence programme (for other Member States). The Commission analyses these programmes and gives recommendations specific to each Member State annually.

Member States are then asked to reflect on these countryspecific recommendations (CSRs) in their national policies.

Under the corrective arm of the SGP, the Excessive Deficit Procedure is launched when a Member State has or risks violating the deficit rule of 3% of GDP or has breached the debt threshold of 60% of GDP and is not reducing it yearly by minimum 1/20 th of the of the difference between the Member State’s debt level and the 60% limit.

The introduction of the ‘Six Pack’ in 2011 strengthened the preventive arm of the SGP, but also gave rise to the MIP, as unsustainable macroeconomic imbalances risk leading to public finance challenges. This surveillance procedure aims to oversee the Member States’ economies to detect macroeconomic imbalances that could put the economic stability of a particular Member State at risk or have an effect on the whole EU. Fourteen indicators related to the three domains of the Semester are used in a macroeconomic scoreboard. At the start of the Semester, in November each year, the Commission uses the scoreboard to create the annual Alert Mechanism Report (AMR). Depending on their performance for each indicator, Member States are categorized as having either ‘no imbalances’, ‘imbalances’ or ‘excessive imbalances’. The results are communicated to Member States via CSRs, handed out around July each year.

Member States in the ‘excessive imbalances’ category receive

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MIP-related recommendations and their actions become closely monitored by the Commission. The Commission is allowed to begin the Excessive Imbalance Procedure, which consists of a corrective action plan which must be adopted by the concerned Member States within certain deadlines. If the corrective action plan is not followed and the deadlines are not met, Member States can be fined 0.1% of their GDP. In 2013, the ‘Two Pack’ legislation was introduced, setting a common timeline and common standards to be taken into account by Member States when planning their national budget. The main requirement in the Two Pack is for Member States to design draft budgetary plans by October 15 th , for the following year. This legislation should lead to stronger synergies by facilitating policy coordination among Member States whose currency is the euro and by ensuring that Council and Commission recommendations are appropriately integrated in the budgetary procedure of the Member States.

6.3 The Recovery and Resilience Facility Member States shall report twice a year in the context of the European Semester on the progress made in the achievement of its RRP, including the operational arrangements (Article 20(6) and on the common indicators Article 29(4) 120 ). In the 2022 Annual Sustainable Growth Survey (ASGS) 121 , the Commission announced that Member States shall submit their bi-annual progress reports by the end of April every year (integrated in their NRP) and by mid-October (at the same time as their draft budgetary plans). Member States can amend their RRPs if milestones and targets are no longer achievable because of ‘objective’ reasons. The Commission does not explicitly explain what is meant by these objective reasons, so the criteria of acceptance of amendments remain vague.

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See e.g. : Climate Action Network (CAN) Europe and ZERO - Association for the Sustainability of the Earth System. (2020), Pave the way for increased climate ambition - Opportunities and Gaps in the final National Energy and Climate Plans. Climate Action Network (CAN) Europe and CEE Bankwatch Network (2020). EU funds for a green recovery: recommendations to steer EU regional and recovery funding towards climate neutrality.

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35

COM(2020) 950 final Annex 2 – Annex – 2020 report on the State of the Energy Union pursuant to Regulation (EU) 2018/1999 on Governance of the Energy Union and Climate Action.

47

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Austria, Belgium, Bulgaria, Germany, Denmark, Greece, Finland, France, Italy, Lithuania, Latvia, Portugal and Spain.

Regulation (EU) 2018/1999 of the European Parliament and of the Council on the Governance of the Energy Union and Climate Action.

49

Regulation (EU) 2018/1999 of the European Parliament and of the Council on the Governance of the Energy Union and Climate Action.

50

51

European Commission (2021) - 'Fit for 55': delivering the EU's 2030 Climate Target on the way to climate neutrality

52

European Commission (2021) - Strategy for Financing the Transition to a Sustainable Economy.

53

European Commission (2021), Platform on Sustainable Finance.

Charveriat & Bodin (2020), Delivering the Green Deal: the role of a reformed European Semester within a new sustainable economy strategy 54

55

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56

European Commission (n.d.), Benefits of the EU budget.

European Union (2021), NextGenerationEU. European Commission (2019) – Communication on the European Green Deal: “As part of the Green Deal, the Commission will refocus the European Semester process of macroeconomic coordination to integrate the United Nations’ sustainable development goals, to put sustainability and the well-being of citizens at the centre of economic policy, and the sustainable development goals at the heart of the EU’s policymaking and action.” (page 3) 57 58

59

Silvia Rainone (2020) ETUI - An overview of the 2020-2021 country-specific recommendations (CSRs) in the social field.

The European Parliament and the Council of the European Union (2021), Regulation (EU) 2021/241 establishing the Recovery and Resilience Facility.

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European Commission (2014). COMMISSION IMPLEMENTING REGULATION (EU) No 215/2014 of 7 March 2014 laying down rules for implementing Regulation (EU) No 1303/2013 of the European Parliament and of the Council laying down common provisions on the European Regional Development Fund, the European Social Fund, the Cohesion Fund, the European Agricultural Fund for Rural Development and the European Maritime and Fisheries Fund and laying down general provisions on the European Regional Development Fund, the European Social Fund, the Cohesion Fund and the European Maritime and Fisheries Fund with regard to methodologies for climate change support, the determination of milestones and targets in the performance framework and the nomenclature of categories of intervention for the European Structural and Investment Funds.

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Wuppertal Institute, E3G (2021), The Green Recovery Tracker.

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Wuppertal Institute, E3G (2021),The Green Recovery Tracker - Country Report: Czech Republic.

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65

European Commission (2021), Delegated Regulation (EU) 2021/2106 on supplementing Regulation (EU) 2021/241 of the European Parliament and of the Council establishing the Recovery and Resilience Facility by setting out the common indicators and the detailed elements of the recovery and resilience scoreboard.

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68 European Commission (2020), Annual Sustainable Growth Strategy 2021.

67

69

European Commission (2021), Annual Sustainable Growth Survey 2022.

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Alcidi & Gros (2017), How to strengthen the European Semester ; Efstathiou & Wolff (2018), Is the European Semester effective and useful? ; Moschella (2020), What role for the European Semester in the recovery plan?

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73

Politico (2021) – France and Germany buddy up on spending plans.

Nguyen, T., Redeker, N. (2022), How to make the marriage work: wedding the Recovery and Resilience Facility and European Semester.

74

75

European Commission (2021), Communication: the EU economy after Covid-19: implications for economic governance.

76

European Commission’s website, Structural reform support.

77

European Commission (2010), Communication on Europe 2020 : A strategy for smart, sustainable and inclusive growth.

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European Environmental Agency (2020) – Trends and projection in Europe 2020.

Wieser, T. (2020), What role for the European Semester in the recovery plan? ; Moschella, M. (2020), What role for the European Semester in the recovery plan? ; Hagelstam, K., Dias, C., Angerer, J and Zoppè, A. (2019), The European Semester for economic policy coordination: a reflection paper ; Alcidi, C. and Gros, D. (2017), How to strengthen the European Semester? ; Ragot, X. (2017), In-depth analysis: How to further strengthen the European Semester? ; Codogno, L; (2020), Macroeconomic Imbalances Procedure: has it worked in practice to improve the resilience of the euro area?

79

Regulation (EU) 2018/1999 of the European Parliament and of the Council on the Governance of the Energy Union and Climate Action.

80

81

Adolf & Nix (2016), The Effectiveness of the European Semester from a Governance Perspective

European Court of Auditors (2021), Sustainable finance: More consistent EU action needed to redirect finance towards sustainable investment ; Climate Action Network (CAN) Europe and ZERO - Association for the Sustainability of the Earth System.

(2020), Pave the way for increased climate ambition - Opportunities and Gaps in the final National Energy and Climate Plans ; Climate Action Network (CAN) Europe and CEE Bankwatch Network (2020), EU funds for a green recovery: recommendations to steer EU regional and recovery funding towards climate neutrality.

82

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83

84

European Commission (2021) - 'Fit for 55': delivering the EU's 2030 Climate Target on the way to climate neutrality

European Commission (2021) - Strategy for Financing the Transition to a Sustainable Economy.

Hofhuis (2020), The European Commission on the Policy Brief brink of a green recovery: will it be able to deliver? ; Hagelstam et al. (2019), The European Semester for economic policy coordination: a reflection paper 85 86

The European Parliament and the Council of the European Union (2021), Regulation (EU) 2021/241 establishing the Recovery and Resilience Facility.

87

Climate & Company (2021), Feedback on the Recovery and Resilience Scoreboard from Climate & Company (published on the Commission’s website).

88

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European Commission (2021) - Strategy for Financing the Transition to a Sustainable Economy

90

European Commission (2021), Platform on Sustainable Finance.

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Claeys, G, Bruegel. (2019), The European Green Deal needs a reformed fiscal framework ; Darvas, Z., Martin, P., Ragot, X. (2018), European fiscal rules require a major overhaul ; Wolff, G., (2021), Can the EU fiscal rules jump on the green bandwagon? ; Bodin, O. (2020), Green Deal - European Semester: Green Golden Rule as a necessary link, Greentervention ; Hafele, J., Bertram, L., Korinek, L., Temory, F., Dirth, E., & Barth, J. (2021), Financing for a future-fit Europe. Feasible and impactful proposals for a reform of the EU fiscal framework, ZOE Institute for Future-fit Economies ; Suttor-Sorel, L. (2022), Breaking The Stalemate: Upgrading EU economic governance for the challenges ahead, Finance Watch ; Giavazzi, F., Guerrieri, V., Lorenzoni, G., Weymuller, C-H. (2021), Revising the European Fiscal Framework.

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European Commission (2022), EU taxonomy for sustainable activities.

Von der Burchard, H. (2022), Germany hits out at Brussels plan to label nuclear and gas ‘green’ ; Politico. Meredith, S. (2022), EU provokes fierce backlash on lans to label nuclear and gas as ‘green’ investments ; CNCB. Simon, F. and Taylor, K. (2022), LEAK: EU drafts plan to label gas and nuclear investments as green ; Euractiv. CAN Europe (2022), The EU can’t afford labelling fossil gas and nuclear as green.

94

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95

Bova, E. for the European Commission (2021), Green Budgeting Practices in the EU: A First Review.

96

Sustainable-Finance-Beirat (2021), Shifting the Trillions Ein nachhaltiges Finanzsystem für die Große Transformation.

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European Court of Auditors (2020), Tracking climate spending in the EU budget.

98

European Commission (2021), Strategy for Financing the Transition to a Sustainable Economy.

99

European Commission & OECD (2021), Green budgeting: Towards common principles.

100

Wuppertal Institute & E3G (2021), The Green Recovery Tracker.

101

Bova, E. for the European Commission (2021), Green Budgeting Practices in the EU: A First Review.

Nguyen, T., Redeker, N. (2022), How to make the marriage work: Wedding the Recovery and Resilience Facility and European Semester, Jacques Delors Centre.

102

Council of the European Union (2021), Proposal for a Decision of the European Parliament and of the Council on a General Union Environment Action Programme to 2030.

103

104

WWF (2021), Missing deadline on fossil fuel subsidies mars otherwise promising EU Environment Action Programme.

105

European Commission (n.d.), The Just Transition Mechanism: making sure no one is left behind.

European Commission (2020), Communication: a Renovation Wave for Europe – greening our buildings, creating jobs, improving lives.

106

European Central Bank (2021), ECB economy-wide climate stress test: methodology and results ; European Central Bank (2021), Shining a light on climate risks: the ECB’s economy-wide climate stress test 107

Financial Stability Institute (2021), FSI Insights on policy implementation: Stress-testing banks for climate change - a comparison of practices.

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109

Bank of England (2016), Let’s talk about the weather: the impact of climate change on central banks.

110

European Central Bank (2021), Shining a light on climate risks: the ECB’s economy-wide climate stress test.

111

European Central Bank (2021), Climate-related risks to financial stability.

112

European Commission (2021), Communication : the EU economy after COVID-19: Implications for economic governance.

113

European Parliament (2021), European Parliament involvement in scrutinising the Recovery and Resilience Facility.

French Presidency of the Council of the European Union (2021). Recovery, Strength and a Sense of Belonging – Programme for the French Presidency of the Council of the European Union.

114

French Presidency of the Council of the European Union (2021), Recovery, Strength and a Sense of Belonging - Programme for the French Presidency of the Council of the European Union.

115

116

European Council (2022), Informal meeting of heads of state or government, Versailles, 10-11 March 2022.

117

European Commission (2022), Communication on Fiscal policy guidance for 2023.

Council of the European Union (2022), Economic and Financial Affairs Council, 15 March 2022.

118

Duwe, M., Deyana S. (2021), Measuring progress towards climate neutrality. Part II: Integrating net zero indicators in EU governance processes, Ecologic Institute, Berlin / IDDRI, Paris.

119

120

See also : European Parliament (2021), Recovery and Resilience Dialogue with the European Commission.

121

European Commission (2021), Annual Sustainable Growth Survey 2022.

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IMPRESSUM

PUBLICATION DETAILS

Angaben gemäß § 5 TMG

HOW TO CITE THIS PUBLICATION

Climate & Company - The Berlin Institute for Climate Training and Research gGmbH

Simon, L., Herrmann, O., Juergens, I., Berendsen, S. and Kaspar, L.: Make EU Economic Governance fit for climate neutrality: Time to reform the European Semester. 03/2022

Ahornallee 2 12623 Berlin Vertreten durch: Ingmar Juergens David Rusnok

This publication and further information on our ongoing project on Greening the European Semester are available online on our dedicated webpage.

PROJECT MANAGEMENT – CLIMATE & COMPANY

Kontakt E-Mail: hello@climcom.org

Dr Oliver Herrmann (oliver@climcom.org) & Louise Simon (louise@climcom.org)

Verantwortlich für den Inhalt nach § 55 Abs. 2 RStV

AUTHORS – CLIMATE & COMPANY

Ingmar Juergens & David Rusnok Ahornallee 2 12623 Berlin

www.climateandcompany.org

Louise Simon, Dr Oliver Herrmann, Ingmar Juergens, Stefanie Berendsen, Laura Kaspar Version: 1.0, March 2022

ACKNOWLEDGEMENTS Extremely helpful comments and input were provided by: Hans Naudts, Helene Banner, David Bartle, Emma Gervasi.

This report has also been supported by the European Climate Foundation. Responsibility for the information and views set out in this paper lies with the authors. The European Climate Foundation cannot be held responsible for any use which may be made of the information contained or expressed therein.

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