How EU ESG Banking Rules Target Poor Performers Yet Spare Key Green Transition Firms

The European Central Bank's working paper authored by Lena Schreiner and Andreas Beyer in collaboration with the European Central Bank and the Frankfurt School of Finance & Management, delves into how recent European Union environmental, social and governance (ESG) banking rules shape banks’ willingness to fund industries that are critical to the green transition yet fraught with ESG risks. At the heart of the analysis are the Sustainable Finance Disclosure Regulation (SFDR) and the EU Taxonomy for Sustainable Activities, both designed to channel investments toward sustainable projects and away from harmful practices. The study addresses a central paradox: achieving climate neutrality and scaling up renewable technologies such as electric vehicles (EVs) requires vast quantities of metals like lithium, cobalt, manganese and nickel, resources typically sourced from mines in regions where production is often associated with environmental harm, human rights violations, corruption, and biodiversity loss.

The Policy Paradox of Green Transition Resources

The research situates this dilemma within the broader challenge of aligning sustainability ambitions with the material requirements of clean technology production. While the EU’s green finance regulations are aimed at eliminating harmful practices from the financial system, they inevitably intersect with sectors whose products are essential to renewable infrastructure but whose operations carry significant ESG baggage. The central question becomes whether these rules are inadvertently cutting off vital funding for such sectors. By examining the mining of battery raw materials, Schreiner and Beyer test whether stricter ESG obligations on EU banks translate into measurable changes in their investment behaviour and, by extension, the financing landscape for these industries.

A Quasi-Natural Experiment with Global Scope

To answer this, the authors use a quasi-natural experiment design, combining large datasets from S&P CapitalIQ, Refinitiv Eikon, Bloomberg, and the ECB’s AnaCredit. This rich dataset covers bank shareholdings in public mining firms across multiple countries and over several years. The methodology hinges on a difference-in-differences approach, comparing EU-based banks, subject to the SFDR and EU Taxonomy, with non-EU banks, which are not bound by the same regulations. This allows the researchers to isolate the impact of the new rules from broader market shifts. The time frame spans the SFDR’s adoption in late 2019, its entry into force in March 2021, and the Taxonomy’s introduction in 2020, enabling the detection of both immediate and lagged effects.

Measurable Decline in Risky ESG Holdings

The results are striking. Following the introduction of these ESG banking rules, EU banks reduced their shareholdings in mining companies producing battery raw materials. The most pronounced drop occurred after the SFDR became applicable, highlighting the potency of disclosure obligations combined with reputational considerations. Notably, this divestment is not uniform, it is concentrated in companies with weaker ESG ratings, particularly those with low scores on social criteria such as labour standards, community relations, and workplace safety. Holdings in high-rated firms remain largely unaffected, indicating that the regulations are not indiscriminately choking capital to the sector but instead targeting its weakest ESG performers.

When broken down by individual metals, the effect is consistent across lithium, cobalt, manganese, and nickel, though the timing and intensity vary. Cobalt holdings appear to react fastest, possibly due to heightened awareness of labour exploitation in its supply chains. Adjustments in manganese and nickel holdings, meanwhile, show a lag of one to three quarters, suggesting that banks may phase in changes as they find alternative investment options or buyers for their shares.

The Ownership Substitution Effect

One of the most important findings is what did not happen: there was no decline in the share prices of the affected mining companies. This suggests that other investors, often outside the EU, stepped in to purchase the shares EU banks sold. The researchers describe this as an ownership substitution effect. In practice, this means that while EU regulations successfully shift regulated banks’ portfolios away from poor ESG performers, they have not, at least for now, made it more expensive for these mining firms to raise equity capital. The implication is that the intended capital-reallocation effect works within the EU financial system, but global investor diversity cushions any potential financing squeeze.

However, this safety net relies on the uneven global application of ESG banking rules. If similar regulations were implemented in other major financial markets, the substitution effect could vanish. In such a scenario, poorly rated mining companies might face higher capital costs, potentially worsening the chronic underinvestment in raw material supply chains, an outcome that could slow rather than speed up the green transition.

Balancing Regulation with Resource Security

On one hand, the SFDR and EU Taxonomy are achieving their primary goal: pushing capital away from companies with poor ESG performance without indiscriminately starving critical sectors of investment. On the other hand, the reduction in EU banks’ ownership stakes may weaken their capacity to influence mining companies toward better practices through active shareholder engagement. Furthermore, future policy shifts, particularly the potential global harmonisation of ESG regulations, could alter the delicate balance, introducing real risks to the supply of essential raw materials.

The authors suggest that policymakers should not only maintain the regulatory push toward better ESG performance but also develop complementary measures to ensure that vital materials remain accessible. This could include internationally harmonised ESG standards, transition pathways for high-impact sectors, and targeted incentives for performance improvement. Such an approach would allow the financial system to play a dual role: enforcing high sustainability standards while ensuring that the green technologies of tomorrow have the resources they need today.

Ultimately, Schreiner and Beyer’s work offers a nuanced, evidence-based narrative of how sustainable finance regulation interacts with the gritty realities of resource-dependent technological change. It shows that well-crafted ESG banking rules can channel capital away from harmful practices without undermining the supply of critical materials, so long as the global regulatory landscape remains diverse. Yet it also warns that as the world moves toward more unified sustainability standards, this balance could shift dramatically. For the green transition to succeed, regulatory ambition must be matched with pragmatic strategies that recognise both the moral imperatives and material necessities of building a sustainable future.