By Robin Hamaker-Taylor
In the years since the Paris Agreement, the European Commission has sought to create the enabling conditions for the EU to meet its targets under the Paris Agreement and goals of the 2030 Agenda for Sustainable Development. The Commission developed their Action Plan for Financing Sustainable Growth in March 2018 and established a Technical Expert Group on sustainable finance (TEG) shortly after to assist in the development of proposals which advance the action plan.
Recognising that the investment industry often uses taxonomies to drive capital towards objectives, the TEG developed the EU Sustainable Finance Taxonomy (‘the EU Taxonomy’). The EU published its Technical Report on the Taxonomy in June 2019.
The EU Taxonomy helps translate the EU’s commitments to the Paris Agreement and the Sustainable Development Goals (SDGs) for investors. The Taxonomy bridges the gap between international goals and investment practice, clearly signalling the types of activities that are consistent with the low-carbon transition, adaptation and other environmental objectives.
What does the EU Taxonomy cover?
The EU Taxonomy provides a common language on what constitutes sustainable activities. It is a list of economic activities with performance criteria for their contribution to six environmental objectives, including:
1. climate change mitigation;
2. climate change adaptation;
3. sustainable use and protection of water and marine resources;
4. transition to a circular economy, waste prevention and recycling;
5. pollution prevention and control;
6. protection of healthy ecosystems.
To be included in the proposed EU Taxonomy, an economic activity must contribute substantially to at least one environmental objective and do no significant harm to the other five, as well as meet minimum social safeguards.
What does the EU Taxonomy mean for adaptation?
The EU Taxonomy holds that an economic activity makes a substantial contribution to adaptation objectives if: (i) all material physical climate risks identified for the economic activity are reduced to the extent possible and on a best effort basis; and/or (ii) it reduces material physical climate risk in other economic activities. Economic activities can contribute to adaptation objectives in two different ways:
1. Adaptation of an economic activity: an economic activity is made more climate resilient by integrating measures to reduce all material physical climate risks to the extent possible and on a best effort basis; and
2. Adaptation by an economic activity: an economic activity contributes to adaptation of other economic activities to physical climate risks and must also be resilient to physical climate risks itself.
How is the EU Taxonomy useful for investors?
As set out in the TEG’s Taxonomy guidance document, a supplement to the technical report, the Taxonomy has various benefits for investors, including the following:
- Provide clarity via a common language for investors, issuers, policymakers and regulators. Investors can use it to express their expectations for their investment decisions. Companies and project developers can use it to plan and raise finance, developing the pipeline of sustainable investment opportunities. All can use it to avoid unintended greenwashing.
- Help translate commitments to the Paris Agreement and the SDG’s for investors. The Taxonomy bridges the gap between international goals and investment practice, clearly signalling the types of activities that are consistent with the low-carbon transition, adaptation and other environmental objectives.
- Save time and money for investors and issuers. The criteria have been developed by environmental and industry experts and references the latest EU and international thinking. This allows investors to focus on what they do best, understanding the risk and return of an investment.
- Support different investment styles and strategies. Investors marketing environmentallysustainable funds can invest in Taxonomy-eligible activities; engage companies on how they are progressing towards Taxonomy thresholds; or provide their own explanation for how they will achieve the fund’s goals. Investing in Taxonomy-eligible activities is not mandatory.
- Put environmental data in context. Investors need to understand which companies are contributing to the low-carbon transition and which are building resilience to climate change, not just carbon footprints.
- Avoid reputational risks. By screening out economic activities that undermine broader environmental, climate and social objectives, investors can avoid reputational risk and ensure that their strategy is robust.
- Deepen the conversation. By focussing on economic activities, the Taxonomy provides a tool to understand company business models. Some business lines may be delivering on sustainability objectives, while others may not. This allows a sophisticated discussion around strategy and consistency with sustainability objectives.
- Reward companies. A science and evidence-based framework to define what is environmentally sustainable provides companies with clear direction. It will help companies access finance for R&D while rewarding those undertaking environmentally sustainable activities.
What’s next after the EU Taxonomy?
Following the publication of its Technical Report on the Taxonomy, the TEG’s mandate has been extended to the end of 2019. The TEG is currently assessing feedback collected from July until September 2019. They are and refining incomplete aspects of the proposed technical screening criteria for substantial contributions and avoidance of significant harm. At the end of its mandate, the TEG will make further recommendations to the European Commission on the need to adjust and complement their work on an EU taxonomy. The TEG’s recommendations are designed to support the European Commission in the development of future regulation, as proposed in the taxonomy regulation.
In October 2019, the Commission published joint statement on the International Platform on Sustainable Finance (IPSF). The IPSF is part of the European Commission’s ongoing work to support a global transition to a low-carbon, more resource-efficient and sustainable economy. It was developed, in part, to realise greater international cooperation to join up efforts to scale up environmentally sustainable finance globally and promote the integration of markets for green financial products at international scale. To this end, the IPSF will act as a forum for facilitating exchanges and, where relevant, coordinating efforts on initiatives and approaches to environmentally sustainable finance, while respecting national and regional contexts. It remains to be seen how the EU Taxonomy will align or integrate with the platform, though this should be clarified in the coming months.