The EU sets a milestone on sustainable and green finance

The EU sets a milestone on sustainable and green finance

By Laura Canevari

On 18th December 2019 the European Council and the European Parliament reached a political agreement on the new Taxonomy Regulation. Soon to become a mandatory reference for sustainable finance products, this landmark regulation sets the first common “green” finance classification system in Europe – and the world.

To class as “environmentally sustainable”, this wide complex system has defined six objectives for economic activities, namely:

1)   Climate Change Mitigation

2)   Climate Change Adaptation

3)   Sustainable Use and Protection of Water and Marine Resources

4)   Transition to a Circular Economy

5)   Pollution Prevention and Control

6)   Protection and Restoration of Biodiversity and Ecosystems

To qualify as green, activities must also:

  • provide a substantial contribution to at least one of the six environmental objectives above,
  • cause “No significant harm” to any of the other environmental objectives,
  • comply with robust and science-based technical screening criteria, and
  • comply with minimum social and governance safeguards

In alignment with the Commission’s Action Plan on Sustainable Finance, the Taxonomy highlights the commitment of the EU towards sustainable finance. Moreover, it is designed to guide investors on what “green financing” means, overcoming barriers such as fragmentation in green investment practices, as well as “greenwashing” (whereby an investment is labelled as “green” when truly it is not).

What’s in the Taxonomy?

The Taxonomy is supported by the work of the Technical Working Group on Sustainable Finance (TEG). Up until now, the group has established technical criteria for 67 activities contributing to climate mitigation, and a methodology for evaluating contributions to adaptation, as well as guidance and case studies for investors. It now has the responsibility to develop delegate acts, through which the Taxonomy is expected to be further developed, and to provide its final recommendations to the European Commission next month.

Although the final list of criteria is still in draft form, once released it will substantially affect financial flows, investments and asset allocation. What remains certain is that nuclear nor gas investments will be labelled as “green”.

What are the implications to companies and financial institutions?

All EU-listed companies with over 500 employees will have to disclose how much of their revenue and capital expenditure aligns with green or environmentally sustainable activities.  A number of funds and pension products, as defined in the regulation, will need to disclose how and to what extent their underlying investments support economic activities that meet the Taxonomy Regulation. Member States and the European Union will need to implement the Taxonomy where financial products or corporate bonds are labelled as environmentally sustainable. In addition, future European labelled sustainable financial products, such as the European Green Bond Standard or the Ecolabel for Financial Products, are respectively expected to be totally and partially aligned with the Taxonomy.

According to Pascal Canfin (French MEP leading the European Parliament’s environment Committee), the Taxonomy is ultimately expected to become “the EU standard for investment managers and clients”. This means that any business claiming to undertake environmentally sustainable activities will need to account for the criteria in the Taxonomy.

Banks such as the European Investment Bank and the European Central Bank have already expressed the usefulness of this system. However, is still unclear how other financial actors (e.g. rating agencies) will embrace it.

What’s next?

The delegated act pertaining to the first two climate-related objectives (i.e. mitigation and adaptation) should be adopted by the Commission by the 31 of December 2020 and will apply from 31 December 2021. In addition, delegated acts for the other four objectives will be adopted by 31 of December 2021 and will apply from 31 December 2021.

Cover photo by Hafiz Issadeen, Climate Visuals CC by 2.0

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