Green finance: taxonomy is done but the real work is only starting

Last month, the European Parliament and EU Council reached a much-anticipated political agreement (PDF) on a draft EU regulation on establishing a framework to facilitate sustainable investment. 

In a nutshell, this so-called taxonomy will set out new criteria to help investors decide which activities may be considered environmentally and socially sustainable.

Even if the process is politically finished, the agreed text needs to be reviewed by lawyer-linguists, who will look at the wording and consistency of the different articles, and then translate the final text in the 24 EU official languages. And while this may be a formality, this process will take months. We strongly recommend you keep a close eye on this process.

The EU's environmental objectives

The taxonomy is based on six EU environmental objectives:

• climate change mitigation;
• climate change adaptation;
• sustainable use and protection of water and marine resources;
• transition to a circular economy;
• pollution prevention and control; and
• protection and restoration of biodiversity and ecosystems.

To qualify as environmentally sustainable, economic activities will have to:

• contribute substantively to at least one of the six environmental objectives listed above;
• not significantly harm any of the environmental objectives;
• be carried out in compliance with minimum social safeguards; and
• comply with specific ‘technical screening criteria’, which are yet to be developed (see below).

The taxonomy should apply to all financial products, meaning that issuers of products that do not claim to be sustainable should indicate this in a disclaimer. 

After pressure from the European Parliament, the classification system will also include two sub-categories covering 'enabling' and 'transitional' activities, and there will be an obligation for investors to disclose for each financial product the proportion invested in those enabling and transitional activities.

Once this text is finalised (the so-called 'level 1'), the devil will be in the detail, ie in the 'level 2' provisions. Indeed, in practice the taxonomy framework will be complemented by technical screening criteria (in the form of the level 2 delegated acts), which will truly establish the actual classification for each relevant environmental objective and sector.

The platform on sustainable finance

To help the European Commission develop and revise the technical screening criteria as well as reviewing their usability, the level 1 text creates a platform on sustainable finance. 

This platform will also advise the Commission on the need to address other objectives and analyse their impact in terms of potential costs and benefits of their application. 

The platform will actually be a follow-up to the current Commission’s technical expert group (TEG), which published a first report (PDF) in July last year along with helpful guidance (PDF) for investors on how to use the taxonomy. 

Since then, the TEG has opened a public consultation on this report and its final report on mitigation and adaptation activities is due next month. In December, the European Commission’s official responsible for the taxonomy workstream announced on social media that the TEG mandate has been extended until the EU platform on sustainable finance is set up. The TEG is almost dead, but long live the platform!

The technical screening criteria for climate change mitigation and climate change adaptation activities should be established by the end of 2020, in order to ensure the taxonomy’s full application for these objectives by 31 December 2021. 

The TEG indicated that it will unveil its final report on these two types of activities, which will serve as a basis for the Commission’s delegated acts, in February. 

For the four other objectives, the technical screening criteria will be established by the end of 2021 in order to enable the application of the whole taxonomy by the end of 2022.

The European Green Deal

Even though the EU-decision makers congratulated themselves for reaching an agreement on the taxonomy before the holidays, this is actually only the beginning of the journey to more legislation promoting sustainability policies in the EU. 

Just before the Christmas break, the European Commission also unveiled the flagship project of this 2019–24 term: the European Green Deal. 

This 24-page Communication (PDF), which is complemented by an Annex (PDF) with a roadmap for key actions, touches all sectors of the economy. In its own words, it is a 'growth strategy that aims to transform the EU into a fair and prosperous society, with a modern, resource-efficient and competitive economy where there are no net emissions of greenhouse gases in 2050 […] It also aims to protect, conserve and enhance the EU's natural capital, and protect the health and well-being of citizens from environment-related risks and impacts. At the same time, this transition must be just and inclusive'.

The Green Deal includes a number of ideas that may impact the valuation of assets investors may be interested in, for instance if, as anticipated, a carbon border tax is put in place.

The European Green Deal is based on 10 pillars for 'deeply transformative policies', ranging from climate and energy issues to clean industry and mobility, as well as the agri-food sector.

On the role of private finance specifically, it indicates that the Commission will present a renewed sustainable finance strategy in the third quarter of 2020, which will focus on:

• further embedding sustainability into the corporate governance framework, 'as many companies still focus too much on short-term financial performance';
• companies and financial institutions further increasing their disclosure on climate and environmental data, notably through the review of the non-financial reporting directive in 2020;
• developing clear labels for retail investment products and an EU green bond standard that facilitates sustainable investment in the most convenient way; and
• better integrating climate and environmental risks into the EU prudential framework and assessing the suitability of the existing capital requirements for green assets.

It is therefore clear that the EU legislative work on mobilising private finance to fund the ecological transition does not end with the taxonomy. 

The Sustainable Europe Investment Plan

Another example is the Commission’s proposal on the Sustainable Europe Investment Plan (PDF), one of the most ambitious programmes of the new EU administration. 

Unveiled on 14 January 2020, this plan aims at unlocking €1trn of climate-related investment over the next decade by mobilising private and public investments for the sustainability transition 'from every corner of the EU'. 

The Commission specifically notes that we need 'a framework to bridge the gap between policy objectives and the significant private financial resources available'. 

The Sustainable Europe Investment Plan also specifically refers to the definition of sustainable investment contained in the taxonomy, confirming that this piece of legislation will be at the centre of all EU upcoming work on sustainable finance. 

Businesses and their advisers should therefore keep a very close eye on this workstream, which promises to be a key focus of EU decision-makers for the months and years ahead.