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EU taxonomy: 414 pages dedicated to climate change to compensate for the absence of a single definition of sustainable investment
On 18 June, the Technical Expert Group (TEG) set up by the European Commission in the framework of its Action plan on sustainable finance released its second long-awaited (and sometimes feared) report regarding taxonomy for green activities.
The 414-page report covering 67 activities refers to the taxonomy the EC wishes to regulate in the area of climate change mitigation and adaptation.
Origin of this report
Over the last two years, the European Commission has embraced the theme of sustainable finance and economy and has clearly affirmed its willingness to be a key player in this theme. Within the framework of its Action Plan on sustainable finance, the European Commission set up a TEG consisting of 35 experts from financial institutions, academia and civil society. Assisted by 160 additional experts, the TEG then issued its proposal for taxonomy regarding climate change.
The taxonomy is a list of economic activities coupled with performance criteria to assess their contribution to the 6 identified environmental objectives.
The six environmental objectives of the EU Taxonomy
Source: Natixis, DPAM
This is not the list of automatically-eligible activities for green finance, but rather the conditions for eligibility based on activity and a 4-step process.
Contribute substantially to one or more of the 6 environmental objectives
Do not significantly harm any other environmental objective
Comply with minimum social safeguards (ILO core labour conventions)
Comply with the technical screening criteria
Carbon neutrality by 2050
The second version of this report extends the number of covered and studied activities from 24 in the December version to 67 today. Nevertheless, key activities are missing, the main ones being mining, fishing, aviation, maritime transport and glass, paper and pulp manufacturing.
As such the taxonomy aims to define stringent thresholds and technical screening to assess the contribution of the specific activity to the six objectives. This is to be done while taking into account the fact that at this stage, the TEG has only focused on the two first objectives.
The screening approach is the result of the extensive work. It aims to be pragmatic and in line with what happens in the field by making use of multiple factors and combining thresholds expressed either in intensity or in relative terms. Nevertheless, criticism has been levelled at the stringency of those thresholds, which are far from current sustainable financial practices and the performance levels observed in industrial and economic reality.
With the exception of coal and nuclear power, which are de facto ineligible, so-called “brown” activities continue to be eligible when considered as transitional activities, provided further stringent criteria are fulfilled. More precisely, the stringency of the thresholds and criteria is the result of an exclusive objective of carbon neutrality by 2050, which involves phasing out fossil-fuel power generation.
Impact and power
The taxonomy is not legally binding except for institutional investors, namely UCITS, AIFS and insurance-based investment products, which must apply the principle of “comply or explain” i.e. “how and to what extent they are using the taxonomy”. Nevertheless, the report published is not yet the final version of the taxonomy, only the second report, and it therefore does not have any legal weight at this stage.
Regarding the legal process, the report will be discussed in the European Council and a so-called “trialogue” with inter-institutional discussions will start in September 2019, after the consultation process which has just started. As soon as an agreement has been reached, the Regulation, so the strictest piece of European legislation (directly applicable to all), can be adopted. From that point on and in parallel, the European Commission will adopt the Delegated Acts which will define the technical criteria to be adopted – as it has already done following the first project released last December. The European Parliament and the Council have two months for remarks regarding these Acts. In absence of remarks, the Acts will be considered adopted. Following on from this, the Regulation’s entry into force is expected to take place on 1 July 2020 as regards the two environmental objectives.
While the Regulation will not be legally binding, it will serve as the backbone for the EU Green Bond standard and will likely be used as a reference by investors for reporting on the green exposure of their investment funds in different asset classes. The situation will be similar to that observed with the Sustainable Development Goals, which have no regulatory role but which are increasingly and universally being used as a benchmark to report on impact of funds’ actions. It is worthwhile to note that the report does not refer to the SDGs in its taxonomy.
A flexible framework
The text is set to evolve over time. In view of this, a permanent platform on sustainable finance bringing together financial and corporate experts will be set up by end of the year. Its main role will be oversight of the taxonomy, including review, adaptation and compliance.
For the sake of completeness, other publications were released on 18 June, specifically: