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Taking the measure of an EU taxonomy for green investment

Classifying which economic activities contribute to environmental objectives is a central part of the EU sustainable finance agenda. Head of the European Sustainable Investment Forum Victor van Hoorn explains what is behind a new EU 'green' taxonomy.

The European Commission is finalising the details of the EU taxonomy, an ambitious and wide-ranging attempt to identify economic activities that contribute to the bloc’s environmental objectives. Energy Monitor spoke with Victor van Hoorn, executive director of the European Sustainable Investment Forum (Eurosif), whose members manage over €8trn in assets, to discuss what it means for investors and companies.

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Eurosif executive director Victor van Hoorn. (Photo courtesy of Eurosif)

Can you explain the EU taxonomy?

The taxonomy aims to identify economic activities we know are compatible with certain environmental objectives and what we believe is sustainable, based on scientific evidence.

Over time, the taxonomy will come to cover the full range of environmental questions, as well as social and governance issues, but at this stage we are only talking about climate mitigation and adaptation. The question it seeks to answer is, what economic activities are compatible with net-zero emissions by 2050, the objective of the Paris Agreement, EU climate law and the EU Green Deal?

What obligations does it introduce?

Companies providing investment products that make sustainability or environmental claims will be required, from the end of 2022, to disclose how their portfolios align with the taxonomy.

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For non-financial companies, the only obligation is to report. Those EU companies already subject to requirements to report non-financial information will, from 2023, also have to disclose how their overall business aligns with the taxonomy when it comes to turnover as well as to capital expenditure.

That information will allow financiers to take this information into account in lending and investment decisions. At this stage, it is only a reporting framework that aims to bring more transparency to the market. There is no requirement for any company to be aligned with the taxonomy.

What is its objective as a policy instrument?

The thinking is that with additional transparency and information, investors, banks and insurance companies will be able to factor the taxonomy into their decision-making. Over time, it should contribute to reorienting capital towards more sustainable economic activities, away from those incompatible with net zero by 2050. At the end of the day, the taxonomy is trying to achieve a differentiation of the cost of capital for different businesses depending on how sustainable they are.

How does it characterise various types of economic activity?

The group of experts who drafted the first set of criteria looked at the biggest sources of greenhouse gas emissions in the EU. They used the NACE classification system, used by Eurostat, the European statistics agency, to identify different sectors of the economy. Based on that, they have identified the type of economic activities that are either making a contribution to solving climate change or are creating emissions. It has been a lengthy, complicated and quite granular process.

At this stage, the taxonomy is first and foremost aimed at activities making a significant contribution to climate action, so-called ‘dark green’ activities. It also identifies ‘enabling’ activities, such as wind turbine or electric vehicle manufacturers, which use lots of materials but will be essential to get us to net zero.

Our best estimate is that around half of the turnover of publicly listed companies in the EU is covered by the taxonomy. Victor van Hoorn, Eurosif

The taxonomy also allows for transitional activities, where there are no alternative low-carbon technologies available, but which support the transition to a net-zero economy and meet certain emissions thresholds.

Our best estimate is that around half of the turnover of publicly listed companies in the EU is covered by the taxonomy. It does not mean the others are not compatible or not aligned with it; it just means the taxonomy is silent about whether they are part of the equation. For example, many services, pharmaceuticals, education and technology companies largely fall outside its scope.

What stage is the taxonomy at?

We are at a very political stage of the process. In April, the European Commission is expected to adopt a renewed version of the delegated acts [that shape the taxonomy] it consulted on in December. Member States and the European Parliament are quite divided on a number of issues – particularly around the treatment of natural gas, nuclear power and bioenergy, as well as on hydrogen. It is not clear what the compromise will look like.

What impacts do you expect it to have on providers of investment products?

When we have all the data, and companies and investors are familiar with the taxonomy, taxonomy-aligned investment products will start to emerge. These will be a reasonable proxy for whether investors are aligning themselves with net zero.

You may see some investors preferring companies with high alignment and some unwinding positions in companies that are less aligned. However, at this stage, the overall level of alignment of the economy with the taxonomy is very low – probably about 1.5–2.5% overall. So even if investment providers wanted to offer a product that is 80% or 90% aligned with the taxonomy, they would struggle to build that portfolio.

So presumably it will not have much impact on companies’ or industries’ access to capital?

At the outset, no, but a number of years down the line it may because the ultimate intent of the policy is to get to a differentiation in the cost of capital between sustainable and non-sustainable activities. However, we have not seen any evidence – as claimed by some sectors that are not aligned with the taxonomy – that they will be shut out completely from capital markets.

The taxonomy is still an imperfect tool and a complex one to use. We are not anticipating a large part of the market suddenly using it to make investment decisions.

What will influence some companies’ access to capital [more directly] is not the taxonomy in and of itself, but other public policies, like a higher carbon price or certain taxes or subsidies. This is already happening as investors begin to differentiate their long-term investment decisions – for example, in the fossil fuel sector – in response to carbon prices.

What do you see as the taxonomy’s near-term impact?

We certainly need more transparency on these issues in the market. The taxonomy can help because everyone will have the same dictionary. That is helpful. Over the last ten years, a number of very sophisticated investors have gone down this path already. The question now is, how do you rapidly get a much larger part of the market to upskill and apply those tools more rapidly? The taxonomy will be particularly helpful for a wider group of professionals to get to grips more quickly with these issues.

Mark Nicholls

Contributing editor Mark Nicholls, co-founder and former editor of Environmental Finance, specialises in sustainable finance and responsible investment, including ESG disclosure and carbon markets.