The European commission is currently working on a green taxonomy with the aim of facilitating the investment necessary to achieve Europe’s climate targets, the transition to a low carbon economy and a sustainable development model. However, in order to respect its energy and climate targets for 2030, the European Union will require additional annual investment of €150-177 billion until 2030.
As such, the finance sector has a major role to play in channelling investment flows towards activities compatible with the climate scenario of the Paris Agreement. But no agreement has yet been reached on what constitutes a "compatible" activity, which is hampering the flow of capital into such activities. An EU taxonomy would provide a remedy by giving investors, financial institutions, businesses and issuers clear and transparent information on environmental sustainability, thereby enabling informed decision-making. It could be used to define economic activities, and therefore products, rather than relating to sectors.
Green and sustainable activities
The definition of a “sustainable activity" comes from a group of sustainable finance experts (HLEG) established by the European Commission, which published its conclusions in March 2018. These are based on four requirements:
The activity must contribute substantially to one of the six EU environmental objectives:
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 The activity must not do significant harm to any of the other five EU environmental objectives The activity must comply with minimum social safeguards The activity must comply with technical screening criteria (TSC)
The taxonomy
The taxonomy that the European Commission is seeking to establish will have to reflect the existing technologies and policies, and will need to be updated regularly.
It is not a standard, nor a mandatory list in which to invest. While the taxonomy will only include activities defined as green, this does not mean that other activities should systematically be considered brown (bad for the environment). Among these other activities, some may make a positive contribution to the environment that is very limited, while some are neutral, and others are "brown".
Lastly, the taxonomy will also include economic activities with a negative impact on the environment, where these activities have substantially reduced their negative impact. As the aim of the taxonomy is to promote the transition towards greener operating methods, and not only for activities already recognised as green, it makes sense to include sectors that need to improve their practices.
The first version of the taxonomy will be published in July 2019, and take the form of a list of activities. Investors will then be able to use it to evaluate their portfolios and/or their investments in line with the green taxonomy, while other parties will be able to use it to create labels. It’s early days, but what we can say is that the taxonomy should serve as a basis for any number of tools yet to be devised.