The EU has recognised for some time that the financial markets lacked transparency, long-termism and suitable sustainability metrics, as well as appropriate regulation. Together with the final report of the high-level expert group on sustainable finance, this formed the basis for the EU action plan on sustainable finance.
The aims of the plan are to re-orientate capital flows towards sustainable investment in order to achieve sustainable and inclusive growth. As part of that effort, the EU wants to support in the effort to manage financial risks stemming from climate change resource depletion, environmental degradation and social issues; and foster transparency and long-termism in financial and economic activity.
The key points within the EU action plan are:
In December 2019, the European Council and the European Parliament reached political agreement on the establishment of a framework to facilitate sustainable investment – the Taxonomy Regulation. This will create an EU-wide classification system providing a common framework for identifying which economic activities can be considered ‘environmentally sustainable’. In combination with the Disclosure Regulation, the Taxonomy Regulation will require firms that are subject to the non-financial reporting directive to provide certain information.
The EU Taxonomy is a list of economic activities with performance criteria for their contribution to six environmental objectives. To be eligible, an economic activity must contribute substantially to at least one environmental objective and do no significant harm to the other five, as well as meet minimum social safeguards. Technical screening criteria set requirements for determining substantial contribution and doing no significant harm. The criteria may include quantitative or qualitative thresholds that investors should expect companies to meet in the performance of the economic activities.
The six taxonomy environmental objectives are:
Treasurers, investors, regulators, policymakers and citizens frequently complain about the lack of standards. Variations in approach and definitions can result in conflicting views of what is green and can potentially result in investors viewing the same company activities differently.
It is hoped that the taxonomy can reduce the barriers of entry for companies trying to demonstrate sustainable activities and avoiding unintended greenwashing. It will also make it easier for retail investors to understand the performance of companies they invest in.
Other benefits include:
It is to be hoped that the taxonomy will contribute towards greater understanding and broader adoption of the goals enshrined within the EU action plan.
Naresh Aggarwal is associate director in the ACT’s policy and technical department