How the EU’s ‘Marmite’ taxonomy might help, or hinder, green finance

The EU looks close to accepting the TEG’s recommendations.

The EU’s green taxonomy is the Marmite of the sustainable finance world: some love it, some hate it.
Last week, Ben Caldecott, the well-known climate finance scholar, wrote a piece for RI saying the taxonomy “encourages laziness and disincentives ambition”. He listed 10 reasons why the current proposal to create a catalogue of business activities that are aligned with a carbon neutral economy by 2050 is a bad idea. The taxonomy doesn’t make room for local context, for example, and lobbying poses a major threat to the integrity of such a framework – as already seen in the political negotiations that took place earlier this year.
Defining activities as ‘green’ reinforces the idea that they’re niche, he added, as well as questioning the scientific expertise of those individuals tasked with developing the technical guidance for the taxonomy.
The piece triggered a lot of response from the market, and highlighted the divisiveness of the taxonomy proposals.
“The lack of policy clarity is exactly why we need the taxonomy – to step into the vacuum left by policymakers, which creates uncertainty for investors,” points out Ingrid Holmes, Head of Policy and Advocacy at Hermes Investment Management, countering Caldecott’s concerns about local context and differing approaches and timeframes taken by governments.
She describes the taxonomy as “a short cut to [investors] understanding what needs to change in the real economy”.
In reaction to the suggestion that the taxonomy encourages apathy by allowing investors to “buy the label” and set a universal level of ambition, Holmes – who was one of 20 members of the HighLevel Expert Group (HLEG) on Sustainable Finance that wrote the initial policy recommendations for the Commission – claims that the Technical Expert Group (TEG) behind the guidance are stuck between a rock and a hard place: “If the TEG had gone for higher thresholds, it would have been accused of being too ambitious and concentrating the investment universe on too small a number of activities.”
On lobbying, Holmes argues that there have been regular public consultations throughout the process to avoid opacity and closed-door discussions: “I fear that some of the loudest complaints may come from those who didn’t take the time to involve themselves in the process fully,” she observes.
Indeed, today marks the launch of the latest public consultation on the Action Plan on Sustainable Finance, which includes a summer-long public feedback period for a suggested taxonomy prototype.
The taxonomy hasn’t yet reached political agreement in Europe, but the TEG – which has 35 official members from the market, academia, business and civil society, along with a further 200+ industry, policy and climate experts – has pushed ahead anyway and published more than 400 pages of recommended business activities, thresholds and indicators to help investors finance the transition to a low-carbon economy.
Its first airing was in December, when a more primitive version was put out for consultation. After receiving more than 1,000 responses within ten weeks, the framework was significantly updated and developed over the springtime, in order to be presented to the Commission this week.
And the document wants to do a lot.
First, if the current legislative proposal gets through political negotiations later this year, the taxonomy will be
a disclosure framework for certain providers selling ‘green’ investment products in the EU. These include UCITS funds, Alternative Investment Funds, portfolio management and Insurance-based Investment Products. These are not required to ‘comply’ with the taxonomy for fear that this will stifle competition and innovation. But they will have to be transparent about how they stack up against it.
That’s the only mandatory requirement being put forward by the Commission on the taxonomy, although there is major resistance to this from some member states that would prefer a totally voluntary framework.
“There was a lot of confusion in the market about the fact that the taxonomy was a legislative proposal,” explains Helena Viñes Fiestas, Global Head of Stewardship & Policy at BNP Paribas Asset Management, and member of the taxonomy sub-group of the TEG: “If you market your fund as ‘green’, you have to disclose the percentage of that fund that relates to the taxonomy. That’s what the Commission’s proposal says, and it’s the only compulsory element.”
The classification system could be used as the basis for product development (it will underpin an EU Ecolabel and a green bond standard from the Commission, at least), as a tool for engagement, a means of ‘mapping’ investment portfolios, and as a lending framework for banks. It may also lay the foundation for other policy developments, such as changes to capital requirements – known as the ‘green supporting factor’.
The 414-page document outlines 67 business activities, and how they fit in with a European transition to zero-carbon by 2050 from both a climate adaptation and mitigation perspective. Whereas the original proposals, put out for feedback at the end of last year, focused strictly on a ‘green economy’, this updated version is far more nuanced and sensitive to the idea of transition.
“One of the core questions we’ve been looking at [since the close of the first consultation] is how we deal with transition activities,” continues Viñes Fiestas. “And I think that one of the key achievements of this updated version of the taxonomy is to divide activities into three categories: low carbon activities, activities that contribute to a transition, and activities that enable other sectors to become low-carbon or contribute to a transition.” She gives the example of transport, saying that zero-emissions vehicles would fit into the first category, while certain electric vehicles would count as ‘transition’ activities, and the production of electric batteries for cars would be an example of ‘enablers’. “What’s really interesting from a financial perspective about those three activities is the link withfinancial products. So, for example, if I’m an aluminium company that doesn’t meet the emissions thresholds in the taxonomy, I can still issue a green bond or get a green loan to help me finance energy efficiency efforts to help align with the taxonomy; those bonds or loans will be eligible. And then, once I’ve completed those projects and fit within the thresholds of the taxonomy, the company becomes eligible from an equities perspective. That’s the beauty of the taxonomy: it provides a clear direction for companies to become greener.”
Insiders say that, as the Council of the European Union develops its position on the taxonomy (the final major step required for political negotiations to be finalised), it is beginning to accept more of the issues that it initially pushed back on. Its final position is expected to be more closely aligned with the original legislative proposal than some people previously anticipated. If all goes according to plan, it will reach its position before the summer break and the negotiations with Parliament and Commission will be complete by the end of the year.
One major element of the negotiations centres on the creation of a Platform on Sustainable Finance. This is the body that will oversee the development of the taxonomy in future once the TEG has been disbanded at the end of the year. It’s unclear what mandate and authority that body will be given and who will be on it, but experts including TEG member Sandrine Dixson-Decleve from think-tank E3G, say “the European Commission must establish a clear government plan and observatory function” for the body if the taxonomy is to be effective. It will be this Platform that develops the taxonomy further, for example, to cover other environmental (and possibly social) activities in future.
E3G also call for the taxonomy to be extended to “assess the unsustainability of economic activities” – in other words, a parallel ‘brown taxonomy’. This request is echoed by Caldecott, who describes it as “much better for focusing minds on reducing unsustainable activities in portfolios, and making ‘brown’ niche”. Hermes’ Holmes says the current taxonomy “is actually structured in such a way (with quantified minimum thresholds) that enables a ‘brown taxonomy’ to be created as a relatively simple next step”.
But for now, the prototype of a climate taxonomy is out for public review, along with a more concise guide to how it can be used.
“It’s a lot of work. It’s not perfect, but it’s a major step forward in the world of sustainable finance and investment in the climate transition,” insists Viñes Fiestas: “We were lacking so much. We were living in this situation where companies and financial institutions were not only deciding if they were green, but just how green they were. Now we have something that is scientific and embedded in the regulatory landscape; something really solid. This is just the first step of the future taxonomy.”