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HLEG: Europe must set the standards on defining sustainable finance

RI takes a closer look at HLEG’s recommendation on sustainability taxonomies

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Defining sustainability has been the top priority of the High Level Expert Group on Sustainable Finance since the get-go. Its list of early recommendations last summer included requests for “an EU classification of financial products that captures all acceptable definitions of ‘sustainable’” and, despite many more topics being introduced into the final report, this one has retained the top spot.
HLEG’s first ‘key recommendation’ in today’s report is that Europe should “establish and maintain a common sustainability taxonomy at the EU level”.
“If Europe is to mobilise capital at scale for sustainable development, it needs a technically robust classification system to establish market clarity on what is ‘sustainable’,” the report reads. This would facilitate more standardisation in green and social products, and “enable market participants to invest in sustainability with greater confidence and ease”.
The taxonomy should be “clearly linked to the Paris Agreement and the Sustainable Development Goals”, both of which would allow governments and policymakers to create national capital-raising plans aligned with the ambitions (and any others at domestic level), and communicate them clearly to the private sector and capital markets. The taxonomy should cover all asset classes and should be able to be used to measure financial flows into sustainable development priorities at asset, portfolio, institutional, regional, national and European levels.
Consensus around what ‘sustainability’ is arguably fundamental for many of the other recommendations in the report. As Olivier Guersent, Director General of the Commission’s DG FISMA said in December on the topic of green banking incentives: “if it is economically profitable to invest in green and sustainable, and we do not have a proper definition, then everything is going to become ‘green’ and ‘sustainable’”. The creation of green bond labels is also a key recommendation for HLEG, and a taxonomy, they say, will form a “starting point” for that (HLEG stresses that the taxonomy will never be a standard itself). The recommendations also prioritise a revision of European investor duties, which should include a requirement to align investment horizons and environmental and social impacts with the needs and desires of the end client. This, too, is something the taxonomy could help with, HLEG claims.
But, according to one member, “there is nothing like enough detail in the taxonomies work at the moment to give you adequate precision for regulatory incentives… This will need a lot of further work.”
Aware of the requirements, the Commission has not sat back and waited for the final verdict: it knew taxonomies would feature prominently in the final report, and work has been underway since last year to ensure a head start. It is clear the EU wants to keep ahead of Asia and elsewhere when it comes to sustainability standards, and a classification system that aligns with the SDGs and the Paris Agreement could potentially become a global benchmark. So, last summer – as requested in HLEG’s interim report – it invited the European Investment Bank to begin work on coordinating the creation of the classification system.A working group was set up within HLEG dedicated to the topic, led by HLEG member Claudia Kruse, Managing Director Sustainability & Corporate Governance at APG at Dutch asset manager APG, accompanied by a handful of other members including David Harris, Group Head of Sustainable Business at London Stock Exchange Group and Sean Kidney, CEO of the Climate Bonds Initiative. Between them, and in consultation with the broader market, they have produced a ‘roadmap’ of how to develop an effective sustainable finance taxonomy.
The Commission also engaged three environmental consultants to produce research on a green classification system for European finance, titled: Defining Green in the Context of Green Finance. The findings, issued in October, offer five options to the EU on what is could do around green definitions, including developing conceptual definitions, green taxonomies and a rating system.

A classification system that aligns with the SDGs and the Paris Agreement could potentially become a global benchmark

That report was made available to the public last week, and now HLEG’s working group has included its roadmap as part of its final recommendations. It requests that the Commission adopts the roadmap to develop “a fully-fledged sustainability taxonomy by 2020”. As part of this development, HLEG also suggests the establishment of a “technical Working Committee” this year comprising experts from the relevant Directorate Generals within the Commission, as well as NGOs, private sector players and existing members of the HLEG working group.
The sustainability focus for the taxonomy is, in the first instance, climate change mitigation and adaptation. Then “healthy natural habits”, water, pollution, agriculture and food, access to basic services and infrastructure. Each sustainability topic will be used to assess sectors such as electricity and heat production and transmission, industry, waste management, transport, buildings, education, healthcare and technology. Supply chains should also be assessed, according to HLEG.
Work has begun on aggregating and aligning existing frameworks and resources from the EIB, Nordic Investment Bank, CBI, APG and FTSE Russell; as well as efforts like the Green and Social Bond Principles, work done by international development banks, and the Natural Capital Protocol. In the long-run, some hope the system will also include a ‘brown’ taxonomy, helping to identify dirty projects that could be divested or penalised by regulators.
Internationally, the People’s Bank of China has been working with the EIB to ‘harmonise’ the two regions’ ideas about what constitutes green. Work on global standard is also underway. As RI has previously reported, the International Standards Organisation has two working groups developing potential green finance standards: one for green bonds and one for broader green finance. It is possible that these could dovetail with those being developed at European level, acting as the foundation for global practices.