Major investors reveal results of testing EU taxonomy on portfolios

Investors trialling the EU’s sustainable taxonomy found “typically low percentages of alignment” during a project convened by the Principles for Responsible Investment. 

BlackRock, AXA Investment Management, KLP and AP Pension were among the 40-strong PRI Taxonomy Practitioners Group that piloted the taxonomy – the European Commission’s flagship classification system of ‘sustainable’ activities – on portfolios. Today, the PRI released its findings, saying the results reflect “differences between the taxonomy framework and some existing methods of assessing sustainability”. 

By the end of 2021, investors that market their funds as environmentally sustainable will be required to disclose alignment with the taxonomy, which specifies that to be deemed “sustainable”, activities must make a substantial contribution to climate mitigation or climate adaptation, must do no significant harm to other environmental goals and must meet minimum social safeguards based on existing EU regulation.

Investment manager La Française said it was “initially surprised” that its climate thematic fund Carbon Impact Euro equity fund was “only 20% aligned with the taxonomy”

Neuberger Berman (NB) implemented the taxonomy for its actively-managed US Equity Impact portfolio, determining 20% alignment with the taxonomy, with a further 4% potentially aligned pending more complete company disclosure, or the forthcoming extension of the taxonomy to cover other environmental objectives.

BlueBay found alignment of its BlueBay Global High Yield ESG Bond to be less than 3%, but said the result was “to be expected” because “the fund is a ‘responsibility’ fund rather than a ‘sustainability/environmentally thematic’ fund”, and because of a “conservative approach” taken in the context of limited data availability.

Morgan Stanley Investment Management looked at its ESG-tilted equity and green bonds exposure, finding the overall taxonomy alignment to stand at 6.3%. 

Investment manager La Française said it was “initially surprised” that its climate thematic fund Carbon Impact Euro equity fund was “only 20% aligned with the taxonomy”. It said in its case study: “This suggests that market participants need to manage expectations about levels of green activities, for both a sector-neutral fund or even a dedicated climate change-related investment strategy […] The EU taxonomy sets a high bar for green activities.”

Not all investor participants – which were 89% investment managers and 11% asset owners – published the taxonomy alignment of their funds or portfolios, and those that did covered different asset classes, investment styles and geographies, as well as utilising a variety of different methodologies to reach their results.

None of the case studies assessed sovereign bonds, “reflecting the absence of a clear methodology to do so”, the report said. 

To assess whether an issuer was performing taxonomy-aligned activities, the majority of participants used third-party data providers, although many supplemented this with in-house research, direct assessment of corporate reports and data available through not-for-profit organisations.

 “Data providers should be encouraged to cover all steps of the taxonomy assessment,” said report

The participants reported coming up against challenges when it came to data. “The data required may not be clearly defined, quantitative, publicly-available, sufficiently granular or reliable,” the report said. It identified a particular lack of expenditure data, which “limited assessments of climate change adaptation”.

Assessing the “do no significant harm” (DNSH) element was “particularly challenging”, the report said, “due to the absence of data and the qualitative nature of many DNSH criteria”. 

Different investors approached this in different ways. NB, for example, used primary research and third-party data, creating a rating system based on levels of compliance. Impax used a company-level proxy test backed by third-party data, while AXA IM assessed DNSH through their minimum ESG standards, which exclude companies with UN Global Compact violations and companies of poor ESG quality. 

Members of the investor group, including Invesco, called for policymakers to avoid competing international taxonomies. Other policy asks were around guidance and supervisory expectations for taxonomy users, and granular data from the right issuers being made available. 

The participants also included advice for other new taxonomy users. Many investors, according to the report, said others should “take a bottom-up approach to fairly assess company alignment with the taxonomy. There is insufficient reported company data to make a top-down assessment.”

The participants also recommended engaging early with investee companies on taxonomy-aligned reporting and data, as well as with data providers to support improvements and fill data gaps, with one example given being to provide more granular opex/capex, as opposed to mainly revenue, data. “Data providers should be encouraged to cover all steps of the taxonomy assessment,” the report said. 

The PRI said: “Despite the practical challenges of trialling a new type of disclosure framework, many signatories demonstrated that the taxonomy is operational and that taxonomy-alignment results are both useful and necessary as we continue our efforts towards a more sustainable financial system.”

“The case studies […] offer important insights for investors beginning their taxonomy preparation.”