Debate around green investment standards has been gathering steam over the past few years and looks set to make a leap forward as a result of HLEG’s interim report, released earlier this summer. The most notable work so far has been focused on the green bond market: the development of the Green Bond Principles in 2014, which have now been expanded to cover social and sustainable bonds; numerous in-house green assessment methodologies created by the likes of Vigeo Eiris, Oekom, Cicero, DNV GL and Sustainalytics; the Climate Bonds Initiative’s (CBI) standards; and development banks around the world who have come up with their versions of what counts as ‘green’ or ‘social’. In addition, China and India are among a growing number of countries to develop ‘catalogues’ of green sectors eligible for endorsement by the state.
In recent months, two proposals have also been put forward to the International Standards Organisation (ISO) – the official global standards body, affiliated with the World Trade Organisation – to create universal standards around green finance. The first, submitted by the American National Standards Institute, but driven by CBI and its verifier NSF, seeks to create a working group to develop climate bond standards, which would be based on the CBI’s taxonomies. The second – already rejected by ISO – was put forward by the Chinese standards authority and sought to create a working group to develop definitions around broader green projects. Submissions are put to a vote by all national standards bodies that make up ISO. “The proposal for the creation of a new Project Committee on green finance by SAC, our member in China, didn’t pass,” said a spokesperson for ISO. “But it is possible that in the future the proposal of the topic could be developed in an existing Technical Committee.” ISO already has one iron in the fire on climate finance: in January it approved a proposal from the French standards agency to develop Standard 14097, focused on metrics and certifiable standards for topics such as alignment with a 2°C scenario. The working group is ‘co-convened’ by Stan Dupre, CEO of the 2 Degrees Investing Initiative and Massamba Thioye, Head of Financial Institution Relations for the UNFCCC.
The process will not be a quick one. ISO standards normally take between 18 months and four years to develop. But if they do go ahead, they could become the first internationally-endorsed standards in the field.
In the meantime, HLEG has made the creation of EU-backed green definitions a priority. Of the eight early recommendations, the first two are devoted to the topic.
Top of the list is “an EU classification of financial products that captures all acceptable definitions of ‘sustainable’”. It should serve to identify those projects that support the environmental policies and goals of member states. The Commission’s role is not to create the definitions itself, but to “organise the definition”, by appointing the European Investment Bank to coordinate its development, in cooperation with others including technical experts, market practitioners and civil society.
French pension fund ERAFP, which manages $30bn of assets, says a pan-European set of definitions would be helpful to help it allocate capital to impactful projects. “In France, we can use the green taxonomy of the Energy and Ecological Transition for the Climate label,” explains CEO Philippe Desfosses. “But it could help to have an official green taxonomy at European level.” This, he adds, could be based on the EETC or the CBI standards.Eila Kreivi, Head of Capital Markets at the EIB, is an official observer of HLEG. She points out that the group’s long-term focus is on sustainability, which covers a vast array of sectors beyond just climate finance. “Under sustainable, you have social and environmental. Under environmental, you have climate and other green topics like pollution control, biodiversity and resource scarcity. Under climate, you have climate change mitigation and climate change adaptation. And the only area out of any of these where there are existing building blocks and recognised taxonomies to work with is climate change mitigation.”
As a result, that’s where the taxonomy would start. CBI will also play a lead role in coordinating the first stage of the work, if invited by the Commission.
“What would be the interest in having a very large institutional investor investing up to 5% of its balance sheet in ‘green projects’ if that pension fund does not apply any ESG criteria on the other 95%?” – ERAFP’s Philippe Defosses
ERAFP’s assets are almost all run by third-parties, so Defosses says “clearer definitions could be even more useful for our asset managers” than for ERAFP itself. Any taxonomy produced should support investors by being “as precise as possible” and “a reference for all economic sectors,” he adds; and it would be interesting to see if it was possible to assess the level of contribution to the energy transition, too.
The taxonomy will not yet be a formal ‘standard’, points out Kreivi. “We might say that solar energy is one category of renewable energy and therefore falls within climate mitigation, but we won’t say how that solar energy must be provided, or which components must be used, for example.” That’s work for further down the line. And while the process must get deeper, it must also get wider: the move beyond climate mitigation will require different expertise, and other institutions will need to get involved – and possibly take over coordination of the project – as it broadens to cover other key areas such as social projects.
If the taxonomy is successful, it may come in time to be integrated into the proposed ISO global standards, or become the basis for EU-only standards. Or, it may simply function as a framework in parallel to similar classification systems out of China and other key markets, enabling each to use a ‘shared language’ to explain what green means in their jurisdictions.
But Desfosses warns that, for investors like ERAFP who want to combine traditional impact investing allocations with a best-in-class approach across all its holdings, taxonomies are not the silver bullet – they are only part of the solution needed.
“Financing projects that can be labelled ‘green’ is important, but we think it’s even more important to encourage companies – and all economic agents – to take into account ESG factors when they consider investing… What would be the interest in having a very large institutional investor investing up to 5% of its balance sheet in ‘green projects’ if that pension fund does not apply any ESG criteria on the other 95%?”