On 24 May 2018, the European Commission put forward the first legislative proposals to put some of the actions laid out in the action plan on sustainable finance into law. The overall aim of the proposed measures is to move towards a European financial system that supports the EU's climate and sustainable development agenda. This is the second in a series of articles focusing on the specific measures that make up last month’s package of proposals.
An environmental taxonomy
The EU and governments around the world committed to the objective of a more sustainable economy and society when they adopted the Paris Agreement on climate change in 2015. More private capital flows need to be oriented towards sustainable investments to close the €180-billion gap of additional investments needed to meet the EU's 2030 targets of the Paris Agreement. But if there is to be a genuine shift of capital flows towards more sustainable economic activities, there needs to be a shared understanding of what 'sustainable' means. Currently, no such common understanding exists. This hampers sustainable investments and increases the risks of 'greenwashing', which is the practice of marketing financial products as 'green' or more generally 'sustainable', when in fact they do not meet the basic environmental standards.
A unified classification system – or taxonomy – would provide clarity on which activities can be considered 'sustainable'. This is why, as part of the May package, the Commission proposed the development of an EU environmentally sustainable classification system. An EU taxonomy would identify which, and to what degree, economic activities can be considered environmentally sustainable. This would make it possible to determine which investments (loans, stocks, bonds) are environmentally sustainable, making it easier for market-participants to finance these activities and limiting the risk of greenwashing.
What is environmentally sustainable?
Under the Commission's proposals, an economic activity would qualify as environmentally sustainable if it meets all of the following requirements. So, it must:
- Contribute substantively to at least one of the six environmental objectives laid out in the proposal; namely climate change mitigation; climate change adaptation; sustainable use and protection of water and marine resources; transition to a circular economy, waste prevention and recycling; pollution prevention and control; and finally protection of healthy ecosystems;
- not significantly harm any of the other five environmental objectives;
- be carried out in compliance with a number of minimum social and governance safeguards, for instance regarding labour rights;
- comply with specific qualitative and quantitative technical screening criteria.
The EU environmental taxonomy will be developed in two stages. The first step is the regulation proposed by the Commission in May. This regulation sets out the four conditions mentioned above. It also defines the six EU environmental objectives to which economic activities will have to contribute and to which they must do no harm. Finally, it empowers the Commission to establish technical screening criteria and frames how these criteria would have to be defined.
As a second step, the Commission will establish (through delegated acts) the technical screening criteria that determine if, and to what extent, an economic activity is environmentally sustainable. These delegated acts will be adopted based on advice from the technical expert group on sustainable finance, which has recently been set up by the Commission.
A taxonomy of which economic activities are environmentally sustainable – and which investments can therefore also be considered sustainable – will lay the foundation for all other measures on sustainable finance. It will help investors, including individuals, to invest their money in line with their sustainability preferences and give a big push for climate-friendly and other environmental investments. The EU is now taking the lead internationally in this field.
Read more on sustainable finance and taxonomy