FINANCE - Sustainable finance

How the EU taxonomy can be an important tool for the transition to a greener economy.

date: 26/02/2021

By Nathan Fabian and Andreas Rajchl

Of all the challenges that the global economy faces right now, the climate crisis is most certainly one of the biggest and most fundamental. In the face of this challenge, Europe has shown political leadership, taking steps towards a net-zero greenhouse gas commitment by 2050. This crisis, however, also presents us with an opportunity. We already have many of the technologies and practices needed to create a sustainable economy. And importantly, we also have the pools of capital necessary to invest in this new economy. What is needed now, is to bring these two together. It is for this reason that the EU is developing a ‘taxonomy for sustainable activities’ – a tool to make clear which investments in Europe are aligned to these goals, and which are not. The aim is to make it easier for investors and companies to know what the sustainable investments are that we need to reach our targets.

What is ‘green’?

What exactly is ‘green’? This is still a challenge and there’s a certain amount of confusion in the market about what is, and is not, sustainable. It’s important to answer the question ‘how good is ‘good enough’ to meet our environmental and social goals?’ The taxonomy is intended to solve this problem by providing a list of economic activities that are aligned to the EU’s climate and Green Deal goals. This list contains criteria with environmental performance thresholds that are science-based and developed using a robust methodology and through an inclusive process of stakeholder involvement.

Very few companies will be 100% in alignment already today, but they can demonstrate their commitment to transition by increasing their share of green activities over time. The taxonomy does not just recognise those activities and companies that are already green, but allows companies making improvements towards the taxonomy standards to claim capital expenditure as ‘taxonomy-aligned’. This means that they could be eligible to raise green financing from the markets, including potentially through the use of a future EU green bond standard or by getting a green loan from a bank.

The taxonomy is not a substitute for an individual company or investor’s judgement. Crucially, companies can use the EU taxonomy to make their own plans for environmental transition and raise financing for it. Similarly, financial companies can use the taxonomy to design credible green financial products. This means it is a transparency tool that makes it possible to compare the proportion of taxonomy-aligned green activities across various investments and can therefore guide market participants in their investment decisions. By improving the visibility and credibility of such investments, the taxonomy will help companies to access a wider pool of increasingly environmentally and socially minded investors. Furthermore, it will contribute to increasing the number of sustainable investments, which will help the EU meet its climate and environmental goals.

Expert group

The EU taxonomy is a valuable tool for investors and companies. But a tool like this requires a lot of development. The Commission has set up a permanent expert group – the EU Platform on Sustainable Finance – to help it develop its sustainable finance policies generally, and the taxonomy in particular.

The platform brings together experts from business, investment, academia, civil society groups, and environmental groups. It is currently exploring several promising ideas to further develop the taxonomy framework and support the green transition. First, defining economic activities with low environmental impact could allow companies and investors to get recognition for a low environmental impact, and could, with appropriate safeguards in place, create a taxonomy where many more sectors and companies can find their place. Second, the platform is also considering how to recognise improvements made when it comes to the heaviest-emitting activities – those that could be considered to be doing ‘significant environmental harm’. It may be possible to cut emissions significantly and improve the performance of the heaviest-emitting sectors to the point that they are no longer causing significant harm. This is an important step and the platform is considering how to recognise these ‘harm reducing’ transitions. Third, the platform will explore complementing the taxonomy framework with a social taxonomy, to integrate the ‘S’ into ESG (environmental, social, and corporate governance).

The central task of the platform is to continue to develop and strengthen the EU taxonomy, incorporate new economic activities, and help markets put it into practice and use it on a day-to-day basis. Fundamentally, the taxonomy is about trust. The users of the taxonomy must have confidence that it is reliable and that it will help them make the decisions they need to make. It cannot describe a practice or an activity as sustainable when it is not. To do this well we must use evidence and have a clear focus on the environmental and social goals that we need to meet in our societies. We must shift our economies to be more sustainable – and we must do it fast.