Sustainable Finance and the EU Taxonomy: Developments from the Trilateral Negotiations

As global leaders meet in Madrid for the COP25 amid mounting concern over the international response to climate change, the EU Taxonomy experienced a setback with the UK and France blocking the plans. The new framework, intended to drive financial flows that will accelerate the shift to a low carbon future, will likely become a global standard affecting investors around the world. If enacted, it could cement the EU’s position as the world’s pace setter on climate legislation.

A lot of climate related news came out of the EU in the last two months of 2019, reflecting the EU’s determination to set the pace when it comes to international climate leadership. The European Parliament approved a resolution declaring a climate and environmental emergency in Europe and across the globe. Ursula von der Leyen – the incoming president of the new European Commission, the executive branch of the EU – declared climate policy as her most pressing priority. The proposed European Green Deal revealed the EU’s objective of reaching climate neutrality in 2050, meaning achieving net zero emissions as a continent. And in early December, news broke that the EU had reached a more ambitious than expected agreement on the EU taxonomy for sustainable activities (the “Taxonomy”), the new green finance framework, only to hit opposition just a few days later.

The European Commission estimates an additional €175 to 290 billion a year of investments in Europe’s energy system and infrastructure is necessary to achieve its climate goals[i]. Private sector finance flows must be directed towards low emissions investments, and to this end the EU Commission published its Action Plan: Financing Sustainable Growth in March 2018. It describes the EU’s strategy for sustainable finance and is part of the implementation plan of Article 2(1)(c) of the Paris Agreement and the UN 2030 Agenda for Sustainable Development.

At the heart of the plan is the EU Taxonomy – a classification framework designed to determine whether an economic activity is environmentally sustainable. It is a legislative proposal that also forms the foundation of other EU objectives such as eco fund labels, green bond standards and possible changes to central bank policies. The two other legislative proposals under the Action Plan are on low carbon benchmarks and disclosure requirements.

     “The Taxonomy could effectively become a global standard.”

Because financial market players outside the EU offering products in the EU will also be obliged to disclose their alignment with the Taxonomy, it could effectively become a global standard. This is reinforced by the recent launch of the International Platform on Sustainable Finance (IPSF) by the EU and other “like-minded jurisdictions from all around the world”, to mobilize international private investors globally[ii]. The IPSF will “act as a forum for facilitating exchanges and, where relevant, coordinating efforts on initiatives and approaches to environmentally sustainable finance”. Furthermore, other countries such as Australia[iii] and Japan[iv] are reportedly closely following the EU’s sustainable finance regulation outcomes and may emulate them.

It is unlikely, however, that the EU framework will simply be replicated everywhere: Canada is working on its own taxonomy that should be more suitable to resource-heavy economies, and China already has its own green bond taxonomy. As a result, investors with an international scope will likely have to manage multiple green taxonomies for some time to come.

“Negotiations may well run into the new year”

The Taxonomy “trilogue”, the trilateral negotiations between the EU Parliament, Commission and Council, seemed to have concluded earlier than expected in early December and resulted in an agreement that was more ambitious than anticipated. The taxonomy would apply to all financial products being offered in the EU, rather than just to “green” funds, and companies covered by the Non-Financial Reporting Directive (large public interest entities in the EU with more than 500 employees[v]) would be required to report against the Taxonomy[vi]. This provision would alleviate concerns over data availability to some degree as current corporate reporting generally does not cover all types of data required by the framework. However, if the approximately 6,000 companies in the EU covered by the directive are required to report in line with the Taxonomy, the level of taxonomy-specific data availability will improve significantly.

These elements are now the subject of further negotiations, which may well run into the new year. The implementation date for the Taxonomy also remains unclear; the EU Parliament would like to implement the Taxonomy as soon as possible, while the EU Council wants to postpone until 2022.

Sustainalytics is following the developments closely. We recently hosted a webinar, explaining the four key priorities of the Action Plan and how we can help investors with each of these. In the coming months, we will be publishing in-depth information for clients on how our research and products can support its implementation.

[i] European Commission (June 2019), “TEG report on EU taxonomy,” https://ec.europa.eu/info/files/190618-sustainable-finance-teg-report-taxonomy_en

[ii] European Commission (October 2019), “EU Strategy on Sustainable Finance,” https://iges.or.jp/sites/default/files/inline-files/20191011-1-2.pdf

[iii] Australia’s Sustainable Finance Initiative is “a collaboration formed to help shape an Australian economy that prioritizes human well-being, social equity and environmental protection, while underpinning financial system resilience and stability. […] Our work is modelled on the work and progress internationally to align the finance sector with the goals of a resilient and sustainable economy, including the European Union’s High-Level Expert Group on Sustainable Finance and the UK’s Green Finance Taskforce.” https://www.sustainablefinance.org.au/

[iv] In October, the EU hosted a seminar for a Japan delegation that featured a session exploring possibilities of further policy coordination and cooperation between the EU and Japan on sustainable finance: https://eeas.europa.eu/delegations/japan_en/68867/EU%20Japan%20Sustainable%20Finance%20Policy%20Seminar

[v] The EU Non-financial Reporting Directive covers “approximately 6,000 large companies and groups across the EU, including listed companies, banks, insurance companies, other companies designated by national authorities as public-interest entities.” https://ec.europa.eu/info/business-economy-euro/company-reporting-and-auditing/company-reporting/non-financial-reporting_en

[vi] Responsible Investor (December 2019), “What just happened with the EU green taxonomy?”, https://www.responsible-investor.com/articles/what-just-happened-with-the-eu-green-taxonomy