Five things to know about the taxonomy
1. The taxonomy can be viewed as a living dictionary providing definitions of sustainable economic activities – activities that contribute significantly to at least one of the six EU environmental objectives, that do not do significant social harm to other environmental objectives and that comply with minimum social safeguards.
2. The basis for this classification system is formed by the EU environmental objectives – to mitigate climate change; to adapt to climate change; protect water and marine resources; control and prevent pollution; move to a circular economy; protect and restore biodiversity and ecosystems – and the underlying EU targets and strategies to achieve them. For instance, for climate mitigation, the EU objective is net zero emissions by 2050 (and the intermediate target of a 50-55% reduction in emissions by 2030).
3. Defining sustainable activities helps provide clarity on which activities are conducive to environmental sustainability, and should be promoted (as well as financed), and which are harmful, and require changes or to be discontinued (or at least not be supported). For example, the definition of fossil fuel based power generation as not sustainable should contribute to the greater use of carbon capture, utilisation and storage (CCUS) or its phase-out.
4. By defining sustainable activities, the taxonomy acts as a ‘bridge’ between environmental and financial performance and can be a decision-making tool in determining which companies, activities or projects to finance when the funding or the provider of the funds is aiming to be ‘environmentally sustainable’. Activities that align, or have a credible intention to align, with the taxonomy (‘taxonomy compliant’) can expect more financing and thus stronger and more consistent growth. Green bonds, loans or mortgages can be considered taxonomy-aligned if the funds are invested in making activities compliant, thus burnishing their credentials and steering clear of greenwashing.
5. Classification on the basis of the taxonomy is part of a wider set of standards, labels, directives and regulations that cover sustainable finance. This includes non-financial reporting, a green bond standard and an ecolabel. The taxonomy can become the basis for green budgeting, green procurement, ESG products (including benchmarks), capital allocation and a green recovery plan.
The taxonomy and investor reporting
The definitions can be used to assess whether and to what extent (the activities of) companies are taxonomy-compliant. By assigning a percentage score to (an activity by) a company, a fund manager can determine how environmentally sustainable (green, ESG-aligned, etc.) the fund is. Using the taxonomy as the common basis to assess all funds results in level-playing-field disclosures to investors and allows for fair and useful ‘apple-to-apple’ comparisons.
In portfolio construction, it can be used to select ‘sustainable’ investments, e.g. companies earning a set percentage of their turnover from taxonomy-aligned activities or spending percentage x on taxonomy-aligned activities such as green hydrogen and renewable energy sources.
Consistent use of taxonomy classifications will result in greater transparency for investors. It will enable asset managers to market funds as verifiably green and allow investors to invest confidently in products that meet their ESG or green preferences.
Areas for development include the need for reliable, quality and comparable data to base assessments on; guidance on how to report, how to conduct due diligence and clarity on regulators´ expectations; simplification and adaptation for different uses and users (e.g., equivalence classification and regulatory tables) and an internet data tool with a link to the EU’s open-source database.
The development of a social taxonomy will most likely be on the agenda as well.
Using the EU taxonomy as guidance, other taxonomies are being developed. The hope is that investors will be able to work with the same environmental metrics – and standardised methods to calculate them – and the same financial metrics.
Shared principles and methodology could result in a truly international framework for sustainable finance that ultimately helps to pinpoint the areas that need the tens of millions of euros of investment to build a net zero, resilient, environmentally more sustainable and inclusive economy.
- Positioning for a green recovery from COVID-19
- EU Climate Target Plan – A stepping-stone to climate neutrality
- Towards a sustainable finance system – Further yet to go
 “Carbon capture, utilisation and storage (CCUS) is the only group of technologies that contributes both to reducing emissions in key sectors directly and to removing CO2 to balance emissions that are challenging to avoid – a critical part of “net” zero goals. Source: https://www.iea.org/reports/ccus-in-clean-energy-transitions
 Using environmental, social and governance criteria for security selection; also read Measurement and reporting are critical to sustainable investing
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. The views expressed in this podcast do not in any way constitute investment advice.
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