The European Commission has published a report from the Technical Expert Group on sustainable finance (TEG) on a proposed classification system – a taxonomy – for environmentally sustainable economic activities based on their contribution to EU sustainability-related policy objectives. The activities cover sectors that account for over 93% of greenhouse gas emissions (GHG), among them manufacturing, utilities, transport, real estate, agriculture and forestry.
The proposed taxonomy, which will be continually updated and refined, aims to enable capital markets to identify and respond to investment opportunities that contribute to the EU’s environmental policy objectives. It is expected that decisions by investors to (re-)allocate capital or influence company activities can contribute substantially to climate goals as well as the related UN Sustainable Development Goals (SDGs).
At least EUR 175 billion needed – each year
While there is no comprehensive picture of the financial exposure to climate change or of the investment needed for adaptation and mitigation, climate-related hazards are already causing substantial economic damage. The total reported economic losses caused by weather and climate-related extremes in the EU between 1980 and 2017 amounted to more than EUR 453 billion.
To help mitigate the effects of climate change in Europe sufficiently, a minimum EUR 175 billion needs to be invested each year, most of it by the private sector. Through financing or investment decisions, and through stewardship, investors can influence the decisions taken by companies, other issuers of financial securities and capital markets as a whole.
For capital markets to contribute effectively to these overarching policy goals, and to financing sustainable growth, there is an increasing need to develop and strengthen the toolbox. The taxonomy is one such powerful tool help manage risk, to promote positive change, improve reporting and data, or to boost an issuer’s reputation.
The taxonomy and benchmarks
The taxonomy can be expected to help define and determine the exposure of investment portfolios, or benchmarks across asset classes, to the green economy. It can also play a role in identifying green revenues or the green share of portfolios. The TEG has recommended that the taxonomy be used in benchmark disclosures. It should help with transparency and improve the comparability of indices, in particular when it comes to sector breakdowns or green revenues and green shares.
The taxonomy can also help benchmark administrators eliminate any exposure of climate indices to companies significantly harming EU environmental objectives or corporate issuers which achieve GHG goals, but whose social standards are low.
How the taxonomy can help investors
The short guide for users of the taxonomy lists a range of its benefits to investors, be they institutional or retail. These include:
- Providing clarity via a common language which can be used by investors to express their expectations for their investment decisions. Companies and project developers can use it to plan and raise finance, developing the pipeline of sustainable investment opportunities. All can use it to avoid unintended greenwashing.
- Saving time and money for investors and issuers. The taxonomy’s criteria have been developed by environmental and industry experts and are based on the latest EU and international thinking. This allows investors to focus on what they do best, understanding the risk and return of an investment.
- Supporting different investment styles and strategies. Investors marketing environmentally sustainable (‘green’) funds can invest in taxonomy-eligible activities; engage companies on how they are progressing towards taxonomy thresholds; or provide their own explanation for how they will achieve the fund’s goals. Investing in taxonomy-eligible activities is not mandatory.
- Putting environmental data into context. Investors need to understand which companies are contributing to the low-carbon transition and which are building resilience to climate change, not just carbon footprints.
- Avoiding reputational risk. By screening out economic activities that undermine broader environmental, climate and social objectives, investors can avoid reputational risk and ensure that their strategy is robust.
A clear direction of travel
Helena Vines Fiestas, BNP Paribas Asset Management’s Deputy Global Head of Sustainability and a member of the TEG’s Taxonomy Working Group, sums up the import of the proposed EU taxonomy. “As well as reassuring both institutional and retail investors and saving them time and resources in the medium and long term, the taxonomy provides a clear direction of travel to companies, encouraging research and development in objectively accepted green technologies and rewarding those that make efforts to green their activities.
“For the first time, it will enable the measurement of private and public, national and international capital flows to environmentally sustainable activities within and beyond Europe. Above all, this standardised, science and evidence-based tool will foster investments where they are most needed.”
While the European Parliament agreed to the proposed taxonomy on 28 March, the European Council has not. Most analysts assert that the final text will not be approved until this autumn.
 The TEG is a group of experts from finance, academia, civil society and industry appointed by the European Commission to identify sustainable economic activities and the level of environmental performance they must achieve.
Also read The EU taxonomy: the metric system of the 21st century by Helena Vines Fiestas
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