May 3, 2021

Monday Morning Memo: Will the EU Taxonomy Become a Toothless Tiger?

by Detlef Glow.

The EU action plan for financing sustainable growth was set up to boost the role of the finance industry in achieving a well-performing economy that delivers on environmental and social goals defined in the EU’s 2030 targets, which are outlined in the so-called Paris Agreement. Since this effort needs an expected investment of around €180 billion a year, it is clear that the EU Commission needs to connect the finance industry with the specific needs of these goals.

The first paragraph of the chapter reorienting capital flows toward a more sustainable economy within the renewed sustainable finance strategy and implementation of the action plan on financing sustainable growth has the title: “Establishing a clear and detailed EU taxonomy, a classification system for sustainable activities.” This should be reached beside other standards and definitions by establishing an EU classification system for sustainability activities.

This classification system, the so-called EU taxonomy, is seen as a very powerful tool through which to identify the percentage of sustainable activities within a given portfolio and on an asset manager level. Questions remain, however, on how the data needed for the classification of the activities within a company can be generated and implemented efficiently in a standardized and transparent manner.

As such a system will clearly showcase the level of sustainability of the investments in a portfolio, it can also be used to evaluate how much of the overall assets of an asset manager are conforming to the sustainability standards of the EU. Therefore, such a classification system could be used to separate “true” sustainable asset managers from those who are offering just a few sustainable funds within their product range. For example, it could be used to identify greenwashing at the product and asset manager levels.

Obviously, the asset management industry wants to look as green as possible and is therefore lobbying for the exclusion of large asset pools from these kind of analyses (Please read my Monday Morning Memo: The Current Lack of Regulation Leads to Confusion on EU Taxonomy Disclosures for more information on this topic).

In addition, the classification of activities is also a target for different lobby groups as companies have an interest in appearing as green as possible, since this would make them more attractive to investors. Therefore, they would like to include as much of their activities as possible within the sustainable (benefitting the environment) bucket or have their suspicious activities excluded from this analysis under the “do no significant harm” principle.

Speaking of this, the latest proposal of EU policymakers raised the eyebrows of investors with a focus on the sustainable investment community, as they are considering broadening the classification for sustainable assets to include gas and fossil fuels. This step would allow asset managers to classify investments in fossil fuel infrastructure such as gas power plants as sustainable.

From my point of view such a move within the classification would make not only the classification itself obsolete, it would also counter all efforts with regard to the EU Ecolabel and the EU green bond standard. No investor would understand why these activities are classified as sustainable, while other usages of fossil fuels, such as the usage of conventional cars or fossil fuel based heating systems, is seen as not sustainable and gets penalized with additional taxes from governments.

After the announcement of the action plan on financing sustainable growth, the EU was seen as the leading region of the world with regard to achieving sustainable growth and to fight climate change. But with all the discussions around exclusions of activities, sectors, and asset pools, the EU action plan is losing its reputation as a powerful tool bit by bit. In other words, if the proposed exclusions and re-classifications are made, the lighthouse project of the EU Commission will become a toothless tiger with no real impact. In addition, I would assume that European investors will lose their faith in the EU Commission.

The views expressed are the views of the author, not necessarily those of Lipper or Refinitiv.

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