EU Platform on Sustainable Finance publish report with recommendations on Extended Environmental Taxonomy
As mentioned in our March edition of ESG Policy and Regulation Round up [1], on 28 March, the EU Platform on Sustainable Finance published its Final Report on Extended Environmental Taxonomy [2]. In this report the Platform is recommending extending the Taxonomy framework to classify activities as 1) unsustainable performance requiring an urgent transition to avoid significant harm; 2) intermediate (or amber) performance; 3) unsustainable, significantly harmful (red) performance where urgent, managed exit/decommissioning is required; 4) Low environmental impact (LEnvI) activities. The European Commission will consider the recommendations and will publish its own report outlining the next steps, such as, for example, whether a new legislative proposal will be put forward or whether voluntary guidelines could be issued first.
Key considerations for sustainable finance market participants
Whilst the Platform’s Report provides the recommendations on the potential structure of a future extended environmental taxonomy without yet outlining the actual technical screening criteria, market participants should be mindful that, according to the Report, the overall market feedback on the extension was favourable which increases the probability of the proposed taxonomy construct to materialise via future developments of the EU Taxonomy Regulation.
Investors / Lenders
According to the feedback summarised by the Platform, extending the Taxonomy beyond green could bring:
- Increased transparency for all investors who want to support finance for urgent and ambitious environmental transitions and who need to manage their climate and environmental risks (including managing investments not making a transition away from environmentally harmful performance)
- Enhanced tools to identify projects resulting in a positive environmental impact as well as stranded assets
We also think that the availability of such an extended taxonomy would allow investors to design more nuanced and granular exclusion policies.
It would also provide for better risk diversification opportunities for investment portfolios (as to date, for example, investing in pure green taxonomy aligned assets would often fail to achieve optimal diversification).
Issuers / Borrowers
Issuers/borrowers may benefit from the following potential benefits of the extended taxonomy:
- More sophisticated toolbox covering a different environmental performance levels to describe transition plans and progress by companies across all sectors could become available. According to the Platform’s report, some corporates indicated that clarity on the aspects of significant harm would enable them to make better transition plans, inform their investors more clearly on those plans and avoid being at the ‘whim’ of a variety of different stakeholders and shareholders with different views.
- Obtaining clarity on the expected speed of the transition in the EU across sectors would provide an impetus for companies to align their business decisions and assess respective financing needs.
- Climate-related KPIs in sustainability-linked structures could be built based off the extended taxonomy framework (for example, a KPI to move from intermediate performance level into green.
However, there may be unintended consequences such as the risk of company “blacklisting”, which may need to be considered further in the development of the Taxonomy.
Potential challenges
A key issue that may arise as a consequence of extending the taxonomy is a significant increase in the complexity of the framework that can hamper its usability, including the associated reporting. Implementation of the EU Green Taxonomy has not been completed yet whilst proving to be a complicated process. Operationalising the extended version of the taxonomy can prove difficult and costly in practice.
With regard to any related future reporting, optimal sequencing of disclosure obligations would need to be ensured with corporates providing information first and followed by investors/lenders. This would be necessary to avoid the challenges experienced so far with the implementation of the Green Taxonomy whereby some reporting obligations for investment managers and institutional investors started to apply prior to those for the portfolio companies.
EU Platform on Sustainable Finance Report with recommendations on the Technical Screening Criteria (TSC) for remaining four environmental objectives in the existing Environmental Taxonomy
On 30 March, the EU Platform published its recommendations [3] (and Annex [4]) to the European Commission on the TSCs for the rest of other four environmental objectives (shown below), with details on how it makes a substantial contribution to at least one of the environmental objectives without doing significant harm to any of the other objectives. The Platform also presented its report during a dedicated webinar [5].
The report includes criteria for about 60 economic activities in 12 sectors. The prioritisation of the activities has been performed based on the magnitude of their impact and improvement potential. Some high-impact activities, such as mining or biodiversity in agriculture, have been left out for future consideration. The Platform plans to release additional criteria in May 2022. The European Commission is then expected to adopt the whole package of the new criteria via delegated acts by the end of 2022.
The four additional environmental objectives are:
- Sustainable use and protection of water and marine resources: To ensure at least good status for all water bodies by 2027, and good environmental status for marine waters as soon as possible; and to prevent the deterioration of bodies of water that already have good status or marine waters that are already in good environmental status.
- Transition to a circular economy: By 2030 economic growth is decoupled from extraction of non-renewable resources and depletion of the stock of renewable resources is reversed, and by 2050 economic activity is largely decoupled from resource extraction, through environmental design for a circular economy to eliminate waste and pollution, keep materials and products in use at their highest value, and to regenerate ecosystems.
- Pollution, prevention and control: By 2030, pollution sources, sinks and pathways due to human activities have been fully identified and measures have been applied that prevent and eliminate pollution across air, water, soil, living organisms and food resources. By 2030, the production and use of substances, materials and products is safe and taxonomy-aligned.
- Protection and restoration of biodiversity and ecosystem: To ensure that by 2050 all of the world’s ecosystems and their services are restored to a good ecological condition, resilient, and adequately protected.
