Friday 13 September 2019

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Expert Report - The importance of EU Taxonomy on Sustainable Finance

What context for the EU taxonomy?

The taxonomy is a recommendation proposed by the expert group on sustainable finance, adopted in March 2018 by the European Commission as part of its development strategy for a sustainable and carbon-neutral economy by 2050. The purpose of this strategy is to rethink the functioning of our financial system to render economic growth compatible with the preservation of the planet and its resources. To this end, the Commission wants to reorient private capital towards more sustainable investments.
The taxonomy is a key measure of the action plan in the regulation on sustainable finance which enables the definition of a method common to all market players to identify 'green' activities.

In the expert group report, other measures are also detailed:

  • The creation of European Union labels for green financial products, on the basis of this classification system,
  • The obligation for asset managers and institutional investors to factor in sustainability aspects in the investment process and to reinforce their obligations with regard to the publication of information,
  • The integration of sustainability in the prudential requirements by calibrating the equity requirements applicable to banks for sustainable investments, when that is justified from a risk perspective,
  • The reinforcement of transparency in terms of the publication of non-financial information by companies.
How can the taxonomy be defined?

The taxonomy is a classification system for economic activities facing environmental constraints. It contains a list of activities concerned (energy production and utilisation, transport, metallurgy) and the level of environmental performance they must secure to limit global warming to less than two degrees. The taxonomy meets six environmental targets which are:

  • The attenuation of climate change,
  • Adaptation to climate change,
  • The sustainable utilisation and protection of water and marine resources,
  • The prevention and reduction of pollution,
  • The transition towards a circular economy, biodiversity and recycling,

The protection of ecosystems. For an activity to be eligible, it must provide a contribution to one of the EU’s six environmental objectives without having a negative impact on any of the other five.

The taxonomy provides a language common to all financial players in the EU by identifying green activities and the expected level of environmental performance. Moreover, it defines the green vision on the European level and will serve as a benchmark in regulation notably on:

  • Green bonds
  • The Eco label
  • The benchmark climate indices
  • Climate reporting
How can investors use the taxonomy?

The taxonomy clearly defines environmental sustainability. It can also be viewed as a list of ecologically sustainable economic activities, as it defines the criteria and thresholds above which the business may be viewed as sustainable. As a result, the taxonomy will aid investors in their decision-making process and the selection of companies. This will also allow them to identify the share of ecologically sustainable enterprises in the investment universe.

How does the taxonomy complete existing labels?

To help structure the offer, the government supports two complementary public labels: the TEEC label focused on the climate and launched in 2015, recently re-named 'Greenfin', and the SRI label, since 2016, which indicates funds managed according to ESG criteria. However, even if the European sustainable finance labels provide information to investors seeking to identify responsible investments, they diverge substantially which undercuts overall investor understanding. Indeed, though some labels show an environmental orientation (the Greenfi n label, the 2 LuxFlag Climate labels, Finance and Environment, the Nordic Swan Ecolabel label) others require the respect of ESG criteria or the exclusion of sectors of activity such as GMOs, arms or tobacco. The label most close to the utilisation of the European taxonomy is the Greenfin label which refers to eight eco-sectors such as energy efficiency, ecologically sustainable construction, etc. A European eco-label is being studied to identify products financing the sustainable activities meeting the European Union's six environmental objectives.

Le label se rapprochant le plus de l’utilisation de la taxonomie européenne est le label Greenfin qui fait référence à huit éco-secteurs tels que l’efficacité énergétique, la construction durable, etc…

Un éco-label européen est à l’étude pour identifier les produits finançant les activités durables suivant les six objectifs environnementaux de l’Union européenne.

What role for companies in the application of the taxonomy?

One of the main objectives of the taxonomy is to encourage the communication on the portion of sales linked to green activities. And the availability of this data will dictate the deployment of the taxonomy. Companies thus play a key role in the successful application of the taxonomy. In conclusion, the taxonomy is a common language for investors, companies and regulators while reflecting Paris Agreement. Even though the climate recommendations in the taxonomy are not obligatory, investor pressure is likely to speed up the availability of data from companies.

Please find the full document below.

Catherine Crozat, Quantitative research analyst, in charge of the ESG project and David Usemma, CFA, Research engineer, in charge of the equities project at CPR AM


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