Within a year, unprecedented efforts allowed to deliver a sort of “encyclopedia” of sustainability. Fortunately, the 414-page report released on June 18 by the Technical Expert Group on Sustainable Finance (TEG) shows significant usability improvements compared with the December draft report. The sectorial coverage has been tremendously extended with a total of 67 activities reviewed, even though a few sensitive ones are still lacking, namely mining, glass manufacturing, paper and pulp manufacturing, aviation or maritime transport… Overall, it appears that the TEG gave its best shot to excogitate the plethora of feedback expressed during the first consultation. The “do no significant harm assessment” is less loquacious. It is trying to be as anchored as possible into existing environmental regulations and standards.
Although a considerable challenge considering the richness and technicality of this document, our main takeaways and comments could be synthesized as follows:
If we were to make one overall comment on the EU Taxonomy, it would probably relate to the stringency of the proposed thresholds, and how far they often currently stand from sustainable finance market and industrial observed performance levels. Though, one should not lose sight of the remit of such Taxonomy: define environmentally sustainable activities which would underline sustainable financing / investing products, standards and regulations as well as the needed disclosure to structure those. (Environmentally) sustainable activities are defined here as those allowing for carbon neutrality in 2050. The TEG, and later the European Commission in itsRegulation proposal “On the establishment of a framework to facilitate sustainable investment” and subsequent Delegated Acts encompassing technical screening criteria (the EU Taxonomy), are not taking any stance on whether activities not falling within the proposed thresholds deserve, or not, financing overall. In that context, stringency is what we expect from the EU Taxonomy to preserve the integrity of Sustainable Finance, which is what we see as the main risk to its development.
Though, we would probably argue that the newly added (and very welcome) “transitioning” activities approach is very narrow, long sighted and demanding and could allow for more progressivity in thresholds in the next decade (see below).
Technical screening criteria are multifaceted and reflect pragmatism. To delineate the “eligibility” of economic activities, the TEG has brought forth a sound mix of thresholds expressed in intensity (e.g. gCO2e/unit of product) or in relative (against company baseline or market counterfactuals), abidance by standards, labels, technologies or practices. Criteria are technology-agnostic whenever possible, alike the threshold for electricity generation (100gCO2e/kWh). Sensitive political topics are not eluded: For example, attention is brought to the option of “reducing cattle numbers and increasing legume production as an alternative source of protein”, even though time or mandate were missing to address them properly. Unsurprisingly, nuclear is out because of waste concerns, but the TEG states that new technologies could enter the taxonomy whenever mature, nuclear fusion being mentioned. Among novelties, strong emphasis is made on “ratcheting ambition and thresholds upgrading” with “clause de rendez-vous”, especially for transition activities.
“Transition activities” are introduced but under stringent criteria. There is room for high emitting activities but under demanding conditions, which are derived either from required trajectories to achieve net carbon neutrality by 2050 and/or from the top 10% performers’ level of the EU-ETS Benchmark in a given sector. If the EU-ETS has until now not made it possible to provide necessary carbon pricing, it may reveal a valuable source of carbon data for industrials. The message is clear, unabated fossil fuel power generation must be phased out. Gas will not be eligible without Carbon Capture, and actual physical measurements are required for methane leakage. Often, thresholds for transition activities will be harder to reach. For instance, in the case of plug-in hybrid vehicles that usually emit more than the 50gCO2/km threshold proposed (especially SUVs). In cement, steel or iron manufacturing industries, only cutting-edge facilities might be eligible. Recycling and circularity are systematically advantaged, with automatic eligibility for aluminum recycling, or scrap steel when representing more than 90% of the feedstock.
Reporting on EU Taxonomy compliance, for instance on revenues from eligible activities, will be demanding but should not stifle its appropriation by market participants. Actual measurement is preferred over calculation through modeling whenever feasible, depending on costs, methodologies and counterfactuals availability and reliability. Third-party certification audits performed by accredited certification bodies are to be required for several activities, at regular intervals (e.g. 3-year intervals audit for carbon sinks for growing of crops). Demonstrating compliance will be dead sure costly, demanding, but game changing. Data providers will be instrumental in Taxonomy’s adoption, by creating “Taxonomy profiles” for companies as suggested by the TEG, an idea that we really laud. The question of the “binding nature” of the Taxonomy and with it, the very question of its adoption at scale is central. Under the proposed Regulation On the establishment of a framework to facilitate sustainable investment”, institutional investors and asset managers are assigned an ambiguous “comply or explain” obligation, as they must report accurately how the financial products they market “as sustainable” relate to the Taxonomy. By this time, the Article 4 of the Regulation that establishes obligations to use the Taxonomy is still under discussion. But apart from this mandatory dimension, we think that from the moment when European sovereign or government-controlled asset owners or managers will commit to invest and report upon the EU taxonomy, and it is reasonable to think that they will, high upfront costs will be absorbed, and private investors and the rest of the industry will follow. Meanwhile, the more the EU Member States use it do device labels, tax incentives or adapt public procurement rules, the faster the penetration will be.
This publication, that we called a “vade mecum”, tries to answer fundamental questions and charters the consequences and transformative potential uses of such a Taxonomy. Uncertainty regarding the content of the future Regulation and Delegated Acts remains. We hope that the negotiations between the Council of the European Union, the European Parliament and the European Commission - will be fruitful and ambitions not be downgraded.
With this publication, Natixis GSH intends to raise awareness and understanding (in particular the Q&A and the stringency and usability activity assessment sheets), on what is at stake, on the tremendous work that has been done and the tasks that loom ahead.
We do not feel we go astray but rather have launched into orbit and esteem that we, collectively in Europe, now have a tool to start with and speak the “same language”.