As a part of The European Files magazine on sustainable finance, Natixis shared its position on the European Union's work.
“Favouring or penalizing specific assets on the basis of environmental criteria was so far not possible as objective criteria had not been defined. […] As soon as such a taxonomy is agreed, the ECB will need to assess whether and how it can apply it to its Assets Purchasing Programs (APP).”
Ms. Christine Lagarde’s assertion during her hearing by the European Parliament for nomination at the European Central Bank1 hints on the extent to which the EU Taxonomy of sustainable economic activities might have tremendous effects on capital markets.
The proposed criteria for 67 economic activities by the Technical Expert Group on Sustainable Finance (TEG) offered a priceless tool, unprecedented by its granularity. This classification – and subsequent metrics and thresholds – is already a reference used in our daily banking activities.
The TEG not only proposed criteria for pure green activities, but also for those that “contribute to a transition to a net-zero emissions economy in 2050 but are not currently close to a net-zero carbon emission level”. Cement or steel industries are for instance in the scope. Overall, thresholds proposed are science-based and extrapolated either from the 2050 climate neutrality goal or from the top 10% performers’ level of the EU-ETS Benchmark. As a result, they are naturally stringent, providing a common language on what is unambiguously green (“dark green”). Nevertheless, setting the bar so high – and it was needed – without providing intermediary levels may have unintended consequences.
The Taxonomy excludes de facto the bulk of companies and existing facilities within high emitting sectors. It is a challenge because this is where the lion’s share of GHG emissions abatement potential lies. It is crucial to engage all sectors and players on decarbonisation, regardless of their initial position, by chartering transition pathways. Not being “dark green” does not necessarily mean being brown. Meanwhile, when looking thoroughly at some green activities – biomass, biofuels or hydro dams – life cycle analysis calls for shades of green. Moreover, we believe that a brown taxonomy is also necessary and that we cannot wait until December 2021. By that time, the Commission is expected to conduct “an impact assessment on revising the taxonomy regulation to define criteria for when and how an economic activity has a significant negative impact on sustainability2”.
Transition requires shades; it is neither binary nor linear. Managing transitional risks requires to gradually and orderly exit from highly emissive activities. It also urges “hard-toabate” irreplaceable industries deep decarbonization through game-changing efficiency gains (e.g. new processes, equipments and feedstock) but also shifting business models through diversification and at last offsetting initiatives (e.g. afforestation). A shaded brown taxonomy would enable the signals to decarbonize our economy at the lowest economic and social cost, to shift financing portfolios and to avoid the pile-up of stranded assets.
Shades would allow many uses, for instance risk-weighted adjustments or differentiated collateral requirements from central banks. Among bold advocates of a brown taxonomy are the Network for Greening the Financial System (NGFS) or the European Insurance and Occupational Pensions Authority (EIOPA). In France, the ACPR stated3 that “Regulators must quickly agree on a robust, clear, detailed and consensual taxonomy of “green” and “brown” assets” and that “if the relative performance of “green” and “non-green” assets, as defined by a commonly agreed taxonomy, implied an intrinsic risk difference, the prudential framework could be adjusted.”
As the European Parliament is greening with society, we can hope for the previously dismissed regulation to extend the Taxonomy to non-green activities to be reconsidered. It is not only about defining activities that are highly emissions intensive or detrimental to the environment but also defining all the shades in between.
The experience of developing a capital allocation tool relying upon a shaded taxonomy
To gradually align its balance sheet with the Paris Agreement, Natixis has designed an internal mechanism that links analytical capital allocation to the degree of sustainability of each financing. This Green Weighting Factor (GWF) applies to all business lines of the corporate investment bank worldwide. It aims to incentivize the origination of financings supporting transition towards a low-carbon economy and penalize financings, which incur climate and environmental risks. It classifies each financing on a 7-level color scale depending on the degree of impact of each financing on the environment and climate, ranging from dark brown to dark green according to a proprietary methodology.
As an example, under GWF methodology, gas-fired power generation final scores range from medium brown to medium green depending on technologies’ GHG intensity, whether it supports renewable integration by compensating their intermittency, or whether it is equipped with carbon capture sequestration technologies. Our experience with the GWF reveals that a shaded taxonomy from brown to green is of the utmost importance to transition balance sheets. Intermediary levels help to determine where it is necessary to invest in, adjust, transform or divest from. The brown gives us “the stick”, and the shades enable some “carrots” within brown sectors, where differentiation between companies and technologies is crucial.
1 European Parliament – Committee on Economic and Monetary Affairs (29.8.2019)
2 European Parliament – Legislative resolution of 28 March 2019 on the proposal for a regulation of the European Parliament and of the Council on the establishment of a framework to facilitate sustainable investment.