What is the EU green taxonomy and how will it drive targets for Net Zero by 2050?

EU green taxonomy drives the Net Zero transition through standardising how companies communicate environmental activities for their investors.

Since 2015, European institutions have encouraged sustainable investments to “make finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development” (Paris Agreement, Article 2.1.c). This requires clear guidance as to whether an asset can be considered sustainable or not. The European Commission’s Technical Expert Group on Sustainable Financing (TEG) has now published its final report on the new green taxonomy, which aims to standardise how companies communicate environmental activities and offers a common vocabulary for investors and other stakeholders, aiming to avoid risks of greenwashing in a bid to drive Net Zero transition.

What is the EU green taxonomy and how does it align with Net Zero?

The green taxonomy is intended for:

• Those who publish information for their stakeholders and especially their investors, i.e. large organisations that are already required to provide a non-financial statement under the Non-Financial Reporting Directive
• Those who use this information: financial market participants, financial supervisory institutions (such as central banks) as well as all EU member states when establishing public measures, standards or labels for green financial products or green bonds

The taxonomy provides a standardised classification for assessing the sustainability of 70 economic activities, representing 93% of the European Union’s greenhouse gas (GHG) emissions, according to different levels:

• Activities that are already considered low carbon and compatible with the Paris Agreement (example: Net Zero emissions transportation)
• Activities that could contribute to the transition to a Net Zero economy in 2050 but are not yet on the path to carbon neutrality, such as building renovation
• Activities that enable the “greening” or reduction of emissions from other activities, such as the development of technologies that lead to substantial emission reductions in other sectors (e.g., wind turbine manufacturing plant)

The goal of the taxonomy is to highlight the sectors that are preferable to invest in, such as those that align with Net Zero and will help Europe to achieve carbon neutrality by 2050. This objective is part of the European Green Deal, which puts climate change at the forefront of the EU’s agenda by proposing three axes:

• Reach and maintain Net zero by 2050
• Decorrelating growth and resource use
• Preserve biodiversity and reduce pollution

To succeed in its low-carbon transition, the European Union must mobilise at least €1 trillion to support sustainable investments over the next decade through the EU budget and associated instruments, in particular InvestEU.

How to align with the European green taxonomy?

To align with the taxonomy, organisations’ economic activities must contribute to at least one of the six environmental objectives defined by the TEG and not undermine the other objectives:

• Climate change mitigation: the impact of an organisation on the environment
• Climate change adaptation: the impact of the environment on the organisation
• Use and protection of water and marine resources
• Transition towards a circular economy
• Pollution prevention and control
• Protection and restoration of biodiversity and ecosystems

An economic activity aligned with the taxonomy will have to comply with qualitative and quantitative criteria specific to each objective (methodologies and thresholds). To date, the TEG has only detailed the criteria for the first two environmental objectives but will soon publish those for the other four objectives. For an activity to be considered green, it also must respect labour and social rights.

What benefit does the green taxonomy provide for investors?

Thanks to the taxonomy, an investor (asset owner or asset manager) can now determine exactly the green share of their portfolio (the share of the turnover of the underlying assets that contributes to the transition) and so easily compare the contribution of their different investment portfolios to the low-carbon and resilient transition.

Why align with the European green taxonomy?

The taxonomy has numerous advantages:

• Makes it easier for companies to demonstrate whether they are working towards a low-carbon transition and strengthening their resilience to climate change
• Allows investors a better understanding of the risks and opportunities in their investment portfolios
• Helps investors avoid reputational risks associated with activities that undermine environmental objectives
• Provides a common language for all economic actors: investors can use it to express their expectations regarding their investment decisions, companies and project developers can use it to plan and raise funds by developing green investments and all can use it to avoid involuntary greenwashing.
• The taxonomy makes it possible to translate the commitments of the Paris Agreement and sustainable development objectives of Net Zero by identifying activities that can be considered green
• Investors will be able to favour green activities that meet the criteria of the European taxonomy, offering more guarantees, compared to the more heterogeneous ‘internal’ taxonomies of organisations. The taxonomy will ensure the financial flows and the injection of capital necessary to finance sustainable activities even if it is not yet compulsory to invest in activities eligible for the taxonomy

New green taxonomy timeline sets out path to Net Zero by 2050

• March 2020: Publication of the details of the criteria for the first two climate change mitigation and adaptation targets
• December 2020: Adoption of the text in relation to the first two environmental objectives and enter into force from 31 December 2021
• Adoption of the text in the Official Journal of the EU detailing the criteria for the other four environmental objectives at the end of 2021 and entry into force at the end of 2022.

The taxonomy will be reviewed every three years to best respond to technological and scientific evolutions as well as new activities.

The EU taxonomy is a major advancement in sustainable finance and will undoubtedly serve as an international reference in the near future. It remains significant to the UK post-Brexit as it is most likely that the UK will retain the framework for the taxonomy, including the high-level environmental objectives.

Though we await final details, the Treasury did confirm that the EU taxonomy will “Play an important role in the development of Green Finance and in preventing greenwashing, an important UK objective. The UK is also committed to promoting globally consistent standards, and these commitments form a key part of our strategy to strengthen the UK’s status as a global hub for sustainable finance.”

To find out more about the different reporting frameworks you can align yourself with, you can consult our Big eBook of Sustainability Reporting Frameworks 2020 which references the main frameworks.

Sources:
– EU TEG on Sustainable Finance. Technical Report.  Taxonomy: Final report of the Technical Expert Group on Sustainable Finance, March 2020

– EU TEG on Sustainable Finance. Taxonomy report. Technical Annex Updated methodology & Updated Technical Screening Criteria, March 2020