The question of how to meet investor and client demand for large flows of funds into sustainable activities, while ensuring such investments are genuinely green, and not just marketed as such, is a key challenge for regulators and policymakers.
Green taxonomies seek to address this problem by identifying a detailed list of economic activities deemed sustainable and creating a set of criteria for making such investments.
First out of the gate in this regard has been the EU, which has led the way in the creation of a green taxonomy as part of its Sustainable Finance Action Plan.
Compliance with the EU’s taxonomy, and therefore the ability to describe an activity as sustainable, requires the activity making a substantial contribution to at least one of the EU’s six environmental objectives (climate change mitigation, adaptation, water, circular economy, pollution prevention and biodiversity) whilst ensuring that such an activity does “no significant harm” to the remaining objectives and complies with minimum safeguards on human rights.
Detailed Technical Screening Criteria (TSCs) are under development for each environmental objective, starting with climate change mitigation. This is proving to be a very challenging exercise.
In recent months, the EU Taxonomy has been plagued with lobbying from both industry and countries concerned their economies will lose out. Part of the reason for this has been a failure on the EU’s part to clearly articulate the role of the taxonomy from the outset, and for attempting to use it for wider purposes for which it wasn’t designed.
The taxonomy is not a tool for short-term government funding allocations – the EU has proposed the taxonomy as the basis for distribution of Covid recovery funds. A taxonomy is also not a mechanism to rapidly withdraw capital from certain industries or prevent access to markets for the real economy as some have claimed. Extensive engagement with businesses could help avoid some of these issues experienced by policymakers in Europe.
A well-structured and communicated taxonomy is a key ‘tool in the toolbox’ – one of several – that can help investors drive the transition to a cleaner, greener and stronger economy over the long term. It should help tackle greenwash and create a common understanding of what is truly sustainable.
Here in the UK, it is certain we will have a green taxonomy, the EU’s framework was effectively adopted by the UK before we left the EU. However, the UK has the opportunity to develop its own technical screening criteria, based on the EU’s TSCs, that align to the UK economy and maximise our ability to address greenwash in investments. A Green Technical Advisory Group (GTAG) has been established by the government to advise the Treasury on approaches to take.
The UK taxonomy must be as useful as possible for decision-making by investors. This means it must cover as much of the economy as possible, including transitional activities, and should build in clear transition pathways.
Investors value forward guidance in regulation. We therefore propose an approach outlining the areas that might be regarded as ‘green’ in the short to medium term because they are essential for the transition and where other solutions are not yet available at scale, despite these not necessarily being the technology that will achieve full decarbonisation. These transition activities should be accompanied by clear ‘sunset dates’ outlining the timeline where it is anticipated new technology will have overtaken these activities and they can no longer be regarded as green.
One example is hybrid cars. For a number of years – before electric vehicles were being manufactured at a scale that made them widely available – hybrid cars were regarded as the greenest available on the mass market. As hybrids use fossil fuels, it was clear they were not the solution for green mobility, however were a key step in the development of the technology and mass adoption of lower polluting vehicles. They may have featured in a taxonomy published five-10 years ago.
Clearly the taxonomy must support the successful transition to net zero by 2050, driving the fullest extent of capital towards the transition by covering as much of the market as possible and being easily operationalised. The taxonomy should align with the wider direction of travel of government and the economy towards net zero. Centred on science, and interfacing with other market and regulator initiatives such as the Science-based Targets Initiative and Transitions Pathway Initiative, the UK taxonomy should support and enhance the UK’s global leadership ambitions on sustainable finance.
With these principles in mind, the UK can develop a taxonomy that matches our global leadership role as the host of COP26.
James Alexander is CEO of UKSIF and an ESG Clarity editorial panellist.