The EU’s green investment ‘taxonomy’ could go global

HBEFORE Brussels entered in 2022, a bomb dropped. In a project sent to EU country, the European Commission has proposed classifying certain nuclear and gas projects as green in its “taxonomy”, a list intended to define sustainable investment. Austria threatened to sue; Germany has cried foul. The plan is still likely to gain the support of the majority of member states, which have until January 12 to vote on it. It could set the conditions for green investment far beyond Europe. But will it direct the capital towards deserving projects?

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The idea was born after the Paris climate agreement of 2015, when the EUS efforts to develop a common standard of green bonds for private and sovereign issuers revealed that members disagreed on what counted as green. Some countries have since worked on their own classifications, but the European one, which maps parts of the economy over 550 pages, is the most comprehensive.

The taxonomy hopes to end the practice of greenwashing and build investor confidence in sustainable assets. It will offer a common set of criteria that investors and banks can use to screen potential investments. Most fund managers already have their own teams and tools for measuring greenery. But the lack of a common benchmark means dashboards remain subjective and inconsistent across the industry, confusing investors. Having a dictionary where they can look up if an investment can be labeled green puts everyone on the same page.

Another aspect of the plan is to link taxonomy to disclosure. From the end of the year, some 11,000 listed European companies will have to report the share of their sales and investment expenditure in the classification (the number of companies covered will eventually increase to 50,000). Since January 1, asset managers must already detail how much of the products they label as sustainable comply with the elements of the taxonomy already in force. From 2024, most European banks will also have to declare a “green asset ratio” according to the same criteria. All of this should put more and better climate data into the public domain. “It’s our best hope globally to measure how much money is being invested in net zero aligned businesses,” says Daniel Klier d’Arabesque, an asset manager.

Ultimately, the ranking will also underpin EU certifications for issuers of securities, creating a direct link to the capital markets. The green bond standard, for example, should use taxonomy as a benchmark for eligibility. The commission will likely also use the classification as it distributes money to member states from its stimulus fund, part of which is tied to greenery.

The level of detail and rigor of the European approach could help make taxonomy the global gold standard. Other countries outside the bloc are working on their own projects. Each will likely be shaped by political compromises, geostrategic concerns and carbon commitments. But foreign companies, asset managers and banks could end up adopting the EUanyway, as their European clients may need them to report the right data, in order to produce their own disclosures. Some may put pressure on their own governments to limit the differences.

Whether all of this is enough to funnel funds to the right investments is another question. An immediate issue is with implementation: Due to missed deadlines, green finance companies are being asked to report on their compliance with the taxonomy before companies are required to provide the underlying data, which complicates task.

A more significant drawback is the limited coverage of the taxonomy. It currently applies to a subset of economic activities. Disclosure requirements also allow small public enterprises and all private enterprises to get off the hook. Morningstar, a research firm, estimates that this will only affect half of the fund’s assets in the EU (excluding private vehicles). That leaves a lot of things in the dark at a time when publicly traded giants, including miners and utilities, are rushing to sell their dirtiest assets to private investors. Others might appear as the EUreporting requirements expand to cover new businesses, some of which are private. But this will take time.

The biggest problem is the mistaken expectation that the mere existence of the taxonomy will alter investor preferences. The greenery of a project is just “a data point,” says David Henry Doyle of S&P, a rating agency. Creditworthiness, interest rates and earnings prospects may be more important. The ranking, in particular, does not create any incentive to support green assets in need of funding, such as low-carbon steel or charging stations for electric cars. Instead, investors can continue to look for safe liquid assets like wind or solar power plants, driving prices higher. Green is good, but it’s not enough.

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This article appeared in the Finance & Economics section of the print edition under the title “Gold standard”


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