TEG final report on the sustainable finance taxonomy

The Technical Expert Group (TEG) on Sustainable Finance has published its final recommendations (plus an annex) for the European Commission on the Taxonomy – or, a ‘framework to facilitate sustainable investment’.

This framework will enable investors to reorient their investments towards more sustainable assets and incentivise companies to change their economic behaviours. The EU hopes this will accelerate progress towards achieving climate neutrality by 2050 and Paris targets by 2030.

The TEG’s final report contains recommendations on the design of the EU’s ‘green list’, including guidance on how companies and financial institutions can use it and the technical screening criteria. The Commission will use these recommendations to develop rules setting out the EU’s final classification of green activities.

Objectives and requirements for classification

In December 2019, EU Member States and the Parliament reached a political agreement on the final text of the Taxonomy and how it should classify economic activities, now giving it a legal basis.

The Taxonomy identifies and defines six EU environmental objectives to be achieved:

In order to qualify as environmentally sustainable, economic activities would have to fulfil the following:

Disclosures

The Taxonomy also requires companies to disclose certain information, as outlined in both the Non-Financial Reporting Directive (NFRD) and the Regulation on disclosures relating to sustainable investments and sustainability risks. Economic activities covered by the NFRD and the Regulation will be considered Taxonomy-aligned. Companies will have to disclose the turnover derived from products or services they offer, and the proportion of their total investments and/or expenditures related to assets or processes associated with environmentally sustainable economic activities. These disclosures will determine if economic activities comply with the three requirements abovementioned.

It can therefore be expected that financial market actors will look more closely at the activities they are financing and investing in, and that they will be incentivised to make more responsible and sustainable choices. The TEG believes financial sector actors will more closely analyse the sectors in which they invest, currently covering: agriculture, forestry, fishing, manufacturing, electricity, gas, water, sewerage, waste, transportation, storage, Information and Communication Technologies (ICT), and buildings.

Do no significant harm

This principle identifies if an activity causes harm to one or more of the environmental objectives. If an activity is considered to do so, it will not be Taxonomy-aligned.

Solid fossil fuels are explicitly excluded as they do not substantially contribute to climate change mitigation, adaptation, or any of the other objectives, but rather they cause harm.

Other activities that produce non-renewable waste, use gas and certain technologies to generate energy, will not be excluded from the Taxonomy, but will depend on disclosures, investors’ Due Diligence work, and the technical screening criteria to be developed through the Commission’s Delegated Acts. The TEG is therefore adopting a ‘technology neutral’ approach.

The classification of nuclear energy remains largely ambiguous therefore, being neither explicitly included nor excluded from the category of ‘substantial contribution’. But like all technologies covered by the Taxonomy, nuclear will also be subject to the strict DNSH principle, and classification will depend on the technical screening criteria.

The Taxonomy has also included a threshold, that if met, an activity can be considered Taxonomy-aligned. For example, a power plant can only be classified as making a “significant contribution” to tackling climate change if it meets the emissions limit of >100g of CO2 per kilowatt hour (kWh). This limit will be reduced every five years. If a power plant fails to meet this limit but still adheres to an emissions limit of 262g CO2e per kWh, it is classed as an activity that does “no significant harm” to the EU’s climate ambitions.

Enabling and transition activities

The Taxonomy also introduces Enabling and Transition activities, which is reinforced in the TEG’s final report. The inclusion of this is essential in order to further define what will be considered environmentally sustainable and how, which will support business in aligning themselves with the Taxonomy.

A Transition activity is an activity that does not have a feasible, low-carbon alternative, but does contribute substantially to climate change mitigation as it supports the transition to a climate-neutral economy. These activities will have greenhouse gas emission levels that correspond to the best performance in the industry, they will not hamper the development and deployment of low-carbon alternatives, and they will not lead to a lock-in of carbon-intensive assets.

An Enabling activity is an activity that contributes substantially to environmental objectives if it directly enables other activities to make significant contributions and where it does not lead to a lock-in of assets that undermine other long-term environmental goals, and has a significant positive environmental impact on the basis of lifecycle considerations.

Governance

Negotiators of the Taxonomy have agreed to establish a Member States Expert Group to ensure the enhanced participation of Member States. An International Platform on Sustainable Finance has also been established by the EU, aiming to encourage participation at the global level. The Platform will develop and maintain the EU Taxonomy, monitor international capital flows to sustainable finance, and encourage harmonised climate action. So far, Argentina, Canada, Chile, China, India, Kenya, Morocco and the EU all sit on the Platform, representing almost half of the world's greenhouse gas emissions.

Process of classification

Under substantial contribution, coal powered energy is excluded completely from the Taxonomy. For hydro powered energy, the threshold needs to be met. In the case that the company has not disclosed this information, substantial contribution cannot be verified and thus it does not pass. Energy from wind power is eligible without threshold.

Under DNSH, investors need to check wind powered energy against DNSH criteria. In this case the company does not provide that information. The investor has to conduct Due Diligence, including screening against controversies.

Under Minimum Safeguards, if the information is not reported, the investor has to conduct Due Diligence, which includes screening against controversies.

Following this example above, 50% of the company’s turnover is Taxonomy-aligned.

What is the CBI warning against?

Key for business will be the Taxonomy’s “two-tier” approach to classifying investments as green or not. The first tier would focus solely on ‘pure green’ investments that contribute to climate change mitigation and adaptation, and the second would cover activities that do “neither substantial contribution nor significant harm” – in essence this would see the creation of a ‘brown-list’.

While the TEG acknowledges that classifying such activities as partially green is risky, they argue that bridging the gap between those that do “significant harm” and those that make “substantial contribution” is very important. The proposed grading system would “help signal when improvements to existing assets had made a substantial difference to the environmental performance of an activity or asset relative to environmental objectives”. The CBI will be calling for actors to consider the role of business in responsible investments that create long term-long sustainable transitions.

What can business be pleased with?

The TEG’s final report contains recommendations on the design of the Taxonomy, including a Usability Guide on how companies and financial institutions can use the technical screening criteria and the Green Bond Standard – as requested through consultations and feedback from summer 2019 – and updated sustainability criteria for 68 economic activities. This should ease business’ concern about how to implement and comply with the Taxonomy.

Next steps

The Commission will use the TEG report as a basis for further developing the rules and final classification of green activities in order to make progress in climate change mitigation and adaptation.

In terms of the Green Bond Standard, the Commission will publish its decision on what form the final standard should take as part of the Renewed Sustainable Finance Strategy in the third quarter of 2020, following a three-month consultation period.

CBI plans

The Taxonomy is just the beginning of EU plans on sustainable finance legislation, with plans for revisions of the Taxonomy to include social obligations in 2022. CBI is working heavily on sustainable finance. We released a Green Finance Position Paper in July 2019 and will continue to build a sustainable finance campaign encompassing the whole ESG spectrum.

The CBI will continue to remain active in this space to ensure sustainable finance is applied uniformly across the EU. We urge that the final Taxonomy must have a clearly defined purpose and scope and must support businesses in their transition processes, preventing exclusion or ‘blacklisting’. As we shape our sustainable finance position, we would like your feedback on the EU’s proposals and how they could affect your business. You can get involved here. For any further information, please contact Meg Griffith Otway.