Europe

EU Taxonomies Must Stand on Their Own Before Combining

EFAMA responds to PSF’s brown and social taxonomy consultations.

The European Commission needs to flesh out individually each of its three proposed taxonomies for sustainable business activities to ensure they are decision-useful for investors before combining them into a single framework, according to Dominik Hatiar, Regulatory Policy Advisor for the European Fund and Asset Management Association (EFAMA). Linking the taxonomies together at this stage would ultimately “slow down the implementation of the more advanced environmental taxonomy”, he said.

Due to come into force next year, the original ‘green’ taxonomy aims to prevent greenwashing by providers of financial services by serving as a classification system outlining which investments are environmentally sustainable. Under the Sustainable Finance Disclosure Regulation (SFDR), fund managers will have to refer to the taxonomy when describing and reporting on green investment products.

At present, economic activities are only assessed in relation to two climate-related criteria. The Commission intends to introduce another four environmental conditions and further extend the taxonomy in two ways.

The brown taxonomy would categorise companies that are not considered wholly environmentally sustainable, yet are working to transition away from causing significant harm. For example, an oil and gas company that still relies on fossil fuels but is actively reducing its overall operational emissions.

The social taxonomy aims to ensure that social-related factors are equally considered by both companies and investors alongside existing environmental factors. The social taxonomy is unlikely to be finalised before 2024.

With the Taxonomy Regulation taking effect from 2022, the finalisation of the technical screening criteria for the remaining four environmental objectives must be the Commission’s “absolute priority” to ensure there are no more delays, Hatiar warned.

The Platform on Sustainable Finance’s preliminary recommendations for the technical screening criteria for these objectives – concerning water use, the circular economy, pollution and biodiversity protection – is open for feedback until 24 September.

The first two objectives (climate mitigation and adaptation) were formally adopted on 4 June.

“In parallel, the Commission can start the process of consulting with industries on whether brown and social taxonomies are needed, conducting impact assessments and eventually presenting legislative proposals,” said Hatiar.

Widening the scope

EFAMA is supportive of developing frameworks for a social taxonomy and a brown taxonomy. In the longer term, the three should be “blended into one”, Hatiar said.

However, before the social taxonomy is incorporated into the existing Taxonomy Regulation, the Commission needs to address ongoing issues with social-related data, he added, flagging the question of the legislative instrument needed to govern the reporting of companies against the social taxonomy.

“To avoid duplicating some of the reporting challenges created with the environmental taxonomy, the social taxonomy needs to be aligned with the current social data availability and will require investee company reporting ahead of investor disclosures,” he said.

EFAMA recommended that the social taxonomy’s list of activities aligns with the existing principal adverse impacts indicators listed under SFDR Level 2.

The association also responded to the consultation for a brown taxonomy, noting that it would support companies in their transitioning away from significantly harmful activities.

“By distinguishing significantly harmful activities that have the potential to transform and no longer cause harm, asset managers will be able to design better, bigger and safer decarbonisation financial products,” EFAMA said.

Enlarging the taxonomy-aligned investible universe would also decrease risks associated with the current Environmental Taxonomy, EFAMA added, such as the “overweighting of highly green assets or the emergence of green asset bubbles”.

The Commission should avoid a “blacklist-based approach” to the extended taxonomy, Hatiar warned, as this could undermine efforts these companies may be making to transition. This could also drive excluded companies to seek investment from less climate-conscious investors.

“Once these taxonomies have proven themselves individually in the market, we can start thinking about merging them together,” said Hatiar.

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