Classification of red, amber and green economic activities to provide clearer pathway to sustainability.
The EU’s advisors on the development of the environmental taxonomy have this week proposed a ‘traffic light’ framework that will support the transition to a more sustainable economy, including activities in high-emitting and hard-to-abate sectors.
New guidance from the Platform on Sustainable Finance (PSF), which framed the original taxonomy, will extend its scope to cover all economic activities, but will include warnings to investors on a range of environmental impacts.
The current environmental taxonomy classifies economic activities that make a ‘substantial contribution’ to at least one of its environmental objectives: climate change mitigation, climate change adaptation, sustainable use and protection of water and marine resources, transition to a circular economy, pollution prevention and control, and the protection and restoration of biodiversity.
A delegated act (DA) for climate change adaptation and mitigation was finalised and published last year. Last year, the Commission included gas and nuclear energy in the taxonomy via a complementary DA, prompting criticism. A final proposal for the remaining four sets of technical screening criteria will be published by the PSF later this week.
The extended taxonomy proposal expands the taxonomy’s scope across all six objectives. Originally called the ‘brown taxonomy’, PSF members said its proposal will hopefully remove the fear held by some that not being labelled as ‘green’ is a negative signal to investors.
“What matters is the end position, not the start,” said Nancy Saich, PSF member and Chief Climate Change Expert at the European Investment Bank, speaking at a webinar on Monday.
“The [extended taxonomy] will be much more inclusive of large parts of the economy, showing a clearer way forward and providing much-needed clarity,” she added.
Red, amber, green
Activities in the proposed ‘red’ category are those that most urgently need to transition to more environmentally sustainable practices in order to qualify for taxonomy-recognised investment.
However, the red category also includes activities that cannot avoid significant environmental harm, such as solid fossil fuel generation, thermal coal mining and the construction of new housing in extreme high flood risk areas. These will require managed decommissioning, with every effort made to ensure a just transition effort.
Activities labelled as ‘amber’ will fall in the space between causing significant harm to the environment (red) and making significant positive contributions (green), and will also qualify for taxonomy-recognised investment if there is a clear transition plan in place.
“It’s not just about ‘green and not green’”, Saich said. “The inclusion of amber and red activities [in the taxonomy] would show how much the economy still needs to move away from really harmful levels of performance.”
The Commission will need to consider the potential challenges this framework presents, panellists noted, as it may add greater complexity and increase resource and cost pressures as investors and companies comply with additional reporting obligations.
Jörg Ladwein, Regional Chief Investment Officer at Allianz Group, said that the extended taxonomy will inform investors’ current ESG-related risk assessments and bolster engagement efforts.
“We can use [the extended taxonomy] as a way in which to engage with companies and ensure that their transition plans align with the framework and that the criteria are being addressed through specific KPIs,” he said.
Fitting it all together
The release of the extended framework follows the publication of the PSF’s final proposal for a social taxonomy in February, which was adjusted to integrate with existing European sustainable finance legislation.
Regulatory experts have previously told ESG Investor that the environmental taxonomy, extended taxonomy and social taxonomy need to be fully fleshed out before they are combined into a single taxonomy.
Reporting against the environmental taxonomy went live at the beginning of this year.
Under its Article 8 DA, which was finalised in December 2021, financial and non-financial entities falling under the scope of the Non-Financial Reporting Directive (NFRD) – which will be replaced by the delayed Corporate Sustainability Reporting Directive (CSRD) – are now expected to identify and disclose the eligibility of their activities in line with the taxonomy.
Currently, eligibility disclosures only concern activities falling under the climate change adaptation and mitigation DA, but the reporting requirements will expand as more DAs are finalised over the course of this year.
From January 2023, non-financial companies will be expected to disclose the degree of alignment their economic activities have with the taxonomy. Financial companies have until 2024.
Further, asset managers complying with the Sustainable Finance Disclosure Regulation (SFDR) will also be expected to provide taxonomy-related product disclosures through Level 2’s regulatory technical standards (RTSs) for their Article 8 and 9 funds. SFDR Level has been delayed until January 2023.
Once all three strands of the taxonomy are combined, the resulting framework will consider both environmental and social objectives for the majority of the European economy.
The Commission will now consider the PSF’s proposal.