Viewpoints: The industry reacts
Will the EU Sustainable Finance Technical Expert Group’s June 2019 reports on the green taxonomy, green bond standards and climate benchmarks succeed in mobilising investors and capital in support of sustainability objectives?
Steffen Hörter, global head of ESG, Allianz Global Investors, and member of the TEG
How do the recommendations from the technical expert group (TEG) help? Let’s start with the EU Sustainable Taxonomy and EU Green Bond Standard. An energy company with multiple energy sources is committed to transitioning to a low carbon emissions business model. The company proposes allocating capex to build a new generation facility eligible under the taxonomy (such as solar) and can issue a green bond that meets the EU Green Bond Standard. Investors understand the strategy, assess the bond documentation, understand the environmental benefits and invest.
Now let’s talk about the TEG’s benchmark recommendations. EU ESG disclosure requirements concern all benchmarks, with the exception of interest rates and FX, and will provide more transparency and facilitate better investment choices. Minimum requirements for EU Climate Transition Benchmarks and EU Paris Aligned Benchmarks aim to make such offerings more ‘true to label’. An ESG survey carried out this year by Allianz GI found that 56% of investors said that they would allocate more to ESG if benchmarks improved.
Will the TEG be helpful? Yes. Will they be sufficient on their own? No. It’s up to corporates to capitalise upon sustainability. On the one hand, it’s up to corporates and investors to use the EU standards to align their interest; on the other it’s up to financial service providers to use them to build attractive products.
Steve Waygood, chief responsible investment officer, Aviva Investors
The TEG’s taxonomy and the EU’s sustainable finance reform agenda is welcome, but we are not close to delivering a sustainable financial system. A sustainable future cannot be achieved without a complete sustainability taxonomy.
The current green taxonomy is a start, but to ensure legislation such as MiFID II, Basel III and Solvency II is fully climate conscious, we need to have standardised factors setting out how ‘brown’ the various types of fossil fuel assets are. Similarly, we need to be conscious of the impact involved.
The EU must bring together all strands of sustainability policy to deliver the most ambitious version possible of the EU Sustainable Finance Action Plan, making sure legislation explicitly requires investors to fully integrate ESG and sustainability into their investment decisions. This should also include investment consultancies.
Savers need easy-to-understand information on how products reflect their views and how their money is used. Placing EU citizens at the heart of a sustainable financial system will encourage them to fully engage with sustainability. Bridging gaps between financial reform and the real economy is important, and the supply of projects will need to increase to satisfy demand. A capital-raising plan, mapping out the type and scale of investments required to deliver the EU’s 2030 sustainability commitments, will help deliver finance to projects that will make the greatest sustainable contribution, regardless of size.
Finally, the EU should use its global leadership role to take sustainable finance to the forefront of the global agenda.
Meaghan Muldoon, head of sustainable investing, EMEA, BlackRock
We welcome the TEG’s detailed reports and understand Europe’s efforts to put in place standards and develop a common language to help prevent ‘green washing’ and promote sustainable investments. However, we see challenges in how these frameworks (especially the taxonomy) could be applied to investments and how the disclosure will be underpinned by publicly available data.
The TEG’s efforts to build a taxonomy have focused on identifying and categorising specific economic activities. We believe this approach will be valuable for project financing, like green bonds and infrastructure investment. However, there may be challenges in applying this to an investment fund with exposures to the equity and debt securities of companies, governments, or projects. We believe sustainable investing is about investing in progress and pioneering better ways of doing business. By focusing on economic activities within entities rather than a framework that enables the assessment of risks and opportunities at the entity level, the taxonomy may not register shifts in business models that may contribute to long-term sustainable and inclusive growth.
In the near term, the lack of issuer disclosure will remain an obstacle. It is important for policymakers to consider that disclosures attached to the taxonomy must come from issuers, be publicly available and legally reliable.
Ingrid Holmes, head of policy and advocacy, Hermes Investment Management
For those investment firms and banks already taking a research-led approach to investing or lending sustainably, the taxonomy is unlikely to provide new information or change behaviours. The taxonomy will accelerate market learning among firms that are not as far along the curve in terms of what can and cannot be considered sustainable economic activities in the transition to becoming low carbon and climate resilient. Given the climate policy vacuum investors face in many EU countries, this is a key step forward. If the taxonomy is later linked to green Ecofund fund labels it could help mobilise demand for sustainable products while offering consumer protections. Similarly, if linked to a green supporting factor, it could incentivise banks to produce more green financial products, such as green loans, mortgages and bonds. That could be a game-changer.
George Latham, managing partner, WHEB Asset Management
Our initial concern about the taxonomy was its complexity and the constraint of seeking to define what qualifies as green investments. Our concerns have turned into reality – the initial definitions exceed 400 pages without being comprehensive.
We wonder how it will be used in listed equities and it does not seem to be designed with these in mind. The section on agriculture, forestry and fishing is detailed and totals 71 pages, but these sectors are not really invested in through listed equity markets. In contrast, the section on the manufacture of low carbon technologies is four pages long – somehow cement seems to qualify
for six pages. We believe there are some gaps in the coverage, particularly in the manufacturing of components and sub-systems for a range of end markets, including manufacturing, water utilities and transportation.
The taxonomy is written as if all technologies are equally valid in all markets. For example, water treatment is not in itself considered to be taxonomy-eligible – only efficient water treatment is covered. That might be a good approach in Europe but is not valid in other markets where the alternative is no water treatment at all.
There is some systematic language, which is welcome, depending on how it is applied. For instance, a technology that has not been recognised by the TEG can still qualify, but only by placing a much higher burden of proof than required in other areas. The report also states that market participants can inform the Commission of cases where they think non-compliant activities should be considered environmentally sustainable. WHEB believes that there should be a publicly available register of suggested activities.
Galina Dimitrova, director for capital markets at the Investment Association
Ensuring that we are all on the same page when we are talking about sustainability and responsible investment is key, and that means agreeing a common language and a clear reference point for investors and companies alike.
The TEG’s report on the taxonomy is one piece of this sustainability puzzle and its merit will be in the agreed identification of activities that are environmentally sustainable and make substantial contribution to climate change mitigation. In order for the taxonomy to mobilise sufficient capital to support the European Commission’s sustainability objectives, it needs to help guide the financing of the transition to a more sustainable economy. This transition involves encouraging all companies to shift to more sustainable business practices.
Matthies Verstegen, senior policy adviser, PensionsEurope
The taxonomy can be an enabler for pension funds that want to understand the environmental impact of their investments or compare investment managers’ ESG offering.
In order to be practically useful, we think it is important the taxonomy captures companies that are part of the transition towards the low carbon economy, even if they are not ‘Paris-aligned’ today. It is encouraging to see the TEG propose pathways for some sectors of the economy.
With these proposals in place, the missing piece of the puzzle is reliable data on companies. Access to capital may be an incentive for companies to report non-financial data voluntarily, but otherwise policymakers should consider regulation. ESG data is essential for the incorporation of ESG factors in investment decisions.
Sara Lovisolo, group sustainability manager, London Stock Exchange Group, and a member of the TEG
“The engine of sustainable finance the EU way is almost finalised, but the fuel supply it needs to run on is not there yet.
All the reports published by the TEG in June show – and in many cases are the baseline for – the current data gap.
The taxonomy report, by bringing science and deep sector-specific knowledge to the definition of substantial contribution to climate change mitigation, uncovers the limits of existing corporate disclosures, both on the equity and debt side. The lack of information about whether an economic activity actually meets the taxonomy criteria is compounded by the lack of green revenues disclosures.
Is the future of high-precision sustainable investment tied to the supply of high-quality, science-based modelled (or estimated) data? Time will tell. However, if there is a silver bullet to the solution of the data problem, this is likely to be the result of the interplay of market forces – high-precision data reported in exchange for access to high-precision capital.
Kate Levick, programme lead, sustainable finance, E3G
The outputs from the EU Sustainable Finance Action Plan process so far mark progress in delivering its agenda, bringing clarity to market players and member states alike. They provide a basis for sustainable finance to deliver a climate neutral European economy by 2050. More is still needed, but the foundations have been laid. The different outputs – most crucially the taxonomy and the disclosure guidelines, as well as low carbon benchmarks and green bonds – pull together multiple elements of the financial system to create systemic change.
There is still much debate around the final form and use of the taxonomy, and it will be important that the European institutions develop strong final legislation. Key outstanding issues for the taxonomy include: ensuring that it applies to a wide set of actors in the financial markets, leaving the door open to address risky or unsustainable activities, and developing a strong platform function that can help markets understand the investment opportunities and show policymakers whether finance is flowing to key sectors.
The Commission’s sustainable finance achievements have the potential to mobilise finance towards investment in sustainability, but only if backed up by a clear long-term political signal. A timely decision by the Council to legislate for carbon neutrality by 2050 will be the most important sustainable finance reform.
Stephanie Pfeifer, CEO, Institutional Investors Group on Climate Change
We welcome the efforts by the European Commission and the TEG to push forward the sustainable finance agenda in the EU. Discussions on issues such as the taxonomy, green bond standards and climate benchmarks have focused minds within the investment community on how the financial markets can be mobilised to support the goals of the Paris Agreement.
As a result, we are seeing investors look at their own portfolios and capital allocation in order to better understand the actions they can take. By taking the first positive steps to establish a sustainable finance policy, the EU also has the opportunity to provide global leadership and encourage others to consider how finance can be leveraged to support sustainability objectives.
While steps are being taken to ensure that the EU finance system can help deliver the low-carbon transition, it is essential that measures are developed in a joined-up manner across the real economy to ensure that signals such as robust carbon pricing and fossil fuel subsidy phase-out are received loud and clear by investors.
Eleni Choidas, European policy manager, ShareAction
The TEG’s work on the taxonomy is laudable – a potential game changer that could not only facilitate capital allocation towards sustainable investments, but ensure millions of savers have access to better data on where their savings are invested. Used correctly, the TEG’s work could be instrumental in ensuring greenwashing is a thing of the past.
Nonetheless, the effectiveness of the TEG in support of sustainable objectives will depend on processes taking place beyond it: the development of a robust legislative framework. This has to focus on two elements: the first is to ensure that human rights safeguards need to be adhered to as part of the taxonomy are developed at EU level – at least a high-level version of them. Without these, the current framework is not fit for purpose. These should include provisions for ensuring investee companies conduct adequate human rights due diligence.
The second is to ensure that provisions will be put in place for the development of a ‘risk-based’ taxonomy, not just an ‘impact-based’ one. Defining which activities are harmful to the environment, only partly addressed in the current version, can function to help shift capital away from unsustainable activities, not just shift it into sustainable activities.
Both these developments fall beyond the TEG – but are linked to its success. The Council and the other co-legislators must ensure these developments take place in the legislative process – and the Permanent Platform on Sustainable Finance, set to replace the TEG, should take the technical work to accompany these provisions forward.”