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What does Fit for 55 mean for the EU Taxonomy?

By Jon Rhodes and Raphaël Delli

In many ways the financial sector has led the European ‘green’ agenda in the past few years. Whilst policy makers have been drawing up new guidelines and targets for industry, hundreds of billions of euros have been raised for green investments, and since 2018, the European Commission’s Financial Services Directorate (DG FISMA) has been working on an action plan – the EU Taxonomy. 

In a nutshell, the Taxonomy is the classification for what is, and what isn’t, counted as ‘green’ or ‘sustainable’. The first chapter of this classification, dealing with environmental activities and specifically focused on whether such activities meet two climate change objectives, is due to come into force in January. 

But like most things in Brussels the journey from conception to adoption hasn’t come without controversy. The rules, in the form of a Delegated Act, are currently held up in the European Parliament and Council amid an increasingly heated debate about whether nuclear and natural gas can and should be accepted as ‘sustainable energy sources’, even if only on a transitional basis. 

This, however, isn’t the only hurdle for the Taxonomy. The financial sector may have taken a lead on sustainability, but everyone else is catching up fast, and in many cases, eager to run ahead. If the Taxonomy can’t fall into line with the EU’s hugely ambitious Fit for 55 package and with the myriad of new targets and ambitions coming out of COP26, it could end up being a white elephant. 

For a start, the Taxonomy regulation, which entered into force last year and well before the publication of the Fit for 55 (‘Green Deal’) proposals were published in July, had to anticipate the goals and means for transition, meaning that in practice despite months of deliberation and argument it might not end up channelling finance in the right direction.

If the Taxonomy fails to designate an economic activity as ‘green’ today, that investors would back as part of  the transition to reach the targets that will be set by Fit for 55 tomorrow, conflict between the two initiatives is unavoidable.

This is the main issue. The EU Taxonomy in its current form cannot cope with the complexities of transition. An investor wanting to back a car maker that is converting to electric vehicle production needs a framework that recognises transitional activity and capital spend. A binary taxonomy, that can only provide an ‘all clear’ once the end state is reached, won’t help. You can’t expect a bank or asset manager to wait five years before it finds out whether or not the asset it has lent to or invested in can be regarded as sustainable. 

The good news is that EU policymakers recognise that their ambitions for climate change and for the green transition cannot succeed without huge growth in sustainable finance. And – as far as we understand – they have begun work on alignment with the Fit for 55 programme and introducing more flexibility around transition. They are willing to listen, and they are willing to engage.  

 

So financial services companies need to arm themselves in the best way possible. They need to keep up with the policy debates, keep pace with the evolving project that the Taxonomy is and, in the meantime, they will need to report regardless, sometimes on a ‘best case basis’ on any potential negative externalities their activities and investments might cause. The same goes with the companies they fund.

Waiting for a final ruling will almost always be too late. Here again, following the Fit for 55 package, which will set the path towards ‘greening’ all our lives, will be one of the best ways for financial services companies to understand and navigate the risks they face. 

A final concern of the Taxonomy is that it becomes overly restrictive – or is at least perceived to be. The principle of  “do no significant harm” (the second criteria of the initial Taxonomy legislation) creates huge uncertainty for investors and lenders. Take an investment marketed as green today; or a green loan in the future. Whilst they might meet the first two climate-focused objectives set out in the Taxonomy and covered by the First Delegated Act, they might not be deemed green tomorrow if one of the four remaining objectives (still to be defined at a later stage) ends up being ‘harmed’ one way or another. 

And finally, the current Taxonomy only addresses the ‘E’ of ESG. In forthcoming months and years a Social Taxonomy will be created and Governance will also be addressed. This undoubtedly means  more change and associated uncertainty with required interaction between environmental, social and governance aspects and their separate, and potentially contradictory, goals. 

Once again, the best approach to ensuring that the Taxonomy reflects the genuine needs of transitioning towards a growing sustainable economy that delivers jobs and higher living standards is through engagement with the main players within the European economy, its industry, its energy mix and value chains. These voices are currently engaged with the Fit for 55 legislative package, making its way through the European Parliament and Council of Ministers. Ambitious financial services companies must join them to bring their expertise and to help policy-makers ensure that ESG policies driven by the taxonomy make sense. 

Overall, we can expect to see new legislation, regulation and associated targets constantly being published, enacted and adjusted over the next few years – and almost always in the direction of a broadening scope and stricter rules. No one can any longer afford to simply live in the world of financial regulation. Successful lenders and investors need to be close to the relevant debates and the ambitions of policymakers as they develop. As the real economy races ahead, financial services need to be sure they don’t get left behind.

BOLDT is working with financial institutions to help them better understand the European Union’s sustainability agenda. Helping them to explain the changes that are coming to colleagues and customers alike, as well as play their part in the debate that is shaping that change.  If you would like to know more about how we could help your business, please get in touch with Raphaël Delli and Jon Rhodes.

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