By: David Harris, Head of Sustainable Business at London Stock Exchange Group
As ESG issues have risen up the investment agenda, so too have the number of green claims made by investment managers, sometimes on the basis of questionable assumptions or limited data. Now, with agreement by EU institutions on the long-awaited EU Green Taxonomy, those claims will have to be firmly grounded in evidence.
Just before Christmas 2019, EU governments and the European Parliament agreed that, from the end of 2021, all financial products on sale in the EU will have to reference the taxonomy, which sets out which economic activities contribute to climate change mitigation and adaptation. Other aspects of the green economy, such as water, waste, biodiversity protection and the circular economy, are to follow.
When marketing environmental or sustainable funds, European investment managers will have to disclose:
- How, and to what extent, they have used the Taxonomy to assess the sustainability of underlying investments;
- What environmental objectives the investments are contributing to; and
- The proportion of underlying investments that are included in the Taxonomy.
For funds that are not marketed as environmental or sustainable, European investment managers can state that they did not take the Taxonomy into account.
Essentially, this means that investors will be able easily to understand the extent to which the investment products they buy are exposed to the green economy.
The main aim of the European Commission in coming up with the Taxonomy was to encourage the flow of capital to companies providing environmental solutions by making it easier for investors to identify products that supplied that capital. Reducing greenwashing claims by financial products companies is a useful by-product.
The challenge for investment managers will be sourcing the data they need to inform their disclosures. As part of the regulation, EU-listed companies with more than 500 employees will have to report how much of their revenues are from activities within the Taxonomy, and capex/opex associated with those activities. Over time, this will begin to address disclosure issues with the data.
However, at FTSE Russell, we have been working with this data since 2009. We developed an environmental markets classification system that assesses the proportion of green revenues, if any, earned by more than 14,000 public companies worldwide. This information is compatible with the EU Taxonomy, allows investment managers to easily comply with the new rules, and enables them to measure the level of exposure to the taxonomy.
So what’s next? The EU has set up a Technical Expert Group – of which London Stock Exchange Group experts are members – that will provide detailed guidance early in 2020. The European Commission will then draft delegated acts supporting the Taxonomy regulation, to be finalised by the end of the year, with compliance required by the end of 2021.
There are some outstanding issues to be addressed – not least whether nuclear power and natural gas should be included in the Taxonomy. And the first areas tackled by the taxonomy – climate change mitigation and adaptation – are technically easier to identify and categorise than some other elements of the green economy that they intend to tackle next, such as the protection of ecosystems.
Nonetheless, agreement on the EU Taxonomy represents a major step forward in ensuring transparency regarding how investors are financing the green economy – and it will likely encourage some fund managers to take a second look at the environmental claims they are making for their products.
David Harris was one of the 20 members selected by the European Commission for their High Level Expert Group (HLEG) on Sustainable Finance who’s recommendations formed the basis of the EU Sustainable Finance Action Plan.
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