Many investors have been jumping on the sustainability bandwagon in recent years, but many have failed to pay much more than mere lip service to their new mission. A forthcoming EU regulation - branded the “EU taxonomy” - aims to reduce green washing on financial markets and makes a radical attempt at creating more transparency.
As such, EU Regulation 2020/852 - a framework to facilitate sustainable investment, came into force quietly on 12 July. While going largely unnoticed by the general public amidst the current crisis, those unwieldy terms hide nothing less than the potential for the start of a green revolution.
The EU Taxonomy is one of the most significant developments in sustainable finance to date and will have wide ranging implications for investors and companies in the EU and beyond. It will provide standardised definitions of how environmentally friendly certain business activities are and help investors evaluate the environmental impact of their investments. The EU Taxonomy will redirect capital to green and sustainable activities
Placed at the heart of the broader EU Action Plan on Sustainable Finance, the taxonomy will create a common language for what green investments are and help direct capital flows towards sustainable activities. The Taxonomy underpins three further legislative initiatives which form part of the EU Action Plan on Sustainable Finance:
Disclosure requirements for financial market participants to report to which extent its financial products align with the Taxonomy
Reporting requirement for companies to disclose activities associated with Taxonomy-aligned activities
Introduction of eco-labels that clarify whether or not a financial product can be deemed sustainable
The Taxonomy Regulation addresses the following six 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 reduction
Protection and restoration of biodiversity and ecosystems
To claim alignment with the taxonomy, economic activities need to substantially contribute to one of six environmental objectives, do no significant harm to any of the others and comply with minimum safeguards and technical standards to be established by the European Commission.
By 31 December 2020, the so-called technical screening criteria for the first two environmental objectives climate change mitigation and adaptation are to be published by the Commission in a delegated act. The conditions laid down there are then to come into force on 1 January 2022.
Severe consequences looming for investors and businesses alike
By creating a common definition of what constitutes sustainable business activities – and as a consequence, increase visibility and comparability - the EU taxonomy has the potential to reshape investment behaviour and put pressure on corporates to reduce their carbon footprint.
Disclosure regulations introduced in tandem with the EU taxonomy will force businesses and investors to make public how they really fare in terms of sustainability, impacting both access to capital and reputation for those who fail to fail to act.
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