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EU Taxonomy – the what, the why and the when

December 2020

The EU’s Action Plan for Financing Sustainable Growth is an ambitious strategy to generate sustainable economic growth and tackle climate change. The Taxonomy regulation is part of that plan and it aims to create a unified classification system for ‘green’ investment activities. Here’s what you need to know.

The what

In a nutshell, the Taxonomy is a framework to help classify whether a company’s activities are environmentally sustainable – and to what extent. It provides a common language that will help facilitate greater transparency and easier comparison within the rapidly growing sustainable investing sector. It also includes performance criteria to measure the contribution of these activities against specific environmental objectives, set by the EU.

The Taxonomy’s parameters and definitions are still evolving but many believe it is essential to the overall effort to direct investment towards sustainable activities. When implemented, anyone marketing an investment product as ‘environmentally sustainable’ must use the Taxonomy. They must show how an Investment contributes to one of the following six environmental objectives to meet the Taxonomy’s eligible criteria.

  • Climate change mitigation
  • Climate change adaptation
  • Sustainable and protection of water and marine resources
  • Transition to a circular economy
  • Pollution prevention and control
  • Protection and restoration of biodiversity and ecosystems

The activity must also meet the following criteria.

1. Positively contribute to at least one environmental objective

  • Activities with reduced impact from direct operations
  • Transitional activities on path to reduced impact
  • Activities enabling transition to sustainable operations

2. Do No Significant Harm in other environmental areas

  • Must demonstrate consistency with climate goals
  • Must show best efforts in reducing physical risks
  • Must minimise waste and material use
  • Must prevent water and air pollution
  • Must not lead to a decrease in the diversity
  • Must not affect environmental objectives of others

3. Meet Minimum Safeguards

  • Alignment with the OECD Guidelines for Multinational Enterprises
  • Alignment with the UN Guiding Principles on Business and Human Rights

Any institutions offering financial products in the EU that are labelled as sustainable will need to make Taxonomy disclosures. They will need to state: how and to what extent they have used the Taxonomy in determining the sustainability of the underlying investments. To what environmental objective(s) the investments contribute must also be disclosed. They must also provide details of the proportion of underlying investments aligned to the Taxonomy.

Importantly, because of the granularity of these disclosures, there will soon be no place to hide for companies with activities deemed ‘planet unfriendly’. Consequently, this should encourage more positive and sustainable corporate behaviour; otherwise, companies could find themselves side lined by investors.

The why

So why do we need the Taxonomy? Because of the inexorable rise in demand for sustainable investments, the industry has grown quickly but with little regulatory rigour. To meet demand, we’ve seen product providers rush to launch solutions claiming to be sustainable or ESG – environmental, social and governance – focused. But there is currently no standardised definitions or methods to check these claims or compare products. As a result, ‘greenwashing’ by investment providers can go largely unchecked. The Taxonomy, when implemented, should help combat this, providing consistency and improving transparency in an industry that we expect to only grow in importance.

Equally, the Taxonomy is a key component of the EU’s wider drive to encourage sustainable economic growth and address environmental concerns. Ultimately, it will help facilitate the EU’s ambition to be carbon neutral, net-zero emissions by 2050.

The when

Investment managers and asset owners from across Europe are rigorously testing the Taxonomy voluntarily, ahead of its introduction. There are some challenges still to iron out including the reliability and availability of data from companies and the cost and burden of reporting. There are also more controversial issues such as how to classify activities such as nuclear power.

Nevertheless, following a staggered roll out from December 2021, the Taxonomy should be fully implemented by the end of 2022 across the EU-bloc. And while it is an EU regulation, other non-EU countries like Norway and Switzerland are likely to adopt it.

In the UK, meanwhile, the FCA has stated its ambition to match that of the EU Sustainable Finance Action Plan, and while debate continues on whether it should adopt the Taxonomy, it looks likely to align with the EU directive.

Final thoughts …

Regulations like the Taxonomy, the UK’s updated Stewardship Code (2020), and others, are clearing a pathway to a more sustainable future for us all. They are helping translate the commendable and worthy action taken by an increasing number of companies into measurable, regulated and impactful outcomes. And at Aberdeen Standard Capital, we welcome all these developments, which align with our vision – to invest for a better future.

Read the previous articles in our series:

Or visit aberdeenstandardcapital.com/sustainable

To find out more, please get in touch with your usual contact at Aberdeen Standard Capital.

You can also email us at asc@aberdeenstandard.com

Investment involves risk. The value of investments, and the income from them, can go down as well as up and an investor may get back less than the amount invested.

Warning

Investment involves risk. - The value of investments, and the income from them, can go down as well as up and an investor may get back less than the amount invested. Past performance is not a guide to future results.