‘Tout ça pour ça?’ or ‘all that for this?’ was the title of a hit-and-miss 1990s comedy by celebrated French director Claude Lelouch. But the expression also feels like an appropriate preliminary conclusion on the impact of the EU’s Taxonomy. ‘Tout ça pour ça?’ was certainly not Lelouch’s finest film and it has justifiably fallen into obscurity. Now on the cusp of its third anniversary, the EU Taxonomy may ultimately face the same fate.
The state of play
We originally wrote about the EU Taxonomy after the Technical Expert Group (TEG) published its recommendations in 2018.1 While welcoming those recommendations we were anxious that the taxonomy focus on the underlying environmental performance standards needed to achieve greenhouse gas (GHG) reductions rather than long lists of products and technologies that are either ‘in’ or ‘out’.
Since then a lot has happened and a lot of pages of guidance, lists and interpretation has followed. The latest contribution from the Platform on Sustainable Finance published in October 2022 runs to 382 pages.2 It contains technical screening criteria for forestry and logging that runs to almost one hundred pages on its own.
One (and a half) steps forward
There are undeniably some positives from the work that the EU has done on the taxonomy. First and foremost is the fact that the taxonomy focuses attention on the ultimate contribution of an economic activity to climate change mitigation or adaptation. For the most part it does not rely on often-flawed ESG ratings – a point we will come back to – and refocuses attention on the positive impact of products and services that companies supply.
We are also now beginning to see good quality data coming through from companies in WHEB’s investment strategy. For example, companies like Vestas have further refined their calculation in 2022 concluding that 96% is taxonomy aligned. Other companies like Infineon have only just started reporting. In November last year the company confirmed that a reassuringly precise 57.7% of its revenues are ‘taxonomy eligible’.3 Several other companies including Ariston, Arcadis and Smurfit Kappa have also published their ‘taxonomy eligible’ numbers with a commitment to publish ‘alignment’ numbers in 2023.4
And one step back
But in all of these disclosures, there is also evidence of confusion and frustration. Some of this will presumably be addressed in time. For example, several businesses report low eligibility figures because the principal contribution they make is to environmental objectives, such as the circular economy, that are not covered by the current taxonomy.
But for others there is a frustration with the narrow definitions that underpin eligible activities. For example, Arcadis argue that their design, engineering and consultancy work ‘enable other companies to be more sustainable… but because Arcadis itself is almost never engaged in [construction] activities, the actual list of relevant taxonomy activities to Arcadis is very narrow.’5
Infineon face a similar problem. The company makes power semiconductors that go into renewable power equipment and battery electric vehicles, which are clearly taxonomy eligible. But some of their products, such as Silicon Carbide (SiC) and Gallium Nitride (GaN) based semiconductors, are inherently more energy efficient than legacy silicon-based technologies whatever end market they are sold into. The company has not included revenue from these products because they are not confident that they are intended to be eligible. ST Microelectronics meanwhile also make SiC and GaN semiconductors and compete directly with Infineon. In contrast to Infineon though, they do consider these products to be taxonomy eligible.6
ABB, a company that we don’t own in the strategy, is more pointed in its frustrations. ‘In our view, the EU taxonomy as it stands significantly underestimates the contribution that our products, solutions and services make in reducing our customers’ carbon footprints… The EU taxonomy… does not consider the management of electricity consumption, which could be substantially reduced in a short time frame through the deployment of readily available and cost-effective technologies.’7
Muddying the waters
Under the Sustainable Finance Disclosure Regulation (SFDR) asset managers and owners are also obliged to report the proportion of their investments that are taxonomy aligned. An entire army of data providers have now stepped forward to offer their support. Utilising a variety of methodologies data tends to be estimated as very few companies have so far reported taxonomy alignment. And their numbers vary dramatically. We have reported previously on examples where companies with 100% of revenues from solar technology get scored 0% for their taxonomy eligibility due to the industry coding that they have.8 Others adopt a more granular approach and attribute the company (rightly in our view) 100% taxonomy eligibility.9
Assessing alignment (rather than eligibility) will be even more convoluted because alignment requires that the company ‘does no significant harm’ to other environmental objectives and meets ‘minimum social safeguards’. These terms have also been the subject of further guidance from the EU10 but many asset managers and owners look to third party data providers to issue ‘red flags’ to companies that are considered to be in breach of core human rights and labour standards. The problem is that there is no shared standard of what a ‘violation’ constitutes. We’ve come across one company that had been ‘red flagged’ on Bloomberg for violations of the UN Global Compact principles. On further investigation, the ‘violation’ was linked to a comment in the company’s 2020 Annual Report that stated that two cases of employee discrimination had been raised. Both of these had been successfully resolved by 2022. Clearly all cases of discrimination need to be treated seriously and fully addressed, but we do not think it is the intent of the ’minimum safeguards’ to screen out companies who have had any type of allegation levelled against them.
Special pleading
Meanwhile of course, at the end of 2022, following intense lobbying by certain member states and affected industries, the Taxonomy was amended to include both nuclear power and natural gas power generation. Natural gas projects will need to meet certain greenhouse gas emission thresholds, but even so, the inclusion of both industries has been deeply controversial. Environmental groups have challenged the inclusion of natural gas as unlawful and in conflict with climate science.11 The decision to include these industries has also encouraged others to seek ways to get their own industries included including the airline industry.12
The US has a business case and Europe makes a law
Meanwhile, the US has successfully passed the ground-breaking Inflation Reduction Act.13 We view this as a game-changer. Not just because of the quantum of money that it delivers, but as importantly, because of its simplicity and directness. Where the EU has spent significant time, resource and political capital constructing a highly complex framework for sustainable finance, the US has directly intervened in industrial policy to turbo-charge the deployment of the technologies that underpin the zero-carbon transition. Policies that deliver quick reductions are particularly appealing given the limited time left to drastically reduce emissions. As one industrialist put it ‘The US has a business case and Europe makes a law’.
No doubt the US will develop its own sustainable finance framework to support the capital flows that underpin the zero-carbon economy. Much easier though to do this once real economy policies have already blazed the trail. The EU (and the UK) will now need to catch-up if the US – and China – are not to end up in the driving seat once again in the coming industrial revolution.
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1 https://www.whebgroup.com/our-thoughts/making-the-european-sustainable-finance-taxonomy-a-carrier-and-not-a-barrier-to-sustainable-finance
2 https://finance.ec.europa.eu/system/files/2022-11/221128-sustainable-finance-platform-technical-working-group_en.pdf
3 https://www.infineon.com/dgdl/Sustainability+at+Infineon+2022.pdf?fileId=8ac78c8b84a33cb40184bd6a9c8f0035
4 An economic activity is described as ‘eligible’ when it qualifies under the technical screening criteria accompanying the Taxonomy. Alignment of an activity goes beyond eligibility and can be shown not to cause significant harm to other taxonomy objectives and to meet the criteria for meeting minimum social safeguards.
5 https://www.arcadis.com/en/investors/arcadis-annual-integrated-report
6 https://sustainabilityreports.st.com/sr22/key-data/eu-taxonomy.html
7 https://sustainabilityreport.abb.com/2021/tables-figures/eu-taxonomy.html
8 NACE codes are the EU’s industry classification system (https://connects.world/nace-codes/#:~:text=The20codes%20are%20a,NAICS)%20for%20classifying%20business%20activities)
9 https://www.whebgroup.com/our-thoughts/esg-ratings-a-quick-fix-or-a-bodged-job
10 For example see the report from the Platform on Sustainable Finance on minimum safeguards at https://finance.ec.europa.eu/system/files/2022-10/221011-sustainable-finance-platform-finance-report-minimum-safeguards_en.pdf
11 https://www.clientearth.org/latest/press-office/press/eu-taxonomy-environmental-groups-start-legal-action-against-sustainable-gas-classification/
12 https://www.transportenvironment.org/discover/eu-taxonomy-for-aviation-will-von-der-leyen-rubber-stamp-the-biggest-act-of-aviation-greenwashing-in-decades/
13 https://www.whebgroup.com/our-thoughts/the-us-inflation-reduction-act-how-significant-is-it
