The finance industry has both the will and the capital to make a significant contribution to the fight against climate change. But while investments in green and sustainable activities are increasing, growth has been restrained by the need for a clear and comprehensive framework to define and compare investments. The European Commission's Sustainable Finance Action Plan, released in March 2018, is designed to help unleash the financial sector's potential to work towards the targets of the2015 Paris Agreement, which aims to strengthen the global response to the threat of climate change, and the United Nation's Sustainable Development Goals (SDGs).
The EU taxonomy for sustainable activities is a major step towards mobilising capital behind the Paris Agreement and UN SDGs says Trevor Allen, Sustainability Analyst at BNP Paribas Global Markets
The Action Plan has now been given a major boost with the release of a taxonomy for sustainable activities. This may not seem an overly glamorous development, but a single, unified classification system for green investment will likely have profound effects on the potential power of finance to drive sustainable growth. This is a welcome development that will make it much easier for investors, issuers and banks to get off the bench and take part in the fight against climate change.
The aim of the taxonomy is simple: to translate the goals of the Paris Agreement and the UN SDGs into financial action by providing a harmonised view across countries and industries on what defines a sustainable investment.
This detailed, uniform approach will reduce the effort and cost involved in defining what sustainability looks like, and will help companies communicate how their activity meets environmental goals. This in turn helps mitigate the risks of 'greenwashing', giving investors more confidence to back green initiatives. Interestingly, it also shifts the focus from measuring the carbon footprints of companies and activities towards proactively encouraging investment in firms or assets that reduce greenhouse gas (GHG) emissions globally, creating a new, encouraging dynamic for private finance to engage with sustainability.
The taxonomy defines six environmental objectives to which companies must make a significant contribution in order to be considered eligible for investment. These include 'Climate Change Mitigation' – a company must be a low-carbon emitter and be likely to have a consistent, unwavering impact on reducing GHG emissions to 2050 and beyond; and 'Climate Change Adaptation': even if not necessarily a low-carbon company, their activity leads to the reduction of emissions, perhaps by facilitating other industries' alignment with the low-carbon economy – think of the production of solar panels for solar farms as an example. Moreover, any company seeking eligibility will not only need to show they are supporting one or more of the goals, but also that they are not doing significant harm to the others.
The goals are then applied across seven industries, with technical, science-based specifications and targets covering nearly 70 activities, accounting for 93.2% of global GHG emissions, according to the taxonomy report.
This creates a robust and transparent measure of how 'green' a company is, opening the door to investment from sustainably-minded financial firms. The framework is expected to have a significant impact on sustainable financial markets in Europe and beyond. By simplifying and clarifying the definition of green investment in such a comprehensive and detailed way, the taxonomy will likely encourage asset managers and insurers in particular to launch more green products, such as investment funds, in the future, with an increase in liquidity for the market overall. In short, the EU Sustainable Finance Action Plan just got a tremendous boost.
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