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EU Taxonomy steps up but still misses the forest for the trees

The EU has raised the attention on sustainable finance to a higher level. The 2nd draft of the taxonomy moves in the right direction to support the evolving green bond market, but still may be missing the forest for the trees in some key aspects.

6 September 2019: CICERO Shades of Green has provided comments to the technical report on EU taxonomy published in June 2019 by the technical expert group on sustainable finance (TEG) which sets out the basis for an EU classification system for sustainable activities. Here is a summary of our comments:

The EU has raised the attention on sustainable finance to a higher level. The extent to which sustainability has become an essential topic for financial institutions and companies is a very welcome development. There is still much to learn before we achieve a market where green and sustainable financial products are easily identifiable, environmentally robust, and scaled up at the pace required to combat climate change.

The 2nd draft of the taxonomy expands the scope to include the important transition to green, relaxes the threshold for building renovations, and adds some nuanced discussion around resiliency – all moving in the right direction to support the evolving green bond market.

However, the extensive details of the taxonomy may be missing the forest for the trees in some key respects:

1)      There will be challenges and additional costs to implementing a taxonomy based on industrial codes. For example, a green building project need only comply with an energy efficiency threshold. Additional considerations for materials and resiliency to extreme weather patterns associated with climate change are not necessary for taxonomy compliance. Yet this is counter to the holistic way some of the best green buildings in the market today approach climate risk. Using project categories as a starting point with simplified elements requiring transparency for compliance would fit better with current market practice and support issuers that take a holistic approach to climate risk.

2)      Good governance aspects such as the ability of a green bond issuer to select and manage green projects are not included in the taxonomy. Incorporating transparency on the issuer’s climate targets and policies could improve confidence that eligible projects are selected and managed in a way that addresses additional recommendations from the TEG such as embodied emissions from materials in buildings. In the case of an oil company issuing a green bond for renewable energy, transparency of governance considerations could provide context of the green bond within the company’s overall trajectory and management of greenhouse gas emissions.

3)      The uneven stringency of thresholds across sectors could have potential unintended consequences. Demolishing an existing building and constructing a new building could be easier way to comply with the taxonomy than to make renovations. Yet renovating an existing building could save some negative environmental impacts from materials and construction. Avoiding these unintended incentives requires a thorough analysis within a sector and across sectors of the potential market impacts of the taxonomy.

To address these issues, we recommend basing the taxonomy on project categories with streamlined criteria for transparency, requiring transparency on governance, and balancing stringency within and across sectors. We look forward to following the next steps of the EU sustainable finance legislative process towards a simplified common green language. In the meantime, we will continue to provide transparency to investors on these cross-cutting issues through CICERO Shades of Green second opinions.

Miriam Dahl