A ray of light is set to penetrate the murky world of finance thanks to a new EU law. Until now, there were no rules on what funds could be marketed as “green”. This means a sustainably-branded pension fund, for example, could actually be funding fossil fuels, pesticides or even weapons.
The EU will now start to define which economic sectors are considered sustainable investments. This means that big banks and other large financial institutions will no longer be able to greenwash the products they sell to consumers.
If the new rules, known as the EU taxonomy, work properly, they will end greenwashing in the finance sector. What is more, they will ensure billions of euros that currently go to harmful sectors, like coal, oil and gas, are redirected to sustainable ones, like wind and solar energy.
The next few months will be crucial to ensuring this happens. There are several critical steps that WWF will be following closely.
First, getting the criteria for the definition right. This is crucial: a green label is useless if it allows dirty sectors, like pesticides, to be labelled as green. But industries which fear they will be negatively hit by the taxonomy are already fighting hard to undermine it. The gas industry, for example, has been actively trying to weaken the CO2 thresholds in the criteria so they are loose enough to include gas.
Those drawing up the criteria, the European Commission and its expert groups of advisors, must base their decisions on science alone. In climate terms, for example, sectors to be considered green should not undermine an EU path to 65% emissions reductions by 2030, which is what science says is needed to keep the temperature rise to 1.5°C and avoid climate catastrophe. This means that all fossil fuels, including natural gas, should be out.
Economic sectors will need to measure up in four environmental areas as well as in terms of their climate impact. These are water, pollution, biodiversity and circular economy. The criteria for measuring these must also be based uniquely on science.
There is also a gaping hole in the taxonomy that must be filled to make it properly effective. As currently agreed, the taxonomy will define sustainable or green activities, but what is missing is a definition of unsustainable or brown activities. Clearly stating which sectors are the most polluting would help financial institutions assess where the climate and environment-related risks lie in their portfolios and enable them to manage and reduce those risks. By discouraging investors from putting money into those sectors, it would give a significant boost to the shift to a clean economy.
Luckily, there is an opportunity to introduce this “unsustainable” category. The EU institutions have agreed for the taxonomy to be reviewed by the end of 2021 to assess how to widen its scope. Many observers like WWF, as well as institutions directly affected by the taxonomy, like Aviva, Boston Common Asset Management and the authoritative group of Central Banks known as the NGFS (Central Banks and Supervisors Network for Greening the Financial System) are calling for policy makers to bring the other end of the spectrum into the taxonomy by setting up a list of brown sectors.
The market is already going in that direction. Several financial service providers, like Moody’s and MSCI have already developed in-house unsustainable taxonomies or multi-category taxonomies and are marketing these to their investor clients. The EU must quickly catch up and develop a science-based and public taxonomy of unsustainable economic activities.
Another issue concerns one of the sub-categories the taxonomy will already include. These categories are “transition” and “enabling” sectors. The “enabling” category can cover a sector like wind turbine manufacturing which, while it may not be fully sustainable itself yet, is necessary for growing a green sector: wind energy. A “transition” activity concerns sectors where there is no “feasible low-carbon alternative”, such as the steel industry, for example. For the time being there is no zero-carbon steel, but there are types of steel production which pollute far less than others, so those are included in this category.
There is an issue with the term “transition”, however: financial institutions already market transition bonds which include sectors that do not fit into the taxonomy definition. This discrepancy must be cleared up: the financial sector must stop marketing transition bonds unless they cover only the sectors compatible with the EU taxonomy’s transition category, or develop new concepts.
The EU taxonomy can be a very useful tool for financial institutions when they engage with companies. Under the new rules, listed companies with over 500 staff members will be obliged to disclose how far their annual revenues, capital and operational expenditure align with the taxonomy. This means investors will be able to compare companies’ environmental performances, and factor this into their decision-making processes and company engagement. This would complement other actions which WWF is calling for, such as for companies to set climate science-based targets and transition plans for their implementation.
Finally, but crucially, financial institutions must begin communicating on their taxonomy alignment as soon as possible. The requirement to disclose alignment with the climate taxonomy will begin to kick in from the end of 2021 for climate, and in 2022 for the other environmental objectives, such as circular economy. Financial institutions should begin disclosing now to make this process smooth and timely, to help national authorities which will be monitoring them, and to bring forward the end of greenwashing in the sector, which will be of massive benefit to the environment, the EU economy and European consumers.
The views expressed in this opinion are those of the author and do not necessarily reflect the position of FORESIGHT Climate & Energy
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