The EU taxonomy: a generational shift for responsible investment

By Will Martindale (@WillJMartindale), Director of Policy and Research, the PRI

If responsible investment is to prove its mettle, it is right that we measure the sustainability of the economic activities we finance. This will allow us to better allocate capital to economic activities consistent with the Paris climate agreement.

To date, our industry has focused on how ESG issues, and in particular, climate change, affect the risk return characteristics of investment portfolios. This is important. ESG integration is having positive real-world impact.

But it is not enough. Few portfolios are consistent with 1.5 degrees of warming. And the longer the delay in climate action, the more forceful, urgent and disruptive the action will inevitably need to be.

The EU taxonomy is a tool to bridge the gap between international sustainability goals, like the Paris climate agreement, and investment practice. To mobilise private finance, European policy makers understand that they need to translate climate targets into tools that investors can use.

This represents a generational shift in how investors think about impact. It’s not just about the carbon saved, or the waste diverted from landfill, but whether the economic activities we finance are consistent with the future environmental state to which our governments are committed. In other words, it is an absolute (the economic activity is consistent with climate targets), not just a comparison (the economic activity is a relative improvement on the status quo).

It’s not just about the carbon saved, or the waste diverted from landfill, but whether the economic activities we finance are consistent with the future environmental state to which our governments are committed

The taxonomy will set performance thresholds, or “technical screening criteria”, for different sectors of the economy. The first set of criteria is for agriculture, manufacturing, energy, transport, water, waste, ICT and buildings. More sectors will follow. The criteria will recognise deep green activities and important transition activities, helping to improve environmental performance across the economy.

We expect users to be surprised – and hopefully, pleased – at the breadth and technical quality of the taxonomy. Hundreds of investors, scientists and other experts have contributed to its development.

Under the proposed legislation, investors that label their portfolio as environmentally sustainable will need to explain if, and how, they have used the taxonomy when setting their strategy. The taxonomy will enable them to determine the proportion of revenue from sustainable economic activities financed by the investment portfolio. The taxonomy will also support active ownership efforts: investors and companies can use the taxonomy to identify future growth opportunities.

The EU is the first government to establish a taxonomy in financial regulation, but it won’t be the last. Other government-endorsed expert groups are investigating the idea, and the Network for Greening the Financial System – an influential group of central banks and supervisory authorities – has called on “members and peers to work towards globally consistent taxonomies.”

Investors will need time to understand the taxonomy and, more time still, to integrate the taxonomy into investment practice. And investors may disagree with categorisations or thresholds. That’s ok. But at this first stage, we encourage investors to get behind the taxonomy, to endorse the concept and to see how they will apply the taxonomy to investment practice.

At this first stage, we encourage investors to get behind the taxonomy, to endorse the concept and to see how they will apply the taxonomy to investment practice

A few weeks ago, levels of atmospheric carbon dioxide surpassed 415 ppm - the highest in human history. In the words of the French central bank governor, “climate change is real, urgent and irreversible”. The PRI is working at both the political level and the technical level to support the EU taxonomy. Over the coming weeks, we will host webinars and work with investors to understand and use it.

We believe the taxonomy is useful and necessary. We back it – and we recommend you do, too.

This blog is written by PRI staff members and guest contributors. Our goal is to contribute to the broader debate around topical issues and to help showcase some of our research and other work that we undertake in support of our signatories.

Please note that although you can expect to find some posts here that broadly accord with the PRI’s official views, the blog authors write in their individual capacity and there is no “house view”. Nor do the views and opinions expressed on this blog constitute financial or other professional advice.

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