EU Taxonomy has become quite important to many companies in the EU region. For someone like me who has never paid attention to this, this LSEG seminar was very useful to get a basic understanding of the importance of where EU taxonomy in the current financial environment.

Takeaways

  • Since the publication of European action plan on Sustainable finance, there have been a lot of regulatory requirements
  • EU introduced a new package of measures in Sustainable finance in 2023
  • There are about 47 taxonomies around the world and it is important to make sure there is interoperability among these taxonomies
  • Pictet Asset Management - Started Water fund 20 years ago
    • Largest marketshare of Article 9 strategies
  • Aberdeen has about 20 Article 8 and Article 9 funds
  • Challenges in putting the taxonomy in practice
    • Idea was to create activities and objectives to stop greenwashing
  • Idea is nice but the implementation is the issue. There are two main challenges
    • Sequencing of the legislation: The fact that SFDR came first and there was an obligation on the companies to disclose the data which they had not collected in the first place
      • PAI - How can the companies that they never collected in the first place
      • Apply for tax rebates will necessitate EU alignments. This has forced companies to manually eligible activities, map those green revenues to economic activities, then make a judgment on whether it passed DNSH test
      • When you have 60 positions in a fund, some of these companies might have two or three economic activities, it takes a lot of time to get to EU taxonomy alignment
      • EU Taxonomy solution from LSEG: Revenue, Opex and Capex aligned to EU taxonomy activities is very appealing
    • Tension between Taxonomy and the concept of Sustainable investment
      • Sustainable investment defines the classification of the fund. Unlike the taxonomy, it is completely undefined. It can be anything that you want.
        • Calculation is different. Classification is pass fail approach
        • Taxonomy is based on Revenue or Capex or Opex based
      • 70 pct on Article 9 funds have a zero percent commitment on taxonomy alignment
      • At the moment, nobody cares about the EU taxonomy alignment
  • What evidence do the company activities so that it meets DNSH criteria ?
    • Group similar criteria together and apply to the company
    • Amount of data is significant
    • Use the ESG data as a proxy of all the criteria
    • LSEG ESG 500 metrics are not sufficient to cover the criteria
      • Language around the criteria is not very clear
    • Match ESG metrics to DNSH criteria
  • Under EU Taxonomy
    • Whether a company are aligned is a binary response - YES/NO
    • if a company is not aligned DNSH, then doing the relevant check is very time and resource intensive
  • Aberdeen Climate Fund
    • Started the taxonomy as it was starting with Revenues
    • Identified companies with more 80 pct Green Revenues
    • Hoping that EU would be lenient on DNSH criteria. But as the regulation came out, commission was not going to tolerate estimates. They wanted to corporate disclosure complying with dozens and dozens of EU regulation pages
    • Issue - SFDR requires sustainable investment percentage for every article 8 and article 9 fund
      • SFDR has article 217 rule for definining sustainable investment
      • It is the simplest high level rule: intention was to use the taxonomy
      • EU taxonomy has gaps as not all objectives are covered
      • Regulator had to allow Investment fund houses to make up rules, use article 217 rule and qualify for article 9 funds
      • Every fund in the industry will have different ways of computing sustainable investment. Every sustainable investment number of a fund will be different from another number of another fund
      • Whole point of SFDR was to stop green washing. But in the current context, SFDR does not have a framework to evaluate sustainable investment and fund houses have to make up their own framework
      • The only way revenues or capex can be qualify to the taxonomy is if the company attests that it complies to all the EU taxonomy
      • It relies on the companies should make the disclosures. Aberdeen cannot employ a set of lawyers and solve this problem
  • State of data availability is not there yet to guide capital allocation. At best, it can be used in the context of reporting. It is not in a stage where systematic investment opportunities can be identified
  • Quality of reporting even in the European companies is not good. The disclosures are all over the place
  • It might be competitively disadvantageous for not to provide transparent data on EU Taxonomy activities
  • Mostly for the reporting purpose
  • Difficult to follow EU Taxonomy guidelines
  • Every country wants to have their own taxonomies. How do we compare activities under different taxonomies. Taxonomies are bound to be different as each country has different sustainable needs
  • There could be variability in the way EU Taxonomy alignment is reported
  • Because there will always be companies that will fall outside the scope of EU regulation, there will be environmental strategies outside from EU taxonomy, there is a need to report parts of portfolio that are not exactly aligned to EU taxonomy. May be the regulation will allow reporting on portfolio companies that is estimates based
  • Financial accounting took decades to get right. It was heroic to expect EU to expect it to get it right first time. Regulation will take time. The current SFDR is not viable. It is going to be quite volatile with a massive amount of green washing. The great thing is that EU has a taxonomy that can somehow be fixed so that current SFDR reporting can be improved
  • We do need to think of interoperability as we cannot expect company to report to adhere to every other taxonomy in the world
  • EU Taxonomy Solution - Next version of green revenues model
    • Long journey 2021 - paper on the EU taxonomy
    • 2023 Mid - EU Taxonomy data feed released
    • Determine the eligibility - Look at business activity. Look at business segments reported by the company. Bifurcate in to Green eligible and Non Green eligible
    • 133 microsectors mapped to EU Taxonomy
    • Identify if the microsector is matching the taxonomy activity
    • Use the microsector data to come up with EU taxonomy eligible activities
    • Look at the TSC and analyze them. Develop a system of a inventory of requirements against which companies can disclose. Map it with the ESG measures data. Use ESG measure as a proxy to TSC. This means ESG measure has to be at a specific level to meet TSC and DNSH
    • Map the topics to ESG indicators and if the company passes ESG, then they pass the minimum safeguards criteria
  • Wishlist from participants
    • Potentially aligned or Possibly aligned criteria
    • Recognize the effort the companies are making to make themselves EU taxonomy compliant
    • Risk based approach towards DNSH.
    • One of the working groups of the recently reconstituted group is usability of the regulations. It signals that teams are thinking of ways to fix the issues with the current implementation efforts