Dawn Slevin explains the thinking and the process behind the EU-appointed Technical Expert Group on Sustainable Finance.
Many companies will have the confidence and capacity to move towards a sustainable business model, using the EU’s taxonomy as a guide. The essence of sustainable finance is to decouple economic growth from environmental degradation, resource constraints and greenhouse gas emissions. Action 1 of the European Commission’s Action Plan on financing sustainable growth, drawing from the High Level Expert Group (HLEG) report of January 2018, took the first essential step in this process when it called for the establishment of an EU classification system for sustainable activities, or the Sustainable Finance EU Taxonomy. Convened in June 2018, the Technical Expert Group (TEG) comprising 35 individuals (from civil society, academia, the business and finance sector) were asked to develop recommendations for technical screening criteria (TSC) for economic activities that can make a substantial contribution to climate change mitigation and adaptation, while avoiding significant harm to all other EU environmental objectives. The remaining four environmental objectives include: sustainable use and protection of water and marine resources, transition to a circular economy, waste prevention and recycling, pollution prevention control and protection of healthy ecosystems.
When it is fully complete, for an activity be considered EU Taxonomy-eligible, it must:
• contribute substantially to one or more of the environmental objectives,
• do no significant harm (DNSH) to any other environmental objective,
• comply with minimum social safeguards,
• comply with the technical screening criteria.
The opportunities that the EU Taxonomy will help to unfold in Europe and globally are substantial. Europe needs to attract private capital to sustainable activities amounting to an additional €175 billion to €290 billion per year of private investment, to meet its climate goals alone.
Globally, realising the Sustainable Development Goals is estimated to require annual investments in sustainable infrastructure, worth around €4.7 trillion to €6.7 trillion between now and 2030.
This creates opportunities for investors, lenders, issuers of financial securities and insurance providers across a wide range of economic activities including agriculture, forestry, manufacturing, energy, transport, information & communication technologies, and construction & real estate – all of which are covered by the EU Taxonomy.
The overall aim of sustainable development is to create prosperity whilst maintaining and improving environmental quality and social equity to the benefit of current and future generations. Currently, views on what constitutes sustainable development vary greatly – it means different things to different people.
The EU Taxonomy, used as a tool to help identify sustainable activities, will help to develop systems approaches to encourage the cooperation of a range of economic actors – producers, consumers, service providers, policymakers, regulators and others.
It will help these economic actors to come together and develop strategies, create value and communicate effectively in order to build evolutionary global sustainable business models.
The journey of the TEG began in earnest on 5 July 2018 in the Berlaymont Building in Brussels with a keynote speech by Valdis Dombrovskis, Vice-President responsible for Financial Stability, Financial Services and Capital Markets Union (DG FISMA). For the first time, all of the members across the four sub-groups of Taxonomy, Benchmarks, Green Bonds and Disclosures were brought together.
Thereafter TEG meetings were held approximately monthly, sometimes more frequently, starting on Day 1 with a Plenary meeting of all subgroups, and on Day 2 with individual subgroup meetings.
The Taxonomy Working Group (TWG) is one of four subgroups comprising 14 members of the TEG, and observed by representatives from United Nations Environment Programme (UNEP), the Organisation for Economic Coordination & Development (OECD), the European Bank for Reconstruction and Development (EBRD), the European Environment Agency (EEA) and European Investment & Occupational Pensions Authority (EIOPA), as well as from several of the Directorate General (DGs) of the Commission.
Before work could begin on the TSC, the groundwork was prepared, building on the recommendations of the HLEG report. This groundwork involved examining the NACE industrial classification system for strengths and weaknesses as the core taxonomy classification system, and mapping onto it several other classification schemes including the classification of products by activity (CPA), classification of environmental protection activities (CEPA) and classification of resource use and management activities (CREMA).
The term ‘Taxonomy’ itself, is related to an empirical scheme of classification, suitable for descriptive analysis. Taxonomic methods are employed in numerous disciplines that face the need for categorisation schemes. The NACE codes have many benefits as a taxonomy, including that it was established by EU law and is compatible with international and EU Member State frameworks, has comprehensive coverage across economic sectors and is already used by some financial institutions.
Most importantly from the TEG’s perspective, the NACE codes provide a systematic means of setting boundaries on the scope of an economic activity, as well as linking activities which form part of an economic activity’s lifecycle. As the TEG was mandated to consider lifecycle aspects of an economic activity this is a very important attribute of the NACE codes.
Where there were gaps in the NACE codes, new sub-sectors were recommended, for example on the renewable energy activities – solar photovoltaic, concentrated solar power, hydroelectric power, ocean and wind energy.
The EU Taxonomy considers three kinds of activity which can make a substantial contribution to climate change mitigation while causing no significant harm to the other five objectives. The EU Taxonomy recommendations are based on conclusive scientific evidence, high quality research and market experience. The TSC are furthermore technology-neutral to the extent possible, thereby supporting innovation. The mitigation activities include:
1) activities that are already low carbon, which are already compatible with a 2050 net zero carbon economy. Examples include zero emissions transport, near to zero carbon electricity generation and afforestation.
2) activities that contribute to a transition to a zero net emissions economy in 2050 but are not currently operating at that level. Examples include electricity generation <100g CO2/kWh or cars with emissions below 50g CO2/km.
3) activities that enable those above. For example, manufacture of wind turbines or installation of highly efficient boilers.
For adaptation, substantial contribution is process-based with context-specific and location-specific aspects to be evaluated. The qualitative screening criteria for adaptation can be applied to all activities. DNSH screening criteria for adaptation are not published at this time.
The process of developing the TSC began in Autumn 2018. At this time, the Taxonomy Working Group formed seven subgroups. Broadly, two co-chairs were responsible for substantial contribution to mitigation in each of the macro-sectors: forestry & agriculture (taken together); manufacturing; energy; transport; ICT and buildings. Two co-chairs were assigned to complete DNSH criteria across the seven mitigation macro-sectors (approximately 65 economic sub-sectors) and four environmental objectives. Finally, two co-chairs were assigned to adaptation, including DNSH to mitigation and substantial contribution to adaptation.
The DNSH evaluation provides the EU Taxonomy with a holistic and robust framework, where achievements in one environmental aspect do not undermine minimum requirements in another. The work of DNSH began with the completion of test cases across randomly selected subsectors. This experience provided the TEG with an overview of the challenges, availability of supporting information and the opportunity to evaluate the particular aspects associated with global application of the DNSH criteria. In order to ensure consistency in approach and outcomes, the DNSH team developed Guidance. In total, four DNSH iterations required three separate pieces of guidance.
The TEG set to work and by December 2018 had completed approximately 24 sub-sectors as ‘First Round’ tables which were published for public comment, accompanied by a call for external experts across the economic sectors. In response to the call, the TEG received over two-hundred applications, including over 70 applications for DNSH. Of the over 150 external experts selected by the TEG, approximately 30 were selected for DNSH. The external experts were allocated to sub-sectors and objectives appropriate to their skills and experience, and presented with the DNSH guidance, a DNSH template table and supporting material. Weekly DNSH external expert meetings chaired by the TEG were held to discuss issues, solutions, work progress and results.
The sub-sector selection and scoping was driven by the mitigation groups and so the DNSH list of sub-sectors changed somewhat during the course of the work. The first Iteration of DNSH evaluations were completed for most of the approximate 65 sub-sectors by end of April 2019, including incorporation of the Round 1 public comments. By end of April, external experts moved to the second iteration, comprising a DNSH preamble focusing on the most significant aspects only, TSC for the most relevant objectives and inclusion of key references only.
The external experts completed their mandate during the first and second weeks of May 2019. For the third DNSH iteration, a team of about ten experts drawn from the TEG, the EEA and closely observed by the DGs, commenced a review of the sub-sectors and objectives for consistency in approach across objectives and comparability with regard to the ambition of DNSH, to avoid treading into substantial contribution. The final fourth iteration was undertaken during the final two weeks prior to publication whereby key DNSH criteria were discussed across the TEG, queries were addressed, consensus reached and recommendations were finalised.
One of the most exciting aspects of the EU Taxonomy is its potential application across different levels of economic activity. Sustainable development and the challenges it presents may be viewed across three levels: micro-level, qualified by projects, products, companies, and supply chains; meso-level such as industrial parks and cities; and macro-level across regions, countries, and continents. Sustainable finance follows this form also in that green bonds may be issued at project, city or corporate level, investment flows may be from company to economic sectoral level regionally and globally, and fiduciary and prudential requirements may be at country and global levels.
Companies around the world are seeking increased resiliency, legitimacy, cost reductions and competitiveness. This needs to be achieved in a cost effective, rational and coherent way, with sustainable finance at its core. Many companies will have the confidence and capacity to move towards a sustainable business model, using the EU’s taxonomy as a guide. For an economic activity of a corporate to be considered compliant with the taxonomy, it would calculate revenue breakdown by Taxonomy-eligible activities, or expenditure allocation to each Taxonomy-eligible activity; demonstrate and document performance against the technical screening criteria (substantial contribution to one objective and DNSH to the other five); demonstrate compliance with minimum social safeguards including labour rights policies; maintain data management systems on environmental and social aspects, carry out audits, and reporting.
The application of the EU Taxonomy at meso-level, may be considered for cities. By the middle of 2009 the global urban population of 3.42 billion, surpassed the rural population of 3.41 billion. This trend has continued and by 2050 70% of the global population, that is 6.7 billion people, are projected to live in urban areas. Problems with infrastructure – mobility, wastewater, energy supply and resource efficiencies, have a pressing need to be fully resolved. Urban development can be addressed with the support of sustainable finance – investments and capital flows can be used to design cities of the future, where robust data collection and sharing networks are deployed to support water resource management, waters are protected and systems are designed to capture, treat and reuse, wetlands thrive as both habitats and important flood mitigation measures, energy is renewable and clean, all waste is considered a valuable resource, high speed low carbon mobility runs on clean energy, and buildings are low carbon and energy efficient.
At the macro-level, Country level, sustainable finance can support policies that transform into actions, where technical configurations interact with socioeconomic interests and needs are at the forefront of necessary change. The transformation of energy systems from fossil fuels to clean renewables constitutes one of the biggest challenges to governments worldwide. Through the EU taxonomy, clarity and transparency can now be achieved at national level across economic sectoral activities of energy, transport, construction, manufacturing, agriculture, forestry and technology.
The financial sector has a crucial role to play in the transition and transformation to a more sustainable economy and society. Current levels of investment are not sufficient to support an environmentally-sustainable economic system. More private capital flows and financial instruments need to be oriented towards sustainable activities to close the investment gap and provide the financial support needed to meet the EU’s 2030 targets and global alignment with the SDGs. Sustainable development is the central challenge of our times. It presents new opportunities and also new risks. We, as a European and global community share these opportunities and risks, and the EU Taxonomy is one of a suite of tools now available to our economic communities to turn shared aspirations into shared actions.
Dawn Slevin, was co-chair of the development of the do no significant harm criteria for the environmental objectives 3 to 6 during the technical expert group (TEG) development of the EU Taxonomy (2018 to 2020) as published in final form in the EU Taxonomy Climate Delegated Act. Dawn is Managing Director of Environmental Liability Solutions Europe Ltd.