by Tanja Havemann (Clarmondial), Dr. Christine Negra (Versant Vision), Jos Lemmens (APG)
When it comes to conversations about sustainable finance in 2020, there is no escaping the EU Taxonomy.
An idea first pitched by the High Level Expert Group (HLEG) on Sustainable Finance – appointed by the European Commission in 2016 to advise on ‘greening’ financial markets – the EU Taxonomy was approved by the European Parliament in June of this year.
The EU Taxonomy was developed by the Technical Expert Group on Sustainable Finance (TEG), which comprises 35 members and more than 100 advisors and observers from the financial markets, industry, science, and civil society. The TEG’s final report to the Commission in March 2020 outlined in detail what it believes to be the most appropriate environmental criteria for dozens of economic sectors. The Commission has worked closely with the TEG over the past 18 months and is expected to accept most of the recommendations put forward.
Leading European institutional investors are embracing the new EU guidance and are adapting their investment approaches, including for their farmland investment strategies. Groups such as APG and PGGM, operating on behalf of their Pension Fund clients are supportive of this guidance and have also contributed to the HLEG and the TEG process. The implementation of EU Taxonomy-aligned approaches by European investors will have major implications for land managers and agricultural companies across the world. Clarmondial and Versant Vision are supporting investors in assessing the EU Taxonomy and adapting their policies, procedures and strategies accordingly.
What’s in the EU Taxonomy?
Essentially, the EU Taxonomy is a detailed list of business activities that are considered ‘green’ based on six objectives:
- Climate change mitigation
- Climate change adaptation
- Sustainable use and protection of water and marine resources
- Circular economy
- Pollution prevention and control
To qualify as ‘green’ under the EU Taxonomy, a business activity must be proven to substantially support at least one of these six areas without doing any significant harm to another, and to comply with minimum social safeguards laid out in existing conventions and UN guidelines. To test whether a business activity contributes to one of the six objectives, it must meet technical screening criteria that are currently being developed under the guidance of a newly established Platform for Sustainable Finance (more on this below).
The criteria and thresholds related to the climate change mitigation objective are the most detailed so far: they cover 70 sectors and more than 90% of Europe’s emissions. EU Taxonomy-aligned activities can fall under one of three categories:
- Business activities that are already ‘low carbon’, i.e. with only minimal net additional greenhouse gas (GHG) emissions (quantified in tons of carbon dioxide-equivalent) within the relevant time frame;
- Business activities that contribute to the transition to net-zero GHG emissions by 2050, but cannot be considered ‘low-carbon’ yet; or
- Business activities that enable others to become ‘low-carbon.’
The intention of the EU seems to be to start the EU Taxonomy process with a focus on climate mitigation and adaptation, before developing similarly detailed guidance for the other four topics mentioned above in due course.
How is agriculture handled in the EU Taxonomy?
The EU Taxonomy recognizes production of perennial and non-perennial crops, as well as livestock, as agriculture sector activities capable of making a substantial contribution to the six environmental objectives.
To show a contribution for climate change mitigation, for example, agriculture investments will have to demonstrate either that a set of Essential Management Practices (EMPs) are being consistently deployed, or that net GHG emissions are declining in line with a specified EU Member State trajectory relative to a baseline and in-line with EU commitments. For either approach, farm-level GHG assessments are required.
‘Contributing’ to the climate adaptation objective requires quantifying lifetime climate-related risks (using defined metrics and referencing future scenarios, including EU and Member State adaptation policies and plans for agriculture). Risk assessment should cover agricultural operations as well as other affected assets, people, and nature and should support reduction of all identified material physical climate risks.
For the other four objectives, only Do No Significant Harm (DNSH) criteria have been developed so far. By the end of 2021, the Platform on Sustainable Finance will establish full technical screening criteria to determine activities that substantially contribute to these objectives. The Platform may also expand the list of activities (e.g. taking land out of production; switching to lower GHG-emitting activities) and refine expectations for livestock operations.
The legal part
In December 2019, the extent of potential legal implications became clearer as did the steps that the EU would take to reduce greenwashing in the financial sector. The EU ultimately decided on a ‘comply or explain’ process, in which asset managers can abstain from disclosing against the framework, but only if they provide an explanation for the non-conformity. The EU Taxonomy applies to all financial products being offered in the EU (e.g. UCITS funds, Alternative Investment Funds – AIFs, portfolio management and Insurance-based Investment Products).
The disclosure requirement on asset managers also has implications for companies. To ensure that Taxonomy-compliant investors can gather the necessary information from their investees, all firms covered by the EU Non-Financial Reporting Directive (i.e. public companies with more than 500 employees) will also have to disclose the alignment of all their business activities. When assessing if an investment is ‘green’, investors must assess the share of the investees’ revenues derived from EU Taxonomy-aligned activities.
Disclosure requirements based on the EU Taxonomy will come into force in phases, to allow the market to prepare, and the European Commission to solidify the technical criteria for all six environmental objectives. Climate change mitigation and adaptation criteria, already substantially developed by the TEG, will be finalized in December 2020 and investors and companies will have to report against these criteria in 2022. By the end of 2021, technical criteria for the other four environmental objectives will set with disclosure required in 2023.
Watch this space
The EU Taxonomy is expected to lay the foundation for further regulatory interventions by the European Commission in the coming years. For example, a study is underway exploring if and how the EU might want to adjust capital requirements for banks to encourage green lending. This may complement incentives that are already in place in certain Member States – for example, the ‘green bank’ tax incentive program in the Netherlands. The EU Taxonomy is also likely to form the basis of a legislative initiative for an EU Green Bond Standard and other potential ‘green’ labels as well. There is a lot of pressure for the Commission to identify environmentally neutral and harmful activities, in addition to beneficial ones. In the future, the EU Taxonomy is expected to expand to capture ‘social’ benefits, which would be additional to other social investment incentive programs such as the European Social Entrepreneurship Fund (EuSEF) regulation.
The EU Taxonomy is undoubtedly ambitious, and many questions are still open. It is not yet clear if and how it will interface with other policies and programs, such as the Common Agricultural Policy, the Farm to Fork Strategy (part of the European Green Deal), the EU Biodiversity Strategy, External Investment Plan and the EU Emissions Trading Scheme (ETS) and European asset management, marketing and distribution rules. We anticipate that there will be additional clarifications and guidance, as well as a level of pragmatism, in particular in the first implementation period.
To implement this relatively complex set of requirements, investors and companies require non-financial data, which is often lacking. The gap in quality datasets for decision making is also relevant for agriculture, as noted in the Clarmondial, Versant Vision and Wageningen University & Research report on Environmental Impact Reporting in Agriculture (EIRA). The EU makes reference to an information ‘platform’ that should address some of these challenges. In the meantime, leading investors have started to adapt their investment and due diligence strategies and monitoring approaches.
We are excited about the momentum that the EU Taxonomy brings to the sustainable agriculture movement. Given the international presence of European investors and companies, the EU’s initiative is expected to have global repercussions.