Recently, during the ongoing coronavirus crisis, the EU presented an important component for decarbonising the economy over the coming decades: heads of state and government have after years of deliberation adopted a definition framework that applies to the entire EU and lays out what is required for businesses to be considered operating sustainably – the so-called taxonomy. All that is needed is approval from the European Parliament, though this is regarded as a mere formality, and the new set of regulations will come into force.
Several experts have declared the taxonomy to be the right tool coming at the right time. Because following the agreement of emergency support for the economy in the wake of the coronavirus pandemic, the EU is planning a stimulus package comprising possibly trillions of euros – recovery should, as Executive Vice-President of the European Commission Frans Timmermans advocates, be a green one. In mid-April, an alliance comprising 13 EU environmental ministers, among them the German officeholder Svenja Schulze (SPD), as well as company heads and representatives of unions and non-governmental organisations called for a “green upturn”.
Concrete suggestions as to how that could be accomplished consist usually of facilitating environmentally friendly technology and measures like e-mobility, public transport, building renovation or the hydrogen economy. “These are all very good points, but also very expected ones,” says Matthias Kopp, Head of Sustainable Financial Systems as WWF. “What doesn’t come up in the discussion at all is how such technology is translated into how the financial sector works,” Kopp adds. Regarding this particular question, the EU member states and the European Commission have executed trailblazing work by directly employing their tools for a more sustainable finance industry in their credit programmes administered by, for instance, the Kreditanstalt für Wiederaufbau (KfW) or the European Investment Bank (EIB).
Sustainable Finance Committee: apply the taxonomy
The taxonomy lies at the heart of this. It defines in detail when a company’s economic activities (not necessarily the company as a whole) can be considered to be sustainable and it does so for numerous different sectors, from grain cultivation to steel production through to the automotive sector. The underlying principle applied is the idea that an activity can be considered ecologically sustainable if it makes a positive contribution to one of the six EU environmental targets – such as climate protection, transition to a circular economy or restoration of biodiversity. At the same time, the activity may not have a negative impact on any of the goals. In addition, minimum social standards must be fulfilled, and the impact must have been evaluated using scientifically sound methods. The Sustainable Finance Committee of the German federal government has now advocated the application of the taxonomy. “Economic stimulus packages should therefore be based on the approaches of the European Commission including among others the Net-Zero 2050 goal, the multi-year EU financial framework, including the European Green Deal and the Sustainable Finance Action Plan, as well as the Taxonomy Regulation,” the Committee writes.
“The taxonomy not only looks at what is green and sustainable now, but also takes transition into account and thus the path to get there,” explains Karsten Löffler of the Frankfurt School of Finance & Management, who is also Chairperson of the Sustainable Finance Committee. As part of the group of technical experts, he helped prepare the details of the taxonomy for the EU. “Linking investment requirements to the taxonomy is definitely conceivable,” says Löffler. For instance, the EU could link its long-term policy goals, like carbon neutrality by 2050, with the path to recovery from the crisis. That said, the taxonomy does not yet take into account all aspects of sustainability – like for example social issues, where currently only minimum standards apply. “If you view sustainability holistically, it’s about much more than just the environment. Nevertheless, the taxonomy is a good place to start,” Löffler believes.
Kopp even goes one step further: “The taxonomy is designed to find out what exactly makes ecological transformation possible. It is thus virtually obligatory that the framework be applied. Europe is already integrating it into a variety of different legislative projects,” says Kopp. This includes, for example, the Green Bond Standard and the new disclosure requirements for companies by which financial market players are to be able to assess whether or not their investments accord with the Paris climate targets. “It would almost be foolish not to apply the taxonomy now, though it is assuredly not yet developed through to its final form,” adds Kopp.
Klein: it’s about risk management
Christian Klein is a professor of sustainable finance at the University of Kassel and has examined how the taxonomy could now be applied in concrete terms. “Let’s just imagine for a moment that we put a CO2 clause in the requirements for companies seeking credits. A concrete reduction target. If a company achieves the target, repayment is deferred or part of the repayment is even waived,” puts forward Klein. Companies must already lower their emissions regardless in view of the EU’s reduction targets. Here it’s now about the state’s risk management. Companies that do not adjust are less competitive and there’s thus a higher probability of them defaulting on the credit.
“If the state is going to be handing out such gigantic sums, it should make sure the companies are future-proof and not set to go bankrupt,” Klein proposes. The exact nature of the clauses and carbon benchmarks could be taxonomy-oriented. There is currently still time to do so as the recovery programme as a result of the coronavirus crisis is still under discussion. “Just imagine how many highly qualified individuals suddenly have space in their heads right now for new thoughts. When will we ever again have an opportunity like this to think strategically about the coming decades?” he asks.
WWF’s Kopp throws in the idea of giving every company a good faith bonus, but to then link additional advantages to certain conditions. “The point that is absolutely central is that companies need concrete plans and paths for the climate adjustments coupled with transparency of progress.” The state has a right to require a path to net zero emissions when it hands out taxpayers’ money. Many companies are prepared for this path, he says, as there are after all corresponding reporting standards. The European Commission had planned to rework its Sustainable Finance Strategy in any case and the consultations are currently under way.
Kopp and Löffler as well take a similar view to Klein: it’s about risk management. “It’s very important for policymakers that climate aspects be incorporated into credit and investment decisions,” says Löffler. “In the private sector, you can see the credit institutes are taking into account more and more the risks associated with business models that are not adapted for a lower-carbon future.” The state would do well to follow this example.