European Union (EU) Sustainable Finance Taxonomy
Will the EU Sustainable Finance Taxonomy stop greenwashing of investment products?
The EU has decided on a landmark anti-greenwashing regulation for fund managers –the Sustainable Finance Disclosure Regulation. What is the status of the implementation of this regulation? And more importantly: Will it end false sustainability claims for non-green investment products for good? And what does this mean for retail investors that want to put their money where it makes a real difference for the climate?
Are we being greenwashed?
Truly sustainable investment funds are a rare find. Even though there are a lot of investments with environmental, social, and governance criteria for stocks, these usually follow a “marketing hype” without a real contribution, as expressed by Tariq Fancy, the former chief investment officer for sustainable investing at BlackRock Inc. He also believes that funds are being remarketed as “green” without noticeable modifications to the fund itself or its strategies. Since investors are paying more attention to environmental responsibility, it has become convenient, and profitable, for funds to label themselves as sustainable for appearances. But with more than 250 European funds being rebadged as sustainable in 2020 , greenwashing has become a problem and that is why the EU has made a regulatory response.
What is the EU planning to do about it?
Readers will no doubt already be aware that the EU set out to put an end to the practice of misleading retail investors on sustainability claims.
Under the Sustainable Finance Disclosure Regulations (SFDR), starting in March 2021, all investment funds available to European investors are required to declare how central sustainability is to their investment process.
The SFDR regulation classifies financial products in three categories, as specified by Articles 6, 8, and 9. Article 6 regulates products with limited ESG integration. Article 8 is for funds with some sustainability focus and Article 9 is for funds where sustainability is a central part of the product.
The EU Taxonomy finally came into force in January this year. This Taxonomy serves as an underlying framework to a range of EU sustainable financial legislation (including the SFDR). Among others, the goal of the Taxonomy is to homogenize definitions of sustainability. Together with the SFDR, this is supposed to help fun managers determine their financial products’ alignment with the taxonomy-eligible economic activities, and to categorize their products into one of the three articles. But some of the technicalities in the Taxonomy are still not decided upon. The final list of activities that can be considered green investments is still not finalized. Since the technical details of the taxonomy also affect SFDR and other sustainable finance regulations, the question remains: can the financial industry continue to offer greenwashed investment products or not?
Are the EU regulations strong enough to prevent greenwashing?
Both the EU Sustainable Finance Taxonomy and the SFDR sound good on paper, but the technicalities behind them have been put into question. In February this year, the European Commission released the second Climate Delegated Act, as part of the EU Taxonomy. The Act allows natural gas and nuclear energy activities to be labeled as sustainable under the following conditions:
Natural gas-fired power plants: For such plants to receive a green label they to replace a more polluting fossil fuel plant (for example a coal-fired one). And the gas plants are not allowed to emit more than 270g of CO2 per kWh of electricity generated. This part of the Act is criticized by experts and environmentalists because, in a previous version of the Act, the benchmark of 100g of CO2 per kWh of electricity generated has been considerably more stringent.
Nuclear power plants: Nuclear power plants can be labeled green until 2045 as long as they manage their radioactive waste safely, switch to “accident-tolerant fuels” beginning in 2025 (if those fuels are available). The detailed plans on the final storage of nuclear waste can be postponed until 2050. Experts and environmentalists alike criticize this part of the regulation as they question the sustainability of nuclear energy and as it is unclear what will happen with the current and future nuclear waste.
What does this mean for the climate-conscious retail investor?
The SFDR and EU Taxonomy are still dynamic pieces of legislation with important technical details unfinished that have an impact on the sustainability of investments still in flux.
The private investor that aims to invest in 100% positive climate impact might not be satisfied with the regulation on the grounds of eligibility of natural gas-fired power plants. For those not wanting to invest in nuclear power plants the blank check for this energy source will be a red flag. Hence, there are good reasons for the conscious retail investor to put a critical eye on financial products using the future sustainability label based on the SFDR. We will continue to provide updates on this important piece of legislation and its final rules so that you can continue to make well-informed investment decisions.
