Does the green investing taxonomy leave the financial service industry open to charges of greenwashing? Are the rules so strict and complex that not only do few investments qualify, with the reasons for this being hard to explain to investors? The “Taxonomy in Practice” panel at last week’s Luxembourg for Finance “Sustainable Finance Forum” discussed the challenges and pointed to solutions.
“In our fact sheets of a typical product, we might say the percentage of sustainable investments is 6%, because that’s all we can credibly verify under the taxonomy,” said Martijn Oosterwoud, Lead Products at the Office of Sustainability with UBS. This, he said, opens up potential accusations of greenwashing against asset managers, who on the face of it are seeking to market a product as green when well over 90% of the investments appear to not be sustainable. “This is frustrating as asset managers are doing their utmost best to make sure that they’re aligned with the current standards,” he added.
Conflicting uses
“The taxonomy started as a way of just classifying those activities, which are substantially green or green enough to make a substantial contribution to achieving carbon neutrality by 2050,” explained Eila Kreivi, Head of the Capital Markets Department at the European Investment Bank. “Subsequently, it has also grown a corporate and financial institutional reporting framework and this really is a separate matter for which it is not designed,” she added.
Thus, in order to be aligned with the taxonomy, investments generally need to be the greenest of the green. Yet the panel noted that this excludes a range of business activity which although relatively highly polluting by standard definitions, is helping the transition to climate sustainability.
The case for brown
She cited the case of hydrogen, which some analysts see as part of the solution towards greening high energy intensity sectors such as the manufacture of steel, cement and aluminium. However, the taxonomy only includes hydrogen manufactured using renewables, which is difficult to manufacture at scale and “isn’t really commercially viable at this stage,” said Kreivi.
However, substantial carbon emission reduction can be achieved by using gas to produce hydrogen rather than oil and coal. Similarly, and perhaps easier for retail investors to understand, she noted that “the European Commission’s taxonomy technical expert group suggested that hybrid vehicles should only be included in the taxonomy up until 2025, being phased out afterwards as only zero tailpipe emissions would be would be permitted after that.”
These realities called for the development of a taxonomy that “brings in some of those different shades of ‘green’ and ‘brown’ to help people decide for themselves where they would like their investments to be targeted.” The European Commission is currently working on plans to develop this so-called “brown” taxonomy which seeks to classify technologies and business processes aimed at making a transition to low carbon by heavily polluting industries. The first draft of this text is due to be published in early 2022.
Complex communication
This approach was supported by the panel, but there remain concerns regarding client communication. Already the level of retail investor understanding of basic investment concepts is not what it could be in Europe and the concept of greening these investments adds an extra layer of complication.
This comes with more long-standing concerns: the lack of full sets of data and the potential for creating narrow investment portfolios that run the risk of failing to offer the diversity of investments that are the hallmark of well-run funds. These challenges are greater still when investing in developing markets where data is even more scarce and possibly where sustainability data will have the most impact.
“We conducted some consumer research earlier this year and found that only 11% of the people we polled understood the ESG acronym,” said Elizabeth Gillam, Head of EU Government Relations and Public Policy at Invesco. “The institutional market will have greater capacity to understand what the taxonomy numbers are telling them and will hopefully understand the context in which those figures are communicated,” she noted.
“When the taxonomy is an investment tool for investment managers to inform them about what companies are doing, how are they transitioning, whether they are on the right pathway, it is a very valuable tool,” she noted. “But as a communication tool to retail investors, I think there’s more work that needs to be done.” Oosterwoud also saw the glass as half full. “There’s a lot of upside, and much that is positive with these developments, but there are definitely also some challenges that we still need confront,” he said.