Chapter 4: EU Green taxonomy

Hello Readers:

Today, I am posting about EU Green Taxonomy. For the GARP SCR exam aspirants, this is an important point for preparation.  SCR exam usually have questions that can be around the criteria points for classifying the economic activities  being termed as "Green" and also the drawbacks about the EU Green taxonomy. So, please read on. 

A very prominent strand of emerging public policy and regulatory responses to climate change and environmental challenges is green taxonomies. Until recently, policymakers and regulators had not felt the need to create lists of economic activities considered “green.” Such green lists or “taxonomies” are now being created in a number of jurisdictions, including ASEAN, Canada, China, the EU, Malaysia, and the UK. The furthest along in this regard is the European Union. 

The EU Taxonomy, first published in draft format in March 2020, sets performance thresholds (referred to as “technical screening criteria”) for economic activities, by sector and sub-sector. To count as “green,” activities must fulfill below criteria: 

(a) Make a substantive contribution to one of six environmental objectives :

1.Climate Change Mitigation: Activities that significantly reduce greenhouse gas emissions, promote renewable energy sources, increase energy efficiency, or support the transition to a low-carbon economy.

2. Climate Change Adaptation: Activities that enhance resilience to climate change impacts, such as infrastructure projects that address increased risks of flooding, drought, or extreme weather events.

3. Sustainable Use and Protection of Water and Marine Resources: Activities that promote sustainable water management, protect water resources, reduce water pollution, or support the conservation of marine ecosystems.

4. Transition to a Circular Economy: Activities that promote resource efficiency, waste prevention, recycling, and the use of renewable materials in order to minimize waste generation and promote a sustainable circular economy.

5. Pollution Prevention and Control: Activities that aim to prevent, reduce, or eliminate pollution across various environmental media, such as air, water, and soil.

6. Protection and Restoration of Biodiversity and Ecosystems: Activities that contribute to the conservation, restoration, and sustainable use of biodiversity, ecosystems, and natural resources, including projects focused on habitat restoration and species protection.

(b) Do no significant harm to the other five,

(c) Meet minimum safeguards (e.g., the OECD Guidelines on Multinational Enterprises and the UN Guiding Principles on Business and Human Rights). 

Application of Green taxonomy:

1. Green taxonomies are intended to inform policy, regulatory, and market decisions. For example, they are often accompanied by requirements to disclose the quantity of green economic activities in investment products. This can then result in green labels for such products to help guide retail investors. Green taxonomies are also being used to guide fiscal policy by helping to determine, for example, in what categories the EU’s €750bn COVID-19 recovery fund can be spent on. 
2. Over time, green taxonomies may play a key role in determining what companies can access green subsidies or incentives from governments, and possibly what tax or other incentives investors could receive based on their investments in green companies and assets.
3. Proponents argue that green taxonomies facilitate comparability across investments, and that they reduce the burden associated with determining whether an investment is green. 
4. Also, green taxonomies can help to tackle greenwashing by making it clearer what is green and what green holdings exist in investment products. To this effect, do-no-significant-harm provisions, including in the EU taxonomy, are meant to ensure that green activities make a positive contribution to environmental outcomes and do not harm other environmental and social objectives in the process. And, because green taxonomies are intended to be common frameworks for determining which activities can be defined as environmentally sustainable, in theory this could help to improve our understanding of the impact of company activities on the environment, thereby helping to green portfolios and loan books. However, while this feels intuitively appealing, it is in fact extremely challenging to assess every type of economic activity, determine whether it is green or not, and then apply that consistently to every company (see Caldecott 2019).

Drawbacks:

Some doubts or drawbacks associated with the EU Green taxonomy include:

1. Shades of Green: The taxonomy may oversimplify the complexity of assessing the environmental impact of different economic activities. There could be variations and nuances depending on local and national contexts, making it challenging to categorize activities into a binary "green" or "non-green" classification.
2. Lobbying and Political Influence: The development of the green taxonomy may be susceptible to lobbying and political influence. This could lead to compromises or exceptions being made that undermine the credibility and integrity of the taxonomy. For example, certain activities or industries may be classified as sustainable investments due to lobbying efforts, even if they have questionable environmental credentials.
3. Potential Asset Bubbles: Over time, the green taxonomy could create an artificial increase in the value of assets labeled as green. This could result in inflated prices and potential financial instability if the market becomes overheated, resembling asset bubbles.
4. Sub-optimal Targeting: Incentives tied to the green taxonomy may not exclusively benefit new green assets or projects. Existing green assets that were already considered profitable at the time of investment could also receive advantages, potentially leading to sub-optimal allocation of resources and limiting the focus on promoting genuinely transformative activities.
5. Decreased Quality: There is a concern that the emphasis on green labels and taxonomy compliance may overshadow the proper assessment of underlying economic activities and cash flows. Institutions might be inclined to prioritize obtaining the label rather than thoroughly evaluating the environmental impact and sustainability of the investment.
6. Limited Role in Tackling Greenwashing: While the green taxonomy aims to combat greenwashing, there is skepticism about its effectiveness in fully addressing the issue. It may be used for public policy and fiscal decisions, but it might not play a central role in eradicating misleading or deceptive practices in financial markets.
7. Emergence of Brown or Transition Taxonomies: The focus on developing green taxonomies could overshadow the creation of complementary brown or transition taxonomies. These alternative frameworks could facilitate the identification and support of activities that are transitioning towards more sustainable practices, potentially offering a more inclusive and flexible approach to sustainability assessments.

It's important to note that these concerns and challenges are subject to ongoing discussion, refinement, and potential mitigation as the implementation of the EU Green taxonomy progresses.

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