Aura Financial

EC making sustainability simple for investors?

 

For over 25 years the Aura team has watched the world of “ethical” investing with idealistic hope. During this time there have been many initiatives to promote sustainable investment leading to a perplexing mixture of schemes and acronyms from the SDGs to BREEAM, to DJSI and the SASB. Whilst often effective on their own terms it is fair to say that this patchwork can be confusing and is therefore unhelpful.

However, could this be about to change? Under the relatively new action plan on sustainable finance the EU is, amongst other things, making an ambitious attempt to develop a unified definition of activities that are considered sustainable. This set of definitions (or Taxonomy see here and here) is intended to cover a range of economic sectors and all financial instruments providing, in the EU’s eyes, much needed simplification for investors who want to easily and consistently make sustainable investments.

Once in place, the proposals are intended to cover anything marketed as a sustainable investment within EU jurisdictions. In broad terms the value of these assets was estimated in a 2018 study by Eurosif, to be €4 trillion.

To qualify under the Taxonomy, investments will be required to contribute to at least one of six key environmental goals (without negatively impacting any of the others) with clear supporting objectives defined for a wide range of activities.

An expert group is currently developing the Taxonomy and the intention is that it will be developed in phases – focussing on the most ambitious and transformational “deep green” climate change and environmental investments first and then expanding to cover mitigation later. Interestingly, the intention is to also expand the Taxonomy to cover social objectives in the future.

To give an example, based upon a recent draft document, to qualify as sustainable investments in industrial facilities producing primary resources (e.g. cement, iron and steel, aluminium, chemicals, glass etc.) will need to:

Excerpt from: INFORMAL SUPPLEMENTARY DOCUMENT ON SUSTAINABLE TAXONOMY

 

“Demonstrate substantial GHG emissions reductions for upgrades of existing industrial facilities through improvements in energy efficiency or changes in production processes, e.g. reducing energy losses, reducing fugitive emissions, methane capture, reducing gas flaring, use of waste gas, replacing cooling agents, integrating carbon capture and storage. Avoid upgrades that substantially increase GHG emissions as a result of increased production capacity. Demonstrate the use of transformational, low carbon technology for new industrial facilities that results in substantial GHG emissions savings compared to new facilities normally developed, and only if such technology prevents lock-in to high carbon infrastructure.

Primary Screening Metric: GHG emissions < XX gCO2e unit of production

Secondary Screening Metric: Monetary value of GHG savings (calculated

using a shadow price of CO2) over the economic life of the asset is worth > XX% of investment cost”

In other words the draft suggests that investments in this sector will be judged against two criteria: their impact on carbon produced for a given unit of production; and an assessment of the cost/benefit of the investment over the long-term. Whilst these definitions are still under development they could have a material impact on how investments are structured and financed.

This seems complex but is not just a theoretical exercise. The EC currently intends that the Taxonomy will be developed and introduced rapidly, with some elements in place this year and full implementation by 2022. And all products offered to investors in the EU would be covered.

Conclusion: it’s happening, its broad based and it will affect anyone allocating capital.

So, what does this mean for companies?

There is no requirement that companies have to align with the EU’s taxonomy and it remains to be seen how rapidly companies and investors adapt the taxonomy. So companies do not have to do anything.

Nevertheless, by aligning with the Taxonomy’s requirements companies have the potential to unlock access to the rapidly growing pool of sustainable capital and, assuming the taxonomy is widely adopted (itself not a given) this could be a significant benefit. There will also be undoubted communications and reputational benefits for those companies who can point to their qualification as sustainable investments.

However, there are risks. Investment decisions are made over the long-term and it is hard for companies to keep adjusting them to meet the evolving demands of policy makers. Also, the taxonomy is intended to be dynamic and investments could be included or excluded from the taxonomy over time. There will also be many potentially unforeseen complexities as these rules are applied – and potentially gamed – in real world situations.

There is also the potential for the taxonomy to clash with schemes developed in other jurisdictions or industry specific initiatives that are already under way.

Nevertheless, a number of different options are available, Aura’s non-exhaustive list would include:

  • First, find out more about the taxonomy and engage with the Commission and their experts now, whilst it is under development.
  • Second, assess how this will impact with your strategy and plans for your entire business as well as different business units and assets.
  • Third, begin planning how you can incorporate the taxonomy into your plans and reporting processes in future.

Our advice is based on the actual benefits which this approach will confer to reporting but also the belief that companies will be rewarded by investors for being on top of their game. Climate change increasingly affects us all and ending the practice of greenwashing helps everyone.