COMMENT With the growing prevalence of sustainable activity across the built environment, the way we describe and classify sustainable investments is essential.
Introduced in 2020, the EU taxonomy for sustainable activities provides a classification for investments to address greenwashing. However, to many even the name of the policy “taxonomy” – a scheme of classification – can cause confusion.
With its financial rather than environmental focus, is the current taxonomy improving transparency in a crowded space or just contributing to further confusion?
What is the EU taxonomy?
The EU taxonomy can be applied to investment activity across the built environment, with several environmental objectives fully developed for corporate real estate: climate change adaptation, climate change mitigation, circular economy and biodiversity. To demonstrate alignment, the activity underlying the investment must contribute substantially to at least one category and do no significant harm to the remaining categories.
The taxonomy covers a range of NACE activities – a classification of economic activities in the European Union, derived from the French: “Nomenclature statistique des activités économiques dans la Communauté européenne”. This includes real estate-specific activities, such as construction, acquisition and ownership of buildings; refurbishment of existing buildings; and corporate and individual measures taken to reduce energy consumption.
The criteria can be applied to corporates and financial products:
- For corporates – economic activities executed by corporates that have to demonstrate eligibility and alignment via non-financial disclosure reporting.
- For financial products – financial products that promote environmental and social characteristics (Article 8, transition or “mid green” funds) and which have sustainable investment as their objective (Article 9, aligned or “dark green” funds), linked to sustainable financial disclosure reporting. These funds must then disclose how and to what extent investments that underlie these products contribute to the objectives of the EU taxonomy.
Rising to the challenge
So far, so good. However, what we find in practice is that the substantial contribution criteria for assessing existing buildings’ compliance in relation to climate change mitigation is fraught with issues. These include:
- Lack of comparable data, making streamlining a pan-European approach very challenging – by contrast, the introduction of comparable data and benchmarks would drive incremental improvement across sustainability credentials and mitigate against differing energy performance certificates, calculation methodologies and rating approaches throughout the EU.
- Consistency in new build – challenges around the criteria and definition of newly constructed net zero energy buildings exist at country level. There is a clear opportunity to align the taxonomy requirements with existing net zero carbon frameworks and in turn standardise energy and carbon reduction targets.
- Binary scoring – sustainability is not a binary distinction and so applying mutually exclusive terms to investment assets around being “green” or “not green” within the taxonomy is not always appropriate when using qualitative indicators. An extension to the taxonomy in March proposes reclassifying impacts based on a more constructive traffic light system.
- Alignment – fundamentally, getting all EU member states to agree on the further development of the EU taxonomy is not a straightforward process given the differing interests and ongoing choices that need to be made. A good example of this is the most recent disagreement around the proposed inclusion of gas and nuclear in the criteria as transition technologies.
Introducing the UK green taxonomy
The UK’s decision to adopt a taxonomy – currently under development and likely to follow the EU taxonomy – as well as make TCFD reporting mandatory, demonstrates the UK’s increased appetite for sustainability reporting.
Historically, the UK has recognised the importance of transparent and regulated financial products and, going forward, it could arguably move quickly to attract real estate capital seeking sustainable assets to invest in, given its competitive advantage to make decisions faster outside the EU.
The UK green taxonomy could also move towards a more sophisticated ranking or scoring system than the EU taxonomy, rather than simpler “sustainable/not sustainable” labelling, given that it already has an accessible EPC database where the top 15% of comparable buildings can be easily established.
Looking to the future
Sustainable finance could be a major growth area for the UK in the coming years, but this will only be realised if the UK adopts standardised reporting that aligns with the EU and can be easily understood.
Once the technical criteria definition issues are addressed, including a reliable database to benchmark equivalent building types, the EU taxonomy could itself be a key enabler in providing financing for decarbonisation of the built environment.
Investors wanting to launch ESG-focused funds need to keep on top of the requirements – monitoring technical developments for environmental screening criteria, integrating these criteria into guidelines and procedures, and preparing for the most stringent disclosure. Positioned to provide insight and clarity across all of this, taxonomy – both EU and UK – should not be disregarded.
Jane Boyle is sustainability director at Upstream, JLL
