loader
banner

EU Taxonomy: Momentum building against controversial proposals

Synopsis: EU Taxonomy currently finds itself between a rock and a hard place. If industries assess that the EU Taxonomy will have a significant negative impact on their businesses, they will be apprehensive and will lobby hard against it. And with support for the local industry from the political brass, EU Taxonomy could see some dilution in its stringent proposals. However, while a pragmatic approach is required, allowing some of the obvious environmentally damaging activities, like logging and burning trees, and going against the ‘scientific evidence’ will be disastrous for EU Taxonomy. Several organizations have also labelled the EU taxonomy to be “greenwashing” itself. Pressure from industry lobbies is growing with the Biofuel makers protesting against EU taxonomy as the Biofuels made from food-and-feed crops do not meet the EU’s green taxonomy criteria. There have also been concerns over proposed disclosure rules in terms of scope of the disclosure, data availability and timing according to representative of banks and asset managers.

EMAlpha’s extensive coverage on EU Taxonomy

Among all the economic blocks globally, the European Union (EU) has been the most proactive in dealing with the challenges the world collectively is facing, in particular the challenge of ‘climate change’ which has been under focus for the EU. To address the issues related with damage to the environment and climate change, the European Commission has developed a classification system to provide more clarity to the companies on the economic activities in terms of where they stand on environmental sustainability.

This system is called EU Taxonomy and it has an objective to nudge the companies operating in the EU to report on and disclose how their business activities are aligned with the EU Taxonomy’s definition of what is sustainable and what is not. To the best possible extent, the EU taxonomy wants to create a level playing field for businesses in terms of how they report the information and relevant data. If done effectively, this will help investors in making better choices on the companies’ efforts to control damage to the environment.

EMAlpha has been actively tracking the major developments related with EU Taxonomy and we have also received a very encouraging feedback on our insights on EU Taxonomy. On the basis of many of our conversations, we realise that there is a very high level of interest among clients which include institutional investors and the companies which are making serious attempts to better understand this regulation. On EU Taxonomy, we have so far published.

  • The next hurdle for EU Taxonomy may come as “requests for exemption”. Sweden’s Financial Supervisory Authority is already arguing that Sweden’s pension foundations should be exempted from the Taxonomy rules. It would be intriguing to see where the pendulum swings next. (EU Taxonomy: Will “Requests For Exemption” be the Next Challenge, 7th June 2021)
  • As it happens with any deal involving multiple stakeholders who hold contrasting viewpoints on critical issues, developing a consensus is the biggest challenge. This was the case with EU Taxonomy too. Did ‘practical’ and ‘acceptable’ facet get precedence over what was ‘stringent’, ‘scientific’ and ‘effective’? (EU Taxonomy: Political Realities vs Positive Change, 13th May 2021)
  • We discuss how the Coronavirus pandemic played a key role in shaping the thought process at the EU and how that may have impacted the EU Taxonomy proposed regulations. (EU Taxonomy: How the Covid-19 Pandemic triggered the April 2021 Package, 10th May 2021)
  • It will be an understatement to make that the rapid developments in EU Taxonomy and the proactive stance of European Commission on Sustainability matters will alter the playing field for the companies in the EU, investment managers and investment advisors. (EU Taxonomy: The Game Changer for Sustainability Reporting and Investment Advice, 30th April 2021)

More challenges ahead for EU Taxonomy

There are already issues like lack of political consensus and requests for exemption that the regulation is struggling with, but the more serious challenges could emerge from the lack of popular support for EU Taxonomy. Although some states trying to find an escape route to exit due to internal pressure matters, what also matters is the ‘further dilution risks’ of the Taxonomy. The worst part is that if the EU Taxonomy proposals do not address the core issues in climate change, even the defenders might be repelled by the undertaking. From that perspective, some of the recent developments are concerning.

  • On 9th June 2021, more than 90 environmental and consumer groups appealed to the European Parliament to do a rethink on logging and the burning of trees to be counted as green investments and hence, postpone their judgement on sustainable finance rules that would allow these activities.
  • In an open letter, organisations such as BirdLife Europe, WWF and BEUC made this request. The letter highlights that the respondents asked for a science-based taxonomy. But intense lobbying by countries like Sweden and Finland has ensured that the science-based criteria be replaced by lobby-based approach for these sectors.
  • The main argument is that the standards for forestry and bioenergy classify the burning of trees, clearcutting of forests, intensive mono-species plantations, use of chemical fertilisers and pesticides in forestry as “green” activities. This is hardly the ideal situation in order to protect the environment.
  • This is very similar to the Civil Society Statement which talked about, a) Economic activities that were rightly excluded and should not be re-included (Fossil fuels including gas, Incineration), b) Economic activities to be improved with tighter criteria (Bioenergy, Hydropower, Forestry, Inland water transport, Biofuels and biogas use in transport, Hydrogen), and, c) Economic activities to be removed from the EU sustainable taxonomy (Sea and coastal water transport, Livestock).
  • You Move Europe, an independent organisation that runs campaigns on behalf of people is currently running a petition ‘The EU must protect forests, not burn them for energy’ which urges EU policymakers and EU Member States to, a) end subsidies and other incentives for burning forest wood and redirect this critical support to energy efficiency and true low-emissions renewable energy sources, b) exclude energy generated from burning forest wood from counting toward renewable energy targets. It has already been signed by 237,272 participants (as on 23rd June 2021, 9am GMT) and plans to reach 300,000.
  • There are also several organizations which claim that EU Taxonomy is hardly sufficient to fight the threat of climate change and many of them have even went to the extent of saying that the EU taxonomy itself is “greenwashing” because it is postponing decisions on several controversial issues including the status of economic activities like gas-based energy, nuclear power and forestry.
  • On 21st June 2021, Greenpeace released an independent study claiming that Sustainable funds fail to redirect capital into activities that meet environmental, social and governance (ESG) criteria and there is a need for stricter sustainable finance rules. Inrate in its study analysing 51 sustainable funds available in Luxembourg and Switzerland, studied the capital allocation of these funds and also the funds’ ESG impact score, carbon intensity, revenue derived from critical activities and environmental controversies related with portfolio companies.

Multi-dimensional ‘pulls’ and ‘pressures’

There are also other areas where the European Commission faces tremendous pressure from industry lobbies to dilute the provisions under EU Taxonomy.

  • There are reports that the Biofuel makers are protesting against EU taxonomy as the Biofuels made from food-and-feed crops do not meet the EU’s green taxonomy criteria. The EU Taxonomy proposals will make it difficult for the EU to meet green transport goals, as per these Biofuel makers. We think that since some of the more controversial industries have gotten away without much repercussions, many other industries might be tempted to think that the norms should be relaxed for them too.
  • There have also been concerns over proposed disclosure rules in terms of scope of the disclosure, data availability and timing according to representative of banks and asset managers. The primary grievance, it seems is that the ‘cost-benefit analyses’ has not been carried out diligently and while the compliance burden would increase significantly for the banking and asset management industry, the benefits for ‘climate change’ risk mitigation are not very clear.
  • Then there is competition for EU Taxonomy as many other countries are working on their own versions of regulation. Among all, UK’s green regulation is going to be a serious contender as the UK has already begun the process of creating its own local yet better versions of the EU’s sustainable finance regulations. It certainly can take the best practices from EU Taxonomy and get a little bit more stringent on some of the more controversial topics to present the UK Taxonomy as a better alternative to EU Taxonomy.
  • There is also criticism of EU Taxonomy on its excessive focus on environmental issues and risks associated with climate change. While the sustainable finance initiatives and economic activities have an important role for environmental topics, the social and governance part can’t be ignored either. There are reports which call for more balance in EU Taxonomy among the environmental, social and governance parameters.

Civil Society vs. Industry and Political compulsions

EU Taxonomy is currently between a rock and a hard place. If industries see the compliance with these regulations as cumbersome or if industries realize that the EU Taxonomy will have a significant negative impact on their businesses, they will be apprehensive. It is possible that some of these fears might be totally irrational but if in their initial assessment, these industries think that the EU Taxonomy could damage them, either by making them less competitive or by impacting their profitability; they will lobby hard against the Taxonomy.

There is also support for the local industry from the political class which is natural. The administration has to take care of local interests. Industry pressure and resistance from political class means that there will be some dilution in the stringent proposals under EU Taxonomy. However, at the same time, while many of the NGOs and Civil society members may also be arguing on some of the less important issues, not everything that they have highlighted can be ignored if EU Taxonomy has to make a real difference in the EU’s fight against climate change. The viability of proposal and a pragmatic approach is required but allowing some of the obvious environmentally damaging activities and going against the ‘scientific evidence’ will be disastrous for EU Taxonomy.

How EMAlpha can help?

While the European Commission need to incorporate concerns of stakeholders, there will also be a need for a solution which looks at a more detailed classification for industries and sectors. At EMAlpha, we have incorporated a Flexible Framework Management System, based on EMAlpha’s proprietary technology making inferences framework agnostic. This also offers a quick adaptation for the users (both companies and investment advisors).

As such, the EMAlpha’s ESG and Sustainability offering is centred around addressing some of the most critical issues. The EMAlpha algorithms provide a choice for separate relevant frameworks and these can be used to review the performance more transparently. This not only helps the investment advisors but also make the clients understand the granular details better which in turn is helpful for them to understand their preferences better. To achieve this, we focus on the following;

  • Go beyond the official reported version – The data source matters and there is a need to look beyond what the companies are reporting and what the official version is. It is essential to rely on the company reported data because other sources might not be collating as much information. Although often, there are other sources as well for environment related information. They include the information disclosure as mandated by regulators and the EMAlpha algorithms scan through unstructured data to pick the unofficial information too.
  • No two ESG scores are same despite same headline figure – It is the composition that makes a big difference and all the three parameters that make up ESG need to be evaluated separately. The EMAlpha algorithms provide separate scores for E, S and G so that an investor can review the sectoral performance more transparently. Over and above, a key feature of EMAlpha’s NLP algorithms is that the attribution analysis is fairly simple and straight forward.
  • An ESG score without context and background is meaningless – The ESG is as much about intent as it is about execution. For this balanced evaluation, having an understanding of the local factors is very crucial. A very good ESG track record (probably more driven by excellent performance in E and/or S) may hide serious Governance related risks and the investors can only ignore them at their own peril. EMAlpha analysis meticulously incorporates this critical part of the ESG evaluation jigsaw puzzle.

References

  1. 90+ NGOs Urge EU Parliament to Rethink ‘Green’ Finance List https://ens-newswire.com/90-ngos-urge-eu-parliament-to-rethink-green-finance-list/ (Accessed on 06th July 2021)
  2. BirdLife and 90+ NGOs call on MEPs to halt approval of ‘green’ finance list https://www.birdlife.org/europe-and-central-asia/news/open-letter-stop-approval-eu-taxonomy-green-finance_09June2021 (Accessed on 06th July 2021)
  3. Open Letter https://www.birdlife.org/sites/default/files/joint_letter_meps_eu_taxonomy_delegated_act_9june2021.pdf (Accessed on 06th July 2021)
  4. Civil Society Statement: Ten Priorities for the Climate Taxonomy Draft Delegated Act: December 2020 https://wwfeu.awsassets.panda.org/downloads/civil_society_statement___ten_priorities_for_the_climate_taxonomy_delegated_acts_december_2020.pdf (Accessed on 06th July 2021)
  5. The EU must protect forests, not burn them for energy https://you.wemove.eu/campaigns/the-eu-must-protect-forests-not-burn-them-for-energy (Accessed on 06th July 2021)
  6. EU taxonomy for sustainable activities: What the EU is doing to create an EU-wide classification system for sustainable activities https://ec.europa.eu/info/business-economy-euro/banking-and-finance/sustainable-finance/eu-taxonomy-sustainable-activities_en#delegated (Accessed on 06th July 2021)
  7. Sustainable finance: TEG final report on the EU taxonomy https://knowledge4policy.ec.europa.eu/publication/sustainable-finance-teg-final-report-eu-taxonomy_en (Accessed on 06th July 2021)
  8. IMPACT ASSESSMENT: Sustainability of Bioenergy https://eur-lex.europa.eu/resource.html?uri=cellar:1bdc63bd-b7e9-11e6-9e3c-01aa75ed71a1.0001.02/DOC_1&format=PDF (Accessed on 06th July 2021)
  9. NO HYDROPOWER IN EUROPE https://wwfeu.awsassets.panda.org/downloads/stop_new_hydropower_in_europe_1_1.pdf (Accessed on 06th July 2021)
  10. “Greenwashing”— phenomenon of pretend environmentalism https://www.prospectmagazine.co.uk/politics/greenwashing-the-growing-phenomenon-of-pretend-environmentalism (Accessed on 06th July 2021)
  11. SUSTAINABLE FUNDS DON’T MEET GREEN CREDENTIALS https://delano.lu/d/detail/news/sustainable-funds-dont-meet-green-credentials-greenpeace/215144 (Accessed on 06th July 2021)
  12. Sustainability Funds Hardly Direct Capital Towards Sustainability: A Statistical Evaluation of Sustainability Funds in CH & LUX https://www.greenpeace.org/static/planet4-luxembourg-stateless/2021/06/ac190a73-inrate-study-on-sustainability-funds-for-greenpeace.pdf (Accessed on 06th July 2021)
  13. Biofuel makers protest against EU’s green investment taxonomy rules https://www.euractiv.com/section/biofuels/news/biofuel-makers-protest-against-eus-green-investment-taxonomy-rules/ (Accessed on 06th July 2021)
  14. EU Taxonomy: Concerns raised over proposed disclosure rules while NGOs rejoin expert group https://www.responsible-investor.com/articles/eu-taxonomy-concerns-raised-over-proposed-disclosure-rules-while-ngos-rejoin-expert-group (Accessed on 06th July 2021)
  15. UK to be torn between harmony and leadership on green regulation https://www.globalcapital.com/article/b1s6v2ck5fwy3x/uk-to-be-torn-between-harmony-and-leadership-on-green-regulation (Accessed on 06th July 2021)
  16. New EU sustainable finance rules: ‘blunt instrument not silver bullet’ https://chinadialogue.net/en/business/new-eu-sustainable-finance-rules-blunt-instrument-not-silver-bullet/ (Accessed on 06th July 2021)
  17. Ico CFO wants EU social taxonomy https://www.globalcapital.com/article/b1s8g969vrrbnp/ico-cfo-wants-eu-social-taxonomy (Accessed on 06th July 2021)
  18. EU countries split over whether to delay green investment rules https://www.reuters.com/business/sustainable-business/eu-countries-split-over-whether-delay-green-investment-rules-2021-04-20/ (Accessed on 06th July 2021)
  19. The EU’s Much-Flaunted Climate Leadership is Full of Loopholes https://carnegieeurope.eu/strategiceurope/84506 (Accessed on 06th July 2021)
  20. NGOs walk out on EU green finance group over forestry, bioenergy rules https://www.euractiv.com/section/energy-environment/news/ngos-walk-out-on-eu-green-finance-group-over-forestry-bioenergy-rules/ (Accessed on 06th July 2021)
  21. An open letter to the European Commission sent by the Civil society organisations and scientists on 31st March 2021 https://www.birdlife.org/sites/default/files/joint_letter_eu_commission_platform_sustainable_finance_taxonomy_greenwashing_31march2021.pdf (Accessed on 06th July 2021)
  22. Last minute EU taxonomy changes water down sustainability criteria for waste, NGOs say, changes made since a draft leaked last week have weakened criteria on waste management. https://www.euractiv.com/section/circular-materials/news/last-minute-eu-taxonomy-changes-water-down-sustainability-criteria-for-waste-ngos-say/ (Accessed on 06th July 2021)
  23. U. Ignores Science-Based Advice, Labels Gas As Green In Sustainable Taxonomy Proposal https://www.greenqueen.com.hk/e-u-ignores-science-based-advice-labels-gas-as-green-isustainable-taxonomy-proposal/ (Accessed on 06th July 2021)
  24. Draft EU taxonomy sparks discord over gas, nuclear future https://www.montelnews.com/en/story/draft-eu-taxonomy-sparks-discord-over-gas-nuclear-future/1207136 (Accessed on 06th July 2021)
  25. NGOs demand place for nuclear in EU Taxonomy https://world-nuclear-news.org/Articles/NGOs-demand-place-for-nuclear-in-EU-Taxonomy (Accessed on 06th July 2021)
  26. 7 EU leaders urge support for nuclear https://world-nuclear-news.org/Articles/Message-Nuclear-is-green-energy,-say-7-EU-leaders (Accessed on 06th July 2021)
  27. Reprieve for Nuclear, Gas in EU’s Sustainable Finance Taxonomy Rules https://www.powermag.com/reprieve-for-nuclear-gas-in-eus-sustainable-finance-taxonomy-rules/ (Accessed on 06th July 2021)
  28. Natural gas bashing is trendy, but is it constructive? https://www.euractiv.com/section/energy-environment/opinion/natural-gas-bashing-is-trendy-but-is-it-constructive/ (Accessed on 06th July 2021)
  29. EU indecision over gas as green imperils supply security: German Utilities https://www.cleanenergywire.org/news/eu-indecision-over-gas-green-investment-imperils-supply-security-german-utilities (Accessed on 06th July 2021)
  30. Sustainable Finance and EU Taxonomy: Commission takes further steps to channel money towards sustainable activities https://ec.europa.eu/commission/presscorner/detail/en/IP_21_1804 (Accessed on 06th July 2021)

EMAlpha Products and Services

In most Emerging Markets, information discovery is a major challenge. For example, even if global investors do show interest, how do they solve the problem of timely access to information? The world’s largest capital allocators hold USD 60 trillion and they include GPIF (Japan), GPF (Norway), ADIA (Abu Dhabi), GIC (Singapore) etc. However, only 10% of the capital gets allocated to EMs and ~90% goes to G10. The big hurdle for EMs is: Foreign investors cannot access relevant local information in a timely fashion.

Most market participants and investors from across the world realise that the low rates in G10 makes EM attractive for investors. But, a) Information access is usually a cost and time intensive process for investors, and b) In many EMs, language is a big barrier and because of multiple regional languages, there is a significant delay before news makes it to the mainstream English language. To address these issues, you need solutions like, a) Real time news collection from multiple languages and, b) Instantaneous machine translation and text analytics leading to actionable recommendations for investors.

There are further challenges such as ensuring that companies behave responsibly and that they adopt sustainable business practices. There is a need to ensure that the investors are contributing towards making the world a better place by making investment decisions which reward responsible behaviour of companies. Case in point, ESG (Environmental, Social & Governance) which is increasingly being used as a filter for investment decisions. There are other issues as well such as which data to use and a lack of a standardized framework for evaluation.

Some of these issues are too important to be postponed to a later date and it is in this regard that EMAlpha is making its contribution. EMAlpha has developed a Flexible ESG Framework Management System which is a proprietary technology that makes ESG scores framework agnostic, thus allowing for quick adaptation. In addition, the users decide what matters to them and the EMAlpha system does a classification into E, S, G and more granular categories.

EMAlpha also has solutions for Multilingual data collection and real time targeted information which are based on proprietary processes to collect relevant data across multiple markets. The coverage expands across emerging market equity, currencies and commodities and the work has also been very successful in testing the signals in some key markets for live trading strategies. This is a continuous cycle and a virtuous loop that allows for iterative improvement through AI-human feedback.

With developments in AI and technology in areas like NLP, there are considerable new possibilities to bridge the gap in information between Emerging Markets and the more Developed Markets. This is an area which is turning out to be very exciting because some of the tools mentioned were not available even a couple of years ago. This implies that the evolution in the field will only get faster as time goes on. While the Emerging Markets and the Capital Flow Conundrum is a complex one, there is now much more hope and optimism that with the usage of technology, things will only get better.

At EMAlpha, the ESG team is doing further research on why some issues like Social get more prominence as compared to others like Environmental or Governance issues. To look at specific cases in the context of ESG is a very intense yet interesting exercise and this has been an incredible learning experience for the EMAlpha Research team. The data, information and ratings are a humongous challenge for ESG and it takes time to reach to the depth of the issues as the field is evolving very quickly.

EMAlpha is making a solid contribution in tackling these challenges. EMAlpha has solutions for ESG which are practical, user friendly and although not too simplistic yet easy to use. EMAlpha has developed a Flexible ESG Framework Management System which is a proprietary technology that makes ESG scores framework agnostic, thus allowing for quick adaptation. In addition, the users decide what matters to them and the EMAlpha system does a classification into E, S, G and more granular categories.

We strongly believe that the entire ESG ecosystem requires multiple stakeholders to pull in the right direction in order to make it operational and that will be the most critically determining factor for ESG’s success in making the corporate responsibility actually work. Most importantly, the investors should view ‘E’, ‘S’ and ‘G’ individually and should not confound issues when it comes to the comprehensive ESG evaluation. It is important to understand the right reasons behind ESG investing because this bias could hurt their investment decision making and portfolio performance.

Research Team
EM Alpha LLC

For more EMAlpha Insights on Emerging Markets, please visit https://emalpha.com/insights/. To know how you can use EMAlpha’s unstructured data and ESG (Environmental, Social and Governance) solutions for better investment decisions, please email us at research@emalpha.com.

About EMAlpha:

EMAlpha, a data analytics and investment management firm focused on making Emerging Markets (EMs) more accessible to global investors and unlocking EM investing using machines. EMAlpha’s focus is on Unstructured Data as the EMs are particularly susceptible to swings in news flow driven investor sentiment. EMAlpha works on information discovery and ESG solutions for Investors in Emerging Markets, using AI and NLP tech. Our mission is: “To help increase capital flow, in terms of FDI and FPI, to Emerging Markets by lowering information barriers using AI/NLP”. EMAlpha Products help achieve both alpha and ESG solutions and the idea is to help asset allocators, asset managers, banks and hedge funds along with companies with cost and time efficient access to relevant information. We use thoroughly researched machine learning tools to track evolving sentiment specifically towards EMs and EMAlpha pays special attention to the timely measurement of news sentiment for investors as these markets can be finicky and sentiment can be capricious. Our team members have deep expertise in research and trading in multiple Emerging Markets and EMAlpha’s collaborative approach to combining machine learning tools with a fundamental approach help us understand these markets better.

Disclaimer:
This insight article is provided for informational purposes only. The information included in this article should not be used as the sole basis for making a decision as to whether or not to invest in any particular security. In making an investment decision, you must rely on your own examination of the securities and the terms of the offering. You should not construe the contents of these materials as legal, tax, investment or other advice, or a recommendation to purchase or sell any particular security. The information included in this article is based upon information reasonably available to EMAlpha as of the date noted herein. Furthermore, the information included in this site has been obtained from sources that EMAlpha believes to be reliable; however, these sources cannot be guaranteed as to their accuracy or completeness. Information contained in this insight article does not purport to be complete, nor does EMAlpha undertake any duty to update the information set forth herein. No representation, warranty or undertaking, express or implied, is given as to the accuracy or completeness of the information contained herein, by EMAlpha, its members, partners or employees, and no liability is accepted by such persons for the accuracy or completeness of any such information. This article contains certain “forward-looking statements,” which may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential,” “outlook,” “forecast,” “plan” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of certain investment strategy. All are subject to various factors, including, but not limited to, general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting the operations of the companies identified herein, any or all of which could cause actual results to differ materially from projected results.