Definitions around what makes a product truly ‘green’ are still vague, so the European Commission technical expert group on sustainable finance has taken on the task of compiling a green taxonomy, writes Silvia Pavoni.
The well-worn motto ‘what gets measured gets done’ is a sensible one. It is particularly relevant when crafting policy that aims at channelling efforts and funds towards important but loosely defined areas. How you attract capital to social impact ventures, for example, when measuring the good that those businesses could bring – similarly to how financial return is accounted for – is often a slippery task. The same is true of environmentally themed products, including green bonds, where ambiguity over definitions rightly invites scepticism.
The European Commission has set out to correct this through its technical expert group (TEG) on sustainable finance, which is compiling a green taxonomy. Feedback was sought up until mid-September, and the commission will then decide how to take the measures forward. The TEG also created a voluntary EU green bond standard earlier in 2019. Getting this right is important for a number of reasons.
Avoiding a greenwash
First, it would help deal with ‘greenwashing’. Environmental, social and governance (ESG) considerations are increasingly woven into market products in response to rising investor interest. Not-for-profit organisation Climate Bonds Initiative estimates that, according to its own definition, green bond issuances will reach $250bn in 2019, representing nearly half of the total since 2007. It is a fast-growing space, which invites the temptation of slapping an ESG label on products that have just a hint of green. Clear definitions would avoid this.
Furthermore, such taxonomy will likely influence jurisdictions outside of Europe. Peter Munro, a director of market practice and regulatory policy at the International Capital Market Association, notes that emerging markets are closely monitoring the EU solution. Green finance experience in those markets is often limited but they arguably have greater potential because of their yawning infrastructure gap, which could be environmentally friendly from the outset, and they hold the potential for projects to transition away from highly polluting energy sources.
Clear and widely accepted definitions on what is green would undoubtedly also help the CEOs of the already 130 banks that have signed up to the UN Principles for Responsible Banking (which launched at the end of September). From France’s BNP Paribas to China’s ICBC to Banco Pichincha in Ecuador, they will all need to steer their businesses towards more sustainable models.
Setting standards
A sensible taxonomy is important also because, ultimately, it could attract funds not only to companies that already meet the green standards, but also to the ones who are trying to get there. This may be the biggest challenge of the TEG's work. In a recent report, rating agency Standard & Poor’s questioned whether the European taxonomy’s proposed qualitative and quantitative thresholds may be too strict and if they can sufficiently encourage the transition to green from businesses that currently are not environmentally friendly. For example, efforts to improve the efficiency of coal-fuelled power plants would not make the cut based on the current proposal.
Fine-tuning definitions to maximise results is a delicate and important task. What makes an asset green needs to be credibly described and measured, but rules could be gradually tightened as progress is made. As the S&P report suggests: “What is considered ‘green’ is worth reviewing regularly.”
This would help to channel greater funds to activities that have both short-term and long-term environmental impacts – and boost further credible green investment and capital markets.
This is the first of a monthly column focusing on ESG principles and how they are reshaping banking, markets and investment. We would like to hear your views on sustainable finance, how it is changing your organisation, your work and your incentives structure. Contact silvia.pavoni@ft.com and, on Twitter, @Silvia_Pavoni
