EU Taxonomy Posing Data Challenge to Corporates and Financial Firms

Two years since its publication, the European Union’s Taxonomy remains a milestone in sustainable investment standards.

Part of the EU’s Green Deal to direct private finance towards the projects that can slow global warming and alleviate its impacts, the Taxonomy is designed to provide benchmarks on what can be considered a green or sustainable economic activity. Its aim is to prevent greenwashing.

Alignment with the Taxonomy is central to compliance with the EU’s main piece of green financing regulation, the Sustainable Finance Disclosure Regulation (SFDR), with which financial institutions must comply. While the Taxonomy has been embedded within the reporting framework of many companies, they are still finding it difficult to fully align with its guidance because of the absence of relevant data.

This handicap is one of the key themes that will be discussed at A-Team Group’s next ESG Insight webinar on September 20th. The event, entitled “Progress and Challenges in Taxonomy and Standards Setting for ESG”, will comprise speakers Alex Merola, executive director of commercial strategies, ESG & private markets, software solutions at S&P Global Market Intelligence; Ghislain Perisse, head of insurance solutions at Fidelity International; and, Brunno Maradei, global head of responsible investment at Aegon Asset Management.

Only data can provide the granular visibility that’s required for corporates to accurately assess their ESG performance and for financial institutions to make investment decisions and risk assessments about them. According to S&P’s Merola, it’s not too late for corporates that are untrained in ESG data gathering to establish a baseline of information on which they can build over time.

Regulators have built flexibility into the Taxonomy that allows companies to gradually work up to reporting their entire performance metrics.

“As long as they are making best efforts, putting processes in place and re-evaluating their approach to both disclose and validate this information, there’s going to be some flexibility,” Merola tells ESG Insight.

S&P is among large private data providers that are offering its corporate clients the tools to assess the sustainability of their own activities, ready for disclosure to regulators and investors.

“Merola thinks that the EU’s Taxonomy has sensibly balanced the need to combat greenwashing against a rulebook that “handcuffs” companies to a process that punishes them as they navigate these new requirements.

ESG Pushback

The ESG project is facing strong political pushback in the US and other jurisdictions in which conservative forces are preaching a narrative that sustainable finance cannot hope to bring about the change it promises. That theme has found some traction at a time when investors are focusing away from ESG and towards beefing up returns as rising inflation and economic uncertainty batter capital markets.

Fidelity’s Perisse – who also sits on the working group of FinDatEx, which gathers all European financial associations and works on establishing ESG data standards for European regulations – said the investment management giant’s clients had reported such concerns.

“When I talk to the head of ESG at a bank or an insurer, they say climate is more important, but when I talk to the distribution side of a client that has lost 20% since the beginning of the year, they don’t care about climate, they want to know when their money will start moving up,” Perisse tells ESG Insight.

Nevertheless, sustainability has remained a central part of the conversation, particularly because the most recent iteration of the EU’s Markets in Financial Instruments Directive (MiFID) requires sellers of funds and other financial products to consult clients on their sustainability preferences.

(Just what impact that latest piece of regulation will have on sustainability markets will become clearer as the first round of feedback from financial institutions comes due this month.)

Merola says that while returns will be uppermost in investors’ minds at the moment, they will certainly be looking at how their decisions might impact the environment.

“To me, it’s about the fundamental understanding of what do you own, what is the impact that it can have and can you potentially influence that for better sustainable investing as well as longer-term value-add,” he says.

Standards Expectations

Few changes are expected to the Taxonomy in the near future, but reporting standards are a continuing bone of contention among market participants. A patchwork of individual standards setters currently set the templates for the data that companies disclose to back up their ESG claims. There has been some consolidation with the combining of a number of guidelines into the IFRS Foundation’s recently created International Sustainability Standards Board.

The absence of a single reporting standard has been blamed by some quarters for the continued existence of greenwashing. Nevertheless, both Perisse and Merola don’t anticipate the emergence of a single framework.

In explaining why, Perisse points to Fidelity’s adoption of recommendations from a variety of standards setters in creating its own investment exclusions rules. The reason for this, he says is that different jurisdictions have different outlooks on what constitutes a green investment.

For instance, while ownership of alcohol stocks would be frowned upon in some places, in the UK that “will never be the case”. Similarly, investment in nuclear power wouldn’t pass a portfolio manager’s approval in Germany.

“That’s the interesting part – it reminds us that definitions of what is ESG are strongly linked to culture or religion and a lot of other aspects that make convergence of standards… a long way off.”

Be sure to join us and listen to the discussion on September 20th in our Progress and Challenges in Taxonomy and Standards Setting for ESG webinar.