Taxonomies provide the definitive framework on which ESG regulations, government policies and business strategies are built. They help define what company, product or service is sustainable from an ESG point of view and they provide the language for labelling those elements, such as “green bonds”.But they are only as valuable as they data that is required to comply with their frameworks, and getting that data is largely dependent on what information companies are compelled to disclose. With no unified global standard governing how that data is reported, financial institutions will struggle to comply.
As the EU’s green Taxonomy reaches a level of maturity that will make it applicable across the entire European economy, ESG Insight’s next webinar will take the temperature of the global reporting standards and taxonomy landscape.
Entitled “ESG Standards and Taxonomies – A Progress Report”, a panel comprising some of the leading minds in the field will discuss how financial institutions are meeting their obligations and what challenges they face in doing so.
The webinar will be held on June 15 and you can still register to attend by clicking here.
Speakers will comprise Panagiota Balfousia, head of sustainable business strategy at asset manager Kieger AG; Navin Rauniar, co-chair, ESG working group and UK SteerCo member of non-profit Professional Risk Managers’ International Association (PRMIA); and, Bodo Windmöller, senior vice president for product management at RegTech firm Regnology.
Before the event, ESG Insight asked them what they thought were the most pressing issues regarding ESG standards and taxonomies.
The single largest hurdle to taxonomy alignment is the shortage of the data needed to enable institutions to assess their investments. According to Regnology’s Windmöller, only a small percentage of the data needed is currently available. Neither is he sure that the EU’s Corporate Sustainability Reporting Directive (CSRD), which will compel most companies listed on an EU regulated market to disclose their ESG data, will be sufficient to plug the gap in the near term.
“The framework is there, but it’s not actually working in practice,” he told ESG Insight. “Are we seeing the data flowing through the system accordingly? Not yet.”
Data quality is another issue that needs addressing to help institutions meet taxonomy obligations, argued Kieger’s Balfousia. While there are ample metrics on climate-related factors with a broad consensus, such as greenhouse gas emissions, the picture for other ESG markers, such as biodiversity loss, social deprivations and governance effectiveness is less complete.
“Social is a whole different discussion because in the environmental sphere, you can fall back to science, but in the social sphere, it’s even more about norms – there is more subjectivity,” she said.
The solution for the data challenge in taxonomy alignment is intertwined with solving for issues surrounding reporting standards. With no internationally agreed set of parameters on what data corporates should disclose, managers are hamstrung in knowing what to submit to regulators.
With more than 2,000 private and voluntary initiatives in corporate social responsibility in existence, Balfousia argues that companies need the clarity and certainty that should come with a harmonised reporting code.
“To apply the taxonomy, you need the data; to have the data you need the data standards,” she said, adding that a unified set of standards will have wider benefits. “Standards setting will also help with the quality because there will be much more clarity around, for example, how net-zero carbon emissions should be calculated.”
She and Windmöller are confident that the many sets of standards will converge soon. On the climate side, that’s already apparent with the adoption of the Taskforce for Climate-related Financial Disclosures’ (TCFD) framework by hundreds of companies and its incorporation into the regulations of several jurisdictions, including those proposed in the UK and US. They also point to the International Sustainability Standards Board (ISSB) as promising a comprehensive suite of disclosure codes.
“Now we see regulators and international bodies really stepping up and taking a very clear stance about what they think sustainability reporting should be like,” said Balfousia. “They will be the standard setters as we’ve seen with financial reporting over the last two decades, where the GAAP and IFRS became the two main standards. That will bring in more of the data that we want.”
Multiple Taxonomies/Taxonomy Convergence
The multiplicity of taxonomies is likely to be a huge headache for companies that operate internationally. Complying with different taxonomies will require additional resources and poses greater regulatory risks.
Already experts see points of potential difficulty. The EU’s Taxonomy, so far confined to the E part of ESG, has become the benchmark for other jurisdictions to follow. However, not all jurisdictions that are adopting similar frameworks have also embraced its double materiality approach, which considers the impact companies have on the environment as well as vice versa.
While jurisdictions will have taxonomy overlap on financial materiality, that’s less likely with impact materiality. Rauniar, who also works with Tata and it’s associated businesses, said this is a particularly thorny issue for heavy industry, which may be regarded as sustainable according to one taxonomy but not so by another.
“Do we classify steel as green or brown?” he asked. “If it’s made using green hydrogen in one factory, then it’s possibly going to be green. But at another factory in another jurisdiction, where coal is used, it might be brown. Taxonomy alignment is going to be complicated.”
Another pain point Rauniar sees is taxonomy competition, in which assets will be priced according to the taxonomy under which they are issued. In that situation, credit might be priced more favourably under one taxonomy than another, creating market distortions.
He is pessimistic for the chances of a common taxonomy emerging, principally because taxonomies are vulnerable to political interference. In the EU last year, for instance, outrage greeted a decision to add gas and nuclear power to the list of green energies following the invasion of Ukraine and the energy crisis that precipitated in mainland Europe.
“The issue is that corporates and financiers want certainty on these things but taxonomies are essentially politically driven and that’s not good,” he said. “We’re definitely not going to have that dream-team taxonomy – that’s not going to happen.”
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