European Taxonomy, a crucial tool for decarbonising the economy

What is European taxonomy and why will it be key to a resilient and sustainable economic recovery?

The European Taxonomy of Sustainable Finance is a new classification of economic activities that contributes to the European Union's environmental targets, such as mitigating and adapting to climate change. This asset listing enables investors to know objectively whether an activity contributes significantly to Europe's sustainability goals.

The aim of this new taxonomy is to increase confidence in green investments and ensure that they meet sound and transparent criteria aligned with the European Green Deal and the commitments under the Paris Agreement and the UN Sustainable Development Goals. With the introduction of the taxonomy, any investor investing in companies and assets that are declared green will be able to know the extent to which they are actually green.

The taxonomy focused on mitigation and adaptation to climate change was adopted by the European Council in June 2020, with recent endorsement from the European Parliament and the support of the Commission's Technical Expert Group on Sustainable Finance. This article explains how it came about and how useful it can be for guiding green recovery packages after the COVID-19 pandemic.

Sustainability as a criteria for building the new economy

The coronavirus crisis is shaking the whole world, a health crisis that could also lead to another period of recession. However, many experts in the field of economics argue that the financial formulas to exit out of the coronavirus crisis are the same as those needed to address the climate crisis, the other global emergency, postponed by the sudden arrival of the pandemic, which is still there and must not be forgotten.

The climate crisis requires decisive action to halve carbon dioxide emissions by 2030 and reach neutrality by 2050 in order to meet the most ambitious goal of the Paris Agreement: that the planet's temperature does not rise by more than 1.5° with respect to the pre-industrial era.

But where do we begin to build this new economy? Tools such as the European taxonomy are key to enabling companies to cope with the necessary transformation.

What is European Taxonomy?

In 2018, the European Union designed a plan to contribute towards moving private capital toward sustainable investments. To this end, it appointed a group of 35 experts who defined a classification of 72 activities that must fulfil, in a measurable manner, these three criteria:

contribute to a carbon neutral economy.
not significantly damage other environmental objectives.
carry out activity with a minimum of ethical and labour standards.

With these quantifiable and measurable technical criteria, the taxonomy pursues these six environmental objectives:

climate change mitigation
climate change adaptation
sustainable use and protection of water and marine resources
transition to a circular economy
pollution prevention and control
protection and restoration of biodiversity and ecosystems

Or in other words: for an economic activity to be aligned with the taxonomy, it must first demonstrate that it contributes to one of the six environmental objectives, demonstrate that it does not harm the rest of the objectives and comply with the minimum social guarantees.

As an example, the taxonomy regulation states that energy generation activities using solid fossil fuels are not considered environmentally sustainable and therefore cannot be included.

One of the most important purposes of defining these criteria, and of drawing up the list of activities, is to encourage the financial sector to move capital toward investments that really respond to the needs of the sustainable agenda.

This is how the European Union Taxonomy was conceived, whose use in response to the impact of the pandemic will help the various financial agents (funds and assets, institutional investors, insurance companies, development banks and private capital, and rating agencies, among others) to identify the risks as well as the opportunities behind sustainable investment.

In short, taxonomy provides the opportunity to build a different recovery and development model as part of a Green Recovery, which after the pandemic will result in a decarbonised, sustainable and resilient economy.