EU Taxonomy: All You Need to Green Your Investments

The EU taxonomy will trigger a sustainable finance revolution.

I’ve been asked many times: “what gets you excited about the future?”

And here I confess. I never said:

“That new law is what really gets me going!”

This time the music is different. There is a new law that wakes me up every morning with a mixture of hope and excitement.

The EU taxonomy will shape the entire life of our kids, and our jobs will be turned upside down by those few words.

But you shouldn’t sit in despair, pondering how fast things are changing around you.

Because I am going to share with you the MATERIAL impact the taxonomy will have on your job, together with some tips to reap the benefits of this revolutionary law.

Bear with me.

Sustainable finance in the EU: dream or reality?

The EU Taxonomy is a tool to help investors, companies, issuers and project promoters navigate the transition to a low-carbon and resource-efficient economy.

Europe has to close a sustainability funding gap of €180 billion a year, if we are to honour the Paris Agreement in time. In 2019, the European Union could count on a total budget of €165.8 billion for all its activities. That means, even if we channeled all its money into sustainable investments, we would still miss €14 billion. Long story short:

No sustainable transition will ever happen without private investments.

Investment managers who invest in companies with a positive ESG (Environmental, Social and Governance) performance are already outperforming traditional investors, especially during the pandemic. For some, ESG investing is even better than gold. So why should the EU bother, if the market already rewards sustainable investments?

Because it’s not very clear what a sustainable investment looks like. Some companies claimed to be sustainable champions, but turned out to be emission smugglers. And greenwashing is the number 1 enemy of financial markets, since flawed information causes trust to plummet and entire markets to crash.

The EU taxonomy is here to make sustainability information reliable and transparent, stimulating private actors to invest sustainably. It will drive every company to follow the same ESG analysis framework, allowing investors to compare companies’ sustainability ratings and pour money into truly sustainable business. 

The taxonomy is the material realization of the sustainable development goals. Its end goal is to unleash the power of free markets to transform sustainable finance from dream to reality. 

So let’s dive right in the consequences for our daily lives.

ESG investing is even better than gold.

EU taxonomy: a material explanation

If I was to synthesize what the taxonomy is all about, I’d say that:

  1. Companies will report their sustainability metrics in much more detail to let investment managers make informed decisions.
  1. Investment managers will give their investors a complete overview of the impact generated by their investments. 

Today ESG investing is a wild world, but the taxonomy will put some order in it. Three main actors will be affected by it: companies, investment managers and investors.

For investors, like pension funds or sovereign funds, life will get easier and more joyful, as they’ll have all the information they need to allocate assets in the most impactful way. 

For investment managers, things will get more complicated. So far, investment managers have been classifying financial products based on (roughly) two parameters: risk and expected returns.

From now on, they will include a third one: taxonomy alignment.

Investment managers will have to make clear what’s the environmental impact of the underlying investments in their financial products. With the new regulation coming into place, investment managers will be mandated to disclose much more information than they used to. Here is what is going to change:

  • Every financial product will state which environmental objective it aims to achieve. Investment managers will be able to choose between six different environmental objectives: climate  change  mitigation; climate  change adaptation; the sustainable use and protection of water and marine resources; the transition to a circular economy;   pollution prevention and control; and finally the protection and restoration of biodiversity and ecosystems.
The six environmental objectives established by the EU taxonomy.
  • Every financial product will disclose the proportion of enabling versus transition activities present in its portfolio. An enabling activity significantly contributes to the decarbonization of a specific industry, like wind turbines installation. A transition activity is instead necessary to build a climate-neutral economy, but is itself incompatible with climate neutrality, like cement production. 
  • Every financial product will quantify the sustainability risk of the managed assets, expressed in terms of returns possibly affected by the sustainability performance of the assets under management. In a planet with a changing climate, sustainability risks will be assessed by investors anyways, they will just publicly disclose it. 
  • Once the overall environmental objective has been established, the percentage of enabling versus transition activities evaluated, and the sustainability risk assessed, investment managers will have to quantify how their investments will contribute to the established environmental objective. In the good old days, pledging to reduce emissions was enough for share prices to climb, but that world is over and will never be back. Europe has taken the scientific road, and everything we claim will need solid numbers to back it up or be forever ignored.

As an investment manager, you might feel overwhelmed. And I think you should, because the industry has never seen such a massive overhaul. But here’s the thing:

Investment managers won’t bear the burden alone. Companies will do their fair share too.

By law, only large companies with more than 500 employees will be obliged to report, in accordance with the Non Financial Reporting Disclosure. But investment managers will require every company they invest in to provide detailed data about their environmental and social impact, no matter the number of their employees.

And here is the last important point you should never forget. Investment managers will have to disclose not only the environmental impact of their aggregated investments, but the separate impact of their CAPEX and OPEX. The European Commission is asking to report on the environmental impact of each and every single Euro spent. 

As of today, less than 1% of all companies issue sustainability reports. So if you own a company, you might feel overwhelmed. And again, I think you should, because you won’t be able keep up with the added workload.

Unless you make some smart decisions. 

The taxonomy forces firms to automate sustainability analyses.

What to do? An actionable timeline to surf the taxonomy

We all played dominoes when we were kids (and if you didn’t, I suggest you try, it’s worth years of video gaming). The point of the game is: the domino effect turns a small movement into a massive change for the whole system. This is happening to the european economy right now. 

So we have two choices:

  1. Keep doing things as we’ve always done, and slowly die off.
  2. Take on the challenge and put technology at the core of our business.

By the end of 2021, thousands of companies will be required to complete their first set of disclosures. Trillions of calculations will need to be performed to reach this goal, and unless european firms hire all the accountants in the world, we will never make it in time.

Over the past few months, I got convinced of one thing over anything else:

automation is the only chance to perform this humongous task.

There are tens of softwares out there, but many of them do not comply with the new taxonomy. So I want to share with you my insights and help you choose the right tools, without wasting precious time.

If you are to comply with the european taxonomy, here’s what your software should do for you:

  • Calculate metrics for all the six environmental objectives, like impact on biodiversity, water resources, air pollution and so forth. Simple carbon accounting won’t be enough any more.
  • Calculate your environmental impact based on your expenditure and not on your activities. Only a spend-based approach can separate the impact of your capital expenditure from the impact of your operational expenditure.
  • Benchmark your environmental performance with the industry average. You will need this to categorise transition activities versus enabling activities.
  • Focus on quantitative metrics and be transparent about the calculations. Your software provider should follow the greenhouse gas protocol (GHG Protocol) and the calculations should be auditable by external auditors.

As of today, Normative is the best software I know of. It really makes ESG reporting simple. The software automatically performs an environmental impact assessment of the company’s entire value chain, based on capital and operational expenditure. The calculations are fully auditable and comprise a wide range of environmental metrics, from biodiversity loss to water and air pollution.

The best thing about Normative is the amount of time it can save.

Every ESG assessment performed with Normative can save up to 500 hours of manual work, letting you focus on what really matters: your business.

If you want to be prepared for the next wave of sustainability reporting, I suggest you start assessing your impact right now. The time is ticking and software companies will be overwhelmed by requests in a few months.

To help investment managers assess their whole portfolio, Normative has a special offering ending December 31st, 2020. But it’s on a first-come first-served basis, so it might soon be over.

Now you know what you need to do.

It’s all on you.

Want to comply with taxonomy?

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