Introduced in 2020, the EU Taxonomy serves as a comprehensive guide that defines which economic activities within each sector can be considered environmentally sustainable. As of 2023, companies with over 500 employees, as well as investors, are required to report their alignment with the taxonomy. This reporting clarifies the extent to which a company, project, or investment portfolio aligns with the EU Taxonomy, providing a measure of its environmental sustainability, or how "green" it truly is.

Criticism

The lawsuits the European Commission is now facing are a clear sign that the Taxonomy is – at least in the perception of several stakeholders – not (yet) delivering on its intention. The first lawsuit, filed by a coalition of NGOs, challenges the EU’s 2030 carbon emission targets, claiming that the latter must be ramped up to bring them in line with the 1.5°C goal of the Paris Climate Agreement. The second lawsuit directly concerns the Taxonomy and claims that the sustainable finance criteria are flawed as it labels polluting investments, such as new planes and ships, as green. This would encourage banks and pension funds to continue investing in a fossil fleet instead of in real climate solutions.

A catalyst for sustainable finance

The EU Taxonomy is part of the European Green Deal, a comprehensive strategy aimed at transforming the EU into a modern, resource-efficient economy where there are no net emissions of greenhouse gases by 2050. The Taxonomy serves as a tool to guide investors, companies, and policymakers in identifying sustainable economic activities that align with the EU's environmental objectives.

To be classified as sustainable under the Taxonomy, an activity must contribute to at least one of six objectives:

  1. Climate change mitigation
  2. Climate change adaptation
  3. Sustainable use and protection of water and marine resources
  4. Transition to a circular economy
  5. Pollution prevention and control
  6. Protection and restoration of biodiversity and ecosystems

Moreover, the activity may not significantly harm any of the other objectives, must meet minimum social safeguards, and comply with technical screening criteria that are continuously updated.

To meet the Taxonomy’s criteria, companies are encouraged to innovate and develop new technologies, processes, and products that reduce environmental impact. This can lead to more sustainable business models and practices and encourages companies to integrate sustainability into their long-term business strategies. The Taxonomy therefore not only helps companies minimise their environmental impact but also supports their transition to more resilient and future-oriented business models.

Criticism of the EU Taxonomy is not new. Already since its introduction, it has been facing headwinds. A major criticism is the inclusion of controversial sectors, such as nuclear energy and natural gas as sustainable. Whereas, important economic activities that can potentially be green, such as agriculture, are not yet in scope of the framework. The debate over these topics has been intense and highly political, demonstrating the complexity of creating such a comprehensive sustainability framework.

“Given its current limitations, we do not steer on maximising the Taxonomy alignment of our portfolios.”

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Moreover, the global nature of financial markets means that the success of the EU Taxonomy also depends on its ability to influence and integrate with similar frameworks in other regions. From our experience so far, some criteria are hard to apply outside the EU because of different standards. In addition, data is not always available and collaborating with other lenders may complicate the data collection process.

The private investor perspective

Even though the taxonomy is not the holy grail, current legislation treats it is such. Before they are ‘allowed’ to invest, retail investors must state their sustainability preferences. Similar to establishing the suitable risk profile of an investor, these questions aim to identify a client’s sustainability motivation and pair it with a suitable investment portfolio. One of the questions concerns clients’ desired level of taxonomy alignment of their portfolio. In case the desired level of taxonomy alignment cannot be offered, clients must adjust their input or are informed there are no suitable investment options available. It is questionable, however, if private investors know enough about the taxonomy and realise what its limitations are. For example, a higher Taxonomy-alignment percentage does not necessarily mean more sustainable. Private investors therefore need more support when building a sustainable investment portfolio.

Valuable but imperfect

The irony is that the Taxonomy aims to eliminate greenwashing and to direct more capital towards sustainable projects that contribute to a greener, more resilient European economy. Yet it also provides a carte blanche for greenwashing by labeling certain activities sustainable that according to science are not sustainable at all, thus lowering the bar for harmful companies to get ‘approval’.

Nikkie Pelzer, impact manager

As an impact investor, we support the intention of the EU Taxonomy and acknowledge its potential to be a trailblazer in sustainable finance and in greening Europe. We only invest in companies that contribute to making our society more sustainable. Our assessment of investment opportunities with an environmental objectivetakes the Taxonomy into account and we stimulate companies to align their operations with the Taxonomy. However, given its current limitations, we do not steer on maximizing the Taxonomy alignment of our portfolios:

  • We exclude investments in activities we do not, but the Taxonomy does consider sustainable, such as natural gas and nuclear.
  • And vice, versa, we invest in activities we consider environmentally sustainable but that are not (yet) covered by the taxonomy.
  • Moreover, we invest in companies with social objectives, which are not in scope of the current Taxonomy framework.
  • And there where the Taxonomy criteria prove difficult to assess, for example in emerging markets, we leverage on other assessment methods to determine the sustainable potential of an investment.

All in all, the Taxonomy certainly is an important step towards a standardised framework for environmental sustainability. In pursuing and assessing broader impact opportunities around the world, however, it should be used with caution and flexibility. At Triodos Investment Management, we continue to invest in activities that promote an environmental objective, regardless of the Taxonomy’s limitations.

Rosl Veltmeijer, portfolio manager

This includes investments in organic farming and clean energy projects in emerging markets. It also includes start-ups that provide solutions critical to building a resilient, future-proof electricity system in Europe but are not yet able to assess their own taxonomy alignment or may lack the necessary policies due to their early-stage nature and small scale of the organisation.

In the meantime, we continue our lobby for further improvement of the Taxonomy and support initiatives that aim to embed the science-based perspective, such as the Independent Science Based Taxonomy (ISBT). Time will tell if the EU Taxonomy indeed proves to be the key to unlocking a greener, more resilient European economy and to achieving the 2050 climate-neutrality target.