Consistent, specific and precise data is the key to understanding how a company is performing. This is not as easy as it should be when one looks at sustainability, and is currently one of the principal hurdles in the greater uptake of ESG investing.
Simply put, if people don’t know how to compare different companies’ environmental performance then there is always the risk that people will be comparing apples with oranges. With a plethora of standards and labels developing at present, this risks creating confusion as we all try to keep up with different developments creating different data reporting requirements.
With this background, it’s important to note that there is a major move in the EU to create a consistent taxonomy designed to help clarify what economic activities can be considered as environmentally sustainable and which will be integrated into legislation. A first draft is due Q1 2019. Article 3 of the Taxonomy regulation proposal sets out the criteria for determining the environmental sustainability of an economic activity, in line with six environmental objectives:
- Climate Change Mitigation
- Climate Change Adaptation
- Sustainable use and protection of water and marine resources
- Transition to a circular economy, waste prevention and recycling
- Pollution prevention control, and
- Protection of healthy ecosystems.
Look past the European legalese and the acronyms, and you’ll see a concerted effort within the EU to solve the apples and oranges problem. A central part of this is creating a system in which definitions give greater certainty to the data being examined, and provide a basis for harmonizing standards and labeling schemes in this area.
This sentiment is to be applauded, but how it develops is another matter. There is a risk that the definitions become unwieldy, and that this could become a “tick box” exercise rather than a flexible regulatory device that evolves over time. We are supportive of the sentiment but concerned about the practicalities, and we’re not the only ones.
Earlier in the year. when the EU Commission announced its plans in this area, a CFA Institute poll of EU investment professionals showed “little support for an EU-level ESG taxonomy of ESG activities: 35 percent were in favour of a voluntary taxonomy and 24 percent would support a mandatory taxonomy”.
We agree with Alexander Barkawi, who said that “… we need a perspective of things that has a continuum. For example, with credit risk ratings, this is not a binary 1 or 0 analysis. This gives us a range from triple A to junk. This is exactly what we need in the sustainability world and, on top of this, we need [environmental analysis] to be integrated into mainstream credit risk assessments.”
The UN-backed Principles for Responsible investment have provided a good summary of the aims and intent here, noting that “the sustainability taxonomy will, in time, become embedded in EU legislation … (and) policy makers in markets outside of the EU will observe the EU’s sustainability taxonomy to inform evolution of their own taxonomies.” There is still time to provide input to the European Commission on this, and a number of organizations are doing so.
