The EU taxonomy for sustainable activities, which came into force in July 2020, introduced a classification system for investment activities in a bid to tackle ‘greenwashing’ and help investors make more environmentally friendly choices. The disclosure regime at the heart of the taxonomy’s implementation comes into effect in January, and managers now face a huge data burden and a level of uncertainty that is putting many off taking action.
Valeria Rosati, a senior partner at Vantage Infrastructure, says the danger is that many infrastructure fund managers will approach the taxonomy as a compliance burden rather than an opportunity to change the conversation on sustainable investing. “When the taxonomy was established and the draft rules were published, we felt that the majority of the manager community saw it as a burden – simply more regulation and more disclosure obligations,” she says. “The way we approached it instead was as an opportunity, because we focused on its objective, which is to encourage capital to flow to where it can make a positive impact by empowering investors to make informed decisions.”
Although the taxonomy is especially relevant to infrastructure managers, because so many of the activities that meet the ‘mitigation’ environmental objective are infrastructure plays, putting it into practice is not easy. Vantage embarked on an early pilot programme, putting in place tools and protocols, and encountered plenty of teething problems. That is not the only thing putting managers off embracing the new approach.
“Consultants tell us the number of managers focused on this is small at the moment,” says Rosati. “There are two challenges behind that. First is the fact that the EU taxonomy is potentially expanding, so there is uncertainty putting people off being too proactive. We have taken a different view – we’ve developed a tool for what we have and if the remit changes, we will go back.
“The second thing is about other countries and other regimes. There’s a general level of concern about the variety of standards that managers now have to report against, and some global managers would rather wait for the dust to settle and figure out what applies.”
The EU published proposals in August to extend the taxonomy beyond climate change to include classifications for companies contributing to other environmental goals, such as biodiversity and the circular economy.
At the same time, there is a growing recognition that the EU taxonomy affects all investment managers marketing to EU-based investors, wherever those managers are based, and that other global regulators might follow a similar path with their own taxonomy regulations.
Paul Ellison, a partner specialising in funds regulation at Clifford Chance, says: “Certainly, the EU taxonomy is having some influence on the requirements in other jurisdictions. It’s picked up quite a lot of interest beyond the UK and Europe, and that is having an impact on the narrative about global ESG standards and developing regulation in different countries.”
“The EU taxonomy is potentially expanding, so there is uncertainty putting people off being too proactive”
For now, Ellison says the publication in March of the draft technical standards – which set out the precise methodology firms will need to apply when making sustainability disclosures – has moved implementation on considerably among managers. The final version of those rules should be published before the end of the year, so that disclosures can start next year.
“In March, firms were able to take their principles-based approach and start to grapple with the granular nature of the data that they need to collate,” says Ellison. “At the moment, although the technical standards remain in draft form, we are seeing a lot of managers considering launching Article 8 and Article 9 products that will make disclosures in accordance with the obligations going forward. But obviously there’s still uncertainty around some of the detail.”
Foresight Group recently announced the final close of Foresight Energy Infrastructure Partners. The sustainability-led energy transition infrastructure fund has more than €800 million of commitments and is one of the first fully validated EU taxonomy-compliant sustainable investment funds. Its first two acquisitions were assessed by third parties and deemed to be in line with all the criteria required to validate them as sustainable under the taxonomy.
Henry Morgan, sustainable investment manager at Foresight, says: “Our approach was that we know we are really closely aligned with the taxonomy across the vast majority of our infrastructure portfolio, but we didn’t want to be accused of marking our own homework. We didn’t have a way of demonstrating that in a robust fashion. But because FEIP reached a first close at the same time as the taxonomy was coming to prevalence, with every acquisition it makes, we seek external validation.”
He agrees that the taxonomy is something of a moving target: “There’s just this constant challenge to stay compliant with the changes. Our approach has changed continuously, rolling with the changes in the taxonomy itself.”
For infrastructure, Ellison points to two challenges around implementation. The first relates to the practicalities around data collection, particularly for assets in other parts of the world where it may be difficult to apply EU standards or there may be a reliance on proxy data.
“The other challenge is perhaps in the nature of some of the assets,” he says. “While solar panels or wind farms may be easy to categorise as promoting environmental objectives, others may be harder to take a view on and different investors may think about them in different ways.”
One example would be financing for a new fleet of diesel trains to connect remote communities to public transport for the first time.
Rosati says her firm has encountered complications: “Sometimes you don’t have all the information you need, and where the information is not complete, there are judgements to be made. If you’re looking to make an investment that is EU taxonomy-aligned and conducting a due diligence phase assessment, you have to look at the information gaps and ask whether that information will become available later, how you can make it available, and whether it will actually even tick the boxes when you do get it.
“Even within a taxonomy-aligned sector, you might find a company doesn’t meet all the tests, so then you have to think about that pathway and start making assumptions.”
It will be some time before we can tell the extent to which the taxonomy will be a game changer in sustainable investing. “It already is a game changer in terms of driving forward the agenda,” says Morgan. “Investors, be they institutional or retail, are really under pressure to ensure they are investing people’s money in a more responsible, sustainable fashion, and the taxonomy is critical in giving investors and investment managers the guidebook to achieving sustainable investment.
“As capital moves towards responsible investing, this will help achieve that shift quickly by taking the objective thinking out of the process. Once investors have decided they want to invest sustainably, the taxonomy will help drive capital towards those sectors at a rate of knots.”