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The EU's classification system, or taxonomy, for green
investments is shaking Europe's financial sector this week, with
debates continuing to rage on the inclusion of bioenergy and
possible inclusion of nuclear and natural gas.
Marked by concessions to lobby groups after an earlier draft was
launched last year, the latest draft Climate Delegated Act was
published after the European Commission (EC) reached an "agreement
in principle" on 21 April.
The taxonomy's technical screening criteria are set out in acts
that define which investments in technologies across the energy,
chemical, waste, and other sectors can be marketed as aligned with
EU climate policy standards for adaptation and mitigation.
The act will enter force on 1 January 2022, if the European
Parliament and the EU Council do not object within four to six
months, according to law firm
Linklaters.
But climate adaptation and mitigation are just two of six
environmental investment goals set to be fulfilled by the taxonomy
regulation, so the EC now must develop acts on water, a circular
economy, pollution, and biodiversity. All acts are scheduled to be
in place, and inform mandatory financial reporting regimes under
the regulation, by January 2023.
Delays will hamper delivery on this schedule. Publication of the
Climate Delegated Act last week already represented a delay, and
the hot-button decision on including gas infrastructure has been
deferred to a complementary Delegated Act later this year. Nuclear
power's green status is also still being researched, the EC said in a Q&A on the
act.
Those working on the EU regulation, like Nathan Fabian, the
Chair of the EU's public-private panel for the taxonomy, the
European Platform on Sustainable Finance, called the publication of
the Climate Delegated Act an "achievement," but representatives of
other organizations on the panel suspended participation in protest
at the act's alleged "greenwashing."
Either way, it will be useful in supporting the EU's green
goals, first and foremost its interim 55% emissions cuts target for
2030 on the path to net zero by 2050. The 55% target is likely to be formally
approved in the next three weeks and put into legislation under
the Green Deal package this year.
For the public sector, the taxonomy regulation will be used for
delivering the EU's economic recovery from the pandemic.
The EU regulation -- including the Climate Delegated Act --
informs the rules governing the €723.8 billion ($874 billion)
Recovery and Resilience Facility, part of which is earmarked to
fund energy transitions in member states.
For the private sector, it will underpin investor-driven changes
as asset managers, investors, and the boards of companies use it to
compare their investments against green criteria that reflect the
EU's policy path.
Alongside the act, the EC published a proposal for a directive
that would address the issue of too little data being submitted by
companies and banks for investors under the Non-Financial Reporting
Directive, while expanding it to include small-to-medium
enterprises, it said.
A further measure driving investor-led greening, the new
reporting disclosure obligations under the Corporate Sustainability
Reporting Directive (CSRD), will be specified in a separate
EC-delegated act.
Financial sector impacts
Few sectors are as positive about the Climate Delegated Act as
the finance sector, which is already applying it. Two recent €500
million ($604 million) bond offerings -- Deutsche Kreditbank's
green bond in February and Austrian generator Verbund's green
sustainability-linked bond in March -- were both linked to the
taxonomy regulation.
Amid a rise in demand for ESG bonds among institutional
investors, investment firms will now use this act to identify
greenwashing and reach internal climate goals. "As firms start to
consider how they might go about implementing the requirements of
the taxonomy, the publication of the technical screening criteria
will provide much-needed clarity as to the implementation deadline
for environmental objectives as 1 January 2022 draws near," said
Daniel Nevzat, government relations manager at law firm Norton Rose
Fulbright.
The impact of the taxonomy on green finance may be far-reaching.
"Although the taxonomy regulation impacts products offered in the
EU market, in practice, given the global nature of international
finance, it will have implications for market participants more
broadly. As such, there is a risk that companies that are not
engaged with the ESG agenda will encounter difficulties in
attracting the same level of investment and financing in Europe
moving forward," said Nevzat.
Banks and pension funds have propelled green finance standards.
"Even if it remains a bit shaky due to this [gas and nuclear]
Delegated Act question, nobody can prevent good banking
institutions in the energy market and pension funds from having
certain quality labels to further ensure that they are not
greenwashing, just as the food industry does with GMO-free
labelling," said Dörte Fouquet, a legal specialist in renewable
energy and a partner at German energy law firm Becker Büttner
Held.
The book is not closed on including fossil fuels in the
taxonomy. "I think the renewable industry and the renewable finance
industry need to remain vigilant that no backdoor money is coming
in. I think it clarifies portfolios for the typical energy market,"
Fouquet added.
Tim Gore, head of the Institute for European Environmental
Policy's Low Carbon and Circular Economy Programme, said research
into the impact of bioenergy and hydrogen is ongoing and has the
potential to reverse EU support, not unlike research on biofuels.
The bioenergy debate will continue when the EU revises the
Renewable Energy Directive this summer. "There is still a lot of
tightening up to do to make sure that this will be a tool which
drives financial investment in Europe towards truly green
projects," said Gore.
The delegated act offers more useful guidance on investments
than voluntary ESG standards, say observers. "More and more people
are paying attention to the taxonomy. It is the only binding legal
instrument that expresses a binding view on the sustainability of
an asset class. I think that will gain in importance when people
assess financial investments […] It's about regulatory stability
and certainty," said Silke Goldberg, a Herbert Smith Freehills
partner specializing in energy law.
The policy stability for approved investments is a major part of
the appeal. "There are many sustainable standards for finance --
guidelines if you wish -- but for the first time, here we have the
EU saying, 'These are the investments that are sustainable, and
these others are not sustainable.' On that basis, it is a powerful
tool, not just in Europe, but I think it will also radiate beyond
the EU," she added.
But the delay on certain criteria is worrying for owners of
diverse energy portfolios. "If you then have a portfolio that has
biomass, biofuels, onshore wind, and solar -- and these are not
unusual combinations -- then having the delay is not going to be
helpful. I think regulatory clarity would be preferable," said
Goldberg.
At the same time, Goldberg said the rules will adjust to meet
changing conditions. "The taxonomy, in my view, is something that
will evolve over time, as new technologies come to the fore," she
explained.
On biomass, for example, public opinion could potentially change
as impact measurements improve, she said. "My prediction is the
taxonomy will be with us for a really long time. It will have a
significant impact in the market, but it will be evolving and not
finalized."
Gas, bioenergy wins for member states
The EC's earlier draft of the Climate Delegated Act caused a
backlash during its November consultation.
Controversy flared up as the EC was inundated with feedback from
member states and their most powerful energy groups seeking the
"green" label for local energy investments.
Lobbies in Sweden and Finland, which rely on forest biomass for
a large share of energy consumption, were successful in retaining
the label for forestry and bioenergy in last week's version of the
act. The EC's Technical Expert Group had cautioned against
including bioenergy.
The inclusion provoked a walkout by participants such as World
Wide Fund For Nature (WWF), consumer umbrella group BEUC, and NGO
Transport & Environment (T&E). WWF objected to the
"greenwashing of the forestry and bioenergy criteria" in the
taxonomy at the expense of the climate and biodiversity, it said in
a statement.
Winning horses in the energy race included hydrogen and carbon
capture, pilot-stage industries that have been given a boost in
seeking needed investment, while those failing to secure the
"green" label included agriculture and certain uses of
bioethanol.
The EC said the criteria supported hydrogen's use as an energy
carrier, storage solution, fuel, or feedstock. When it came to
whether fossil fuels or non-renewable generation could be a source
for hydrogen, criteria were "set at a level considered sufficiently
ambitious to ensure a substantial contribution to climate change
mitigation, favoring the production of hydrogen from renewable
sources," it said in the Q&A.
Fossil-fuel origin hydrogen that meets specific criteria appears
to be allowed, with a "lower GHG emissions savings requirement"
than in an earlier draft, according to a
memo from law firm Covington & Burling. But the memo noted
the EC is planning future directives and standards for renewable
hydrogen.
The latest act will make it "easier for hydrogen to be
manufactured using natural gas with carbon capture and storage or
grid energy coming from non-renewable sources," said France-based
nonprofit Reclaim Finance in a statement.
Another potential winner is gas-fired power generation, which
had been de facto excluded in a November draft but will
instead be defined by new criteria in an upcoming delegated
act.
The earlier draft applied a 100g CO2e/kWh lifecycle emissions
limit to electricity and heat generation from gas and liquid fuels.
"In November, the draft technical screening criteria had included
gas-fired power only where the lifecycle carbon emissions were
below a certain level, which would have necessitated the power
plants use carbon capture, utilization, and storage systems,"
Andrew Hedges, climate change and clean energy partner at Norton
Rose Fulbright, told IHS Markit.
"However, following the publication of technical screening
criteria, the [EC] proposed to substantially increase the CO2
emission rates for electricity production from gas, such that up to
half of EU production would fall within the taxonomy as a
transition activity. This change of position was due to concerns
about grid stability if there is too much reliance on intermittent
renewable energy generation, but was opposed by some member
states," said Hedges.
By March, the governments of Austria, Denmark, Ireland,
Luxembourg, and Spain sent a
letter saying the criteria were being loosened and warned the
EC this could lead to a "lock-in of carbon-intensive assets." A
similar argument against the inclusion of non-decarbonized gas
generation was made in a strongly-worded
letter from the Institutional Investors Group on Climate
Change.
The EC's deferral of the gas criteria decision is seen as a
potential win by the gas industry. Industry associations Eurogas,
which represents gas networks, and EUTurbines, which represents
manufacturers, generally welcomed the opportunity to continue to
make their case for inclusion. They highlighted the potential of
gas as a transition fuel in places that use coal, as well as the
potential to use gas pipeline infrastructure to supply hydrogen and
biomethane power plants.
IHS Markit Executive Director, Global Head of Strategic
Governance Advisory and ESG Christine Chow noted that some
countries face market constraints and have no choice but to
maintain their use of gas. Last year, a position paper backing the use of
gas-fired power for decarbonization was published by eight
countries: Bulgaria, Czechia, Greece, Hungary, Lithuania, Poland,
Romania, and Slovakia.
Finally, inclusion may yet be granted for nuclear power, which
received support in a letter signed by leaders of France, Czechia,
Hungary, Poland, Romania, Slovakia, and Slovenia.
Nuclear energy does not produce GHG emissions, but produces
environmentally damaging waste. The EC "might aim to harness the
taxonomy to prompt industry players to innovate and develop better
solutions for the storage and disposal of nuclear waste," said
Hedges.
Attorneys expect the EC to produce legislative proposals for
both nuclear and gas in the fourth quarter of 2021.
Posted 27 April 2021 by Cristina Brooks, Senior Journalist, Climate and Sustainability