EU taxonomy act embraces hydrogen, delays call on nuclear, gas

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