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Foreign green bond investors can’t fully use EU Taxonomy: ICMA

17 February 2022 Cristina Brooks

A global investor group voiced its concern that European companies and financial institutions will not submit complete reports as required under the 2020 EU Taxonomy regulation.

A paper by the Switzerland-based investor trade body, the International Capital Market Association (ICMA), says investors and companies will be unable to fully use the EU Taxonomy and its delegated acts that specify which sustainable investments are in step with the EU as it moves towards carbon neutrality.

Without changes to policy, investors will be "seriously impaired" when they try to label investments as green under the EU Taxonomy regulation, and foreign investors' portfolios may look less green than they are.

At the same time, the ICMA confirmed an issue that NGOs have previously reported: that certain proposed criteria for gas-fired power plants create a need for grandfathering of investments.

Using the criteria in the regulation to grade the sustainability of investments, investors such as European financial institutions and companies are required to make disclosures about the turnover, capital spending, and operating expenses of green products they finance.

Prior to this, they used the ESG financial reporting mechanism known as the 2018 Non-Financial Reporting Directive (NFRD), which captures 11,000 companies in Europe.

The NFRD is set to be replaced by the Corporate Sustainability Reporting Directive (CSRD) and EU Taxonomy regulation, which will expand reporting requirements to around 50,000 companies, while asset managers and financial advisors will be caught by the Sustainable Finance Disclosure Regulation (SFDR).

Member states will also have to align the green financial products they issue to the EU Taxonomy rules.

Data issues for international investors

Investors caught by these regulations must report on how "green" their green investments are, but problems lie ahead for all those filing data under the rules.

The hurdles were originally outlined in reports by the UN-backed investor network Principles for Responsible Investment, the UN partnership UNEP FI, as well as in academic, trade body, and public sector reports.

For example, they must present data showing their green investments align with the EU Taxonomy principle, do no significant harm (DNSH), which outlines specific criteria each kind of investment must meet, and also submit data showing how it makes a substantial contribution (SC) to EU objectives.

But almost every investor in existing green bonds still struggles to report the bonds' alignment with the DNSH due to a lack of "granular data at project/use of proceeds-level," and a similar issue plagues the SC criteria, according to the ICMA.

The scarcity of data on investments means companies, for example, risk submitting incomplete disclosures where data is not available. Likewise, banks and big asset managers may struggle to make complete filings on their "green assets" as a share of its total assets, under a reporting requirement called the Green Asset Ratio.

This is especially the case where EU companies are trying to classify the green activities of their non-EU businesses.

For example, European banks that provide foreign direct investment will not be able to affirm that it aligns to the EU Taxonomy's green criteria if the investment is in a country that does not use criteria based on European regulation such as labeling and certification schemes.

This is a problem as the EU is "the world's main provider and destination of foreign direct investment," according to ICMA, with €9 trillion (about $10 trillion) at the end of 2019. Without better guidance, EU Taxonomy standards won't be used for these investments, ICMA said.

"Ambition," but risk for gas-fired-power criteria

At the moment, a controversial piece of legislation, the Climate Delegated Act (CDA) of the EU Taxonomy, is being mulled by European Parliament, which gives further investment criteria.

The European Commission proposed the CDA, which provides a green label for certain power sector investment criteria for "transitional" technologies, earlier this month.

It has proven a hot-button issue, with Germany, Austria, and Luxembourg threatening legal action over the inclusion of nuclear power. On the other hand, a group of 12 EU countries released a statement saying they wanted nuclear energy included in October.

The CDA also defines criteria for sustainable investment in natural gas-fired power that expire in 2030.

While the controversy seems unlikely to prevent the CDA's passage through European Parliament, the outcome is not certain, according to an IHS Markit report on the EU Taxonomy.

The ICMA said believes that changing criteria for "transitional" power generation, such as natural gas-fired power, means "the bar of ambition for the required environmental performance, where applicable, is set high."

But it has warned that it may cause investors to hesitate to issue or invest in related EU Green Bond Standard designated bonds as their backers might force them to sell the bonds when the activities cease to be EU Taxonomy-aligned.

ICMA said EU lawmakers must ensure that the EU Taxonomy regulation makes it clear that grandfathering is acceptable, as it is in the EC's proposed EU Green Bond legislation, and that criteria at the time of issuance of a bond stay in place for the life of the bond.


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