Ruling by taxonomy

The EU intends to tell the world what is green. This is a power grab that may work if the recent GDRP initiative is taken as an example. Here the EU is pushing for a much needed taxonomy in all things green.

Like most economic players, the EU has long promoted a strategy of sustainable growth without assigning a clear definition to it, being instead guided by the general principle of a necessary greenhouse gas emission reduction. This is about to change, as the European Commission has eventually agreed on so-called “green gold standards” to harmonise its member states’ practices. This will be the first of its kind with far-reaching consequences in the fight against “greenwashing” and wrongly-labelled financial products.

The work on a taxonomy for long-term economic activities at the EU level started back in March 2018 with the disclosure of its Action Plan for Sustainable Finance. It is supported by a panel of financial experts and public bodies (big Financials like Allianz and Nordea are part of it) which helped define classifications and recommendations.

The EU sustainable economic activities taxonomy aims at better aligning financial flows with the unavoidable transition in order to achieve the EU goal of carbon neutrality by 2050. It will be a key component of the EU “New Green Deal” that Ursula von der Leyen is keen to implement (estimated at more than $1tn). The taxonomy has been developed to be applied to all kinds of investments and also directly to big companies (with more than … 500 workers).

Under the EU taxonomy of green investments, technical criteria have been set to assess as sustainable the activities that make a “substantial contribution to climate change mitigation”, while causing “no harm to other environmental objectives”. Among economic activities that will fall under this green classification one will find those that make a substantial contribution, those that are in transition and those classified as “enablers”.

Source: EU Taxonomy Technical Report, Page 33 (June 2019)

As always with the EU, discussions have been running until the very last minute to find a consensus. Arguments were mainly about whether banks and financial services companies should classify all their products according to the new taxonomy or only the ones that they market as sustainable. Another moot point was about the exclusion of gas (particularly important for the German energy transition and not so green) and nuclear (important for Paris) in the green taxonomy as part of either “enabling” or “transition” activities, because of the “no harm” principle. Eventually, the last requirements for an activity to get its taxonomy passport include Minimum Social Safeguards to be respected.

Data availability and reliability questioned

The report finally puts the stress on the data available for investors, highlighting that most of the environmental data are re-worked figures. It encourages companies to adopt new reporting standards, chief of which is to break down revenue/expenditures by their exposure to carbon-intensive or green activities.

Carbon intensity metrics (notably per unit of electricity generated or per unit of output) will be key technical criteria in this new EU taxonomy. Still, among the 13,500 largest companies, “only 12% of companies disclose scope 1 and 2 for all operations in a standardised satisfactory manner, with an extra 8% in a sufficiently workable way”, the Commission found.

Within the AlphaValue coverage (462 large European capitalisations), 70% of companies do report CO2 Equivalent Emissions (Scope 1 and 2), 60% their total waste, and 60% their annual water withdrawal (based on 2018 reporting). Monitoring trends for these negative economic externalities by company is still a high-wire exercise as missing data is the norm and reported figures are subject to massive swings and sometimes massive revisions in what is nothing but discovery work in progress.

To avoid the traps of exclusion, environmental metrics are set against capital employed before being tested on trends. Screening for stocks that experienced substantial improvements over the past four years: ASML, EdenRed, London Stock Exchange and British American Tobacco score the highest. 

In terms of carbon, water and waste intensity, in relation to their level of capital employed, these stocks appear to be doing much better than their sector peers. At least up to the next set of data.

Best stock by sector in respect to carbon, energy, water and waste emissions trends (against capital employed) :

The EU Parliament and member States still have to endorse the agreement.

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