EU eyes harmonizing data for low-carbon goal

Pension funds are engaging with investee companies to secure environmental data that they will need to meet their own requirements under an upcoming European disclosure regulation.

The European Union currently is working to redirect private capital toward low-carbon investments, setting a broad goal that calls for asset owners and money managers collectively to invest €175 billion ($199 billion) to €290 billion a year in low-carbon activities to reduce net carbon emissions to zero by 2050.

To help asset owners and managers meet that goal, the European Commission released results June 18 from an expert working group that set out a detailed taxonomy — a classification system — for evaluating how sustainable a particular corporate activity is for the environment.

Corporate activities considered contributory to climate change mitigation could either be direct, through, for example, phasing out fossil-fuel-based power generation or through transitional activities, such as installing efficient boilers in buildings.

The taxonomy report from the working group has three main themes:

• A list of environmentally sustainable activities to guide companies and investors in their transition to a low-carbon economy.
• Guidance on how proceeds from green bonds should be invested by the issuer so that investors can clearly identify the climate mitigation benefit.
• Minimum standards for ESG or sustainable benchmarks to reduce the possibility of so-called greenwashing — making misleading or unsubstantiated claims.

The taxonomy report focused only on carbon activities but will later be expanded to five more areas, including water and waste management. The carbon taxonomy will be refined before the end of the year by the working group, which is set to develop further guidance on how to use taxonomy criteria before the commission can implement it into existing EU law.

In the taxonomy report, a wide range of activities were evaluated, including the manufacturing of plastics and fertilizers, and, for example, the activities of companies engaged in mining, construction and transportation. Under the upcoming EU disclosure rules, investors expect to be required to identify if any activities of their investee companies are permitted under existing or future EU law, verify if these activities meet taxonomy criteria and calculate if their investments align with taxonomy thresholds of how much carbon output a given activity can have. To achieve that, investors must engage with companies and have them measure the carbon output of their activities.

Pension fund executives will be on the hook to report their portfolios' environmental, social and governance impacts as part of the EU's disclosure regulation, expected by the market to take effect in the next 12 to 15 months. And they recognize that producing information about their holdings' exposure to carbon poses challenges even with the new taxonomy system.

Investors warned that investee companies might not able to explain how and to what extent their revenues are derived from carbon-intensive activities or if their supply chains could be harming the environment. Sources also noted existing information supplied by data providers is not always relevant.

"Data is difficult — the consistency between data providers, different methodologies (for creating ESG ratings) and both the availability and timeliness of the underlying information," said Mark Walker, London-based chief investment officer of Coal Pension Trustees Services, which manages £21 billion ($26.7 billion) in assets of the Mineworkers' Pension Scheme and the British Coal Staff Superannuation Scheme.

"For example, in the past, I recall a discussion about a British company that could have been excluded because a part of its business related to a compound potentially used in chemical weapons, only to discover there was no military use for products of the company derived from this compound and it generated an extremely small part of the company's revenues," he noted.

Ole Buhl, vice president and head of environmental, social and governance at the 785 billion Danish kroner ($119.5 billion) ATP, Hilleroed, Denmark, said the fund supports the taxonomy.

"In our view, the taxonomy is of great importance as far as forming a common language about green investments. At the moment, we see 50 shades of green when all we need is one and the taxonomy is providing just that."

Still, Mr. Buhl added: "For the taxonomy to work in practice, investors need to have data from companies on how their activities match the taxonomy — producing this data will be a real challenge.

"We need to be asking companies how their activities generate a positive impact. At the same time, we will be asking if their activities are generating a negative impact."

In turn, investors are engaging more with investee companies on how they plan to move their businesses to a low-carbon economy to deliver the data required when the disclosure regulation takes effect.

ATP is eager to see public reporting on what is being financed from green bonds' proceeds as its €2 billion green bonds allocation is set to increase. ATP did not disclose its target green bonds allocation.

"We are starting to have a dialogue (with issuers) about how we can make their reporting more transparent and how they (plan) aligning with taxonomy," Mr. Buhl said. He noted that the fund planned to share that information with its beneficiaries.

In the Netherlands, all Dutch investors, pension funds and managers are collaborating to standardize how information will be requested from the companies to lessen the collective burden on investee companies. "Under taxonomy, investors need to know what proportion of revenues is green and to break down the impact of all the other revenues," said Brenda Kramer, adviser for responsible investment at PGGM, the manager of the €216.6 billion Stichting Pensioenfonds Zorg en Welzijn in Zeist, Netherlands. Ms. Kramer also is a member of the expert group that issued the taxonomy advice to the European Commission.

"If you standardize (how you) request data that you need from companies, the more likely you can harmonize the market under the regulation," Ms. Kramer added.

A number of other European investors including the €419 billion Stichting Pensioenfonds ABP, Heerlen, Netherlands, Legal and General Group PLC, BNP Paribas Asset Management and Hermes Investment Management in mid June signed an agreement in Vatican City with 13 large energy producers, under which the corporations pledged to deliver meaningful and financially material information about the steps they are taking toward energy transition. Additionally, big global investors such as BlackRock Inc., Vanguard Group Inc. and the $226.1 billion California State Teachers' Retirement System in West Sacramento also signed the agreement.

Kirsty Jenkinson, director of sustainable investment and stewardship strategist at CalSTRS, said the pension fund has been working to get companies to use Sustainability Accounting Standards Board Foundation standards to provide financially material information.

But Ms. Jenkinson said the big push results from all investors realizing that by coming together they can encourage better disclosures and that there can't be a different set of disclosure standards in Europe vs. in the U.S.

Still, she said: "We are at an early stage even though we are moving at a fairly dramatic speed."

"Investors are not going to get perfect information the first time around but companies are getting more exposed to what they should think about, how they should understand carbon readiness or physical risk," she said.

One money manager said that as global awareness of how climate change can affect corporate performance has grown, the issue has moved onto the radar of senior management.

"There has been increasing talk of future mandatory sustainability disclosure, primarily on climate-related matters, driven by central banks, the EU and various national regulators," said Vladimir Demine, head of ESG research for the international equity team at Morgan Stanley Investment Management in London. "We believe CFOs have started to actively think about it."