European heads of states and the European Parliament on Wednesday reached a milestone agreement that codifies the criteria for permitted carbon emissions of investment portfolios, known as the taxonomy, for universal use by investors across the Continent.
Following negotiations led by Finland's presidency of the EU Council, a classification system will be adapted in two European fund management frameworks, Undertakings for the Collective Investment in Transferable Securities Directive and Alternative Investment Fund Managers Directive, as a new regulation expected to take effect at the end of 2021.
The taxonomy will be formally included in the law in the form of a regulation by the end of December 2020, giving investors and managers more than a year to adapt portfolios.
Compiled by an expert technical group consisting of money managers, sustainable investment organizations and investors, the taxonomy outlines levels of carbon output that corporations are permitted to have, incorporating two considerations: climate "mitigation" and climate "adaptation" activities.
Under the climate mitigation objective, the taxonomy will help investors determine to what extent their portfolios align with the European Union's overall goal to reduce carbon emissions to zero by 2050, with substantial progress expected already to be made by 2030. Under the climate adaptation objective of the taxonomy, portfolio holders will also show how they are making their assets — buildings, for example — more resilient to events caused by climate change, such as the ability to withstand floods.
The "taxonomy is one of cornerstones of the EU's Green Deal," said Nathan Fabian, rapporteur of the taxonomy group for the EU technical expert group on sustainable finance and chief responsible investment officer for the United Nation's Principles for Responsible Investment. Mr. Fabian said in an interview that over time the taxonomy will help investors decide which companies to invest in.
The taxonomy, sources said, will also play a key role in the EU's forthcoming disclosures regulation, which becomes effective in July.
In its current form, the regulation will require money managers to disclose to investors to what extent their financial products and strategies marketed in Europe are detrimental to the environment or support the transition to the green economy, using the pan-European taxonomy criteria.
The agreement between the EU Parliament and EU Council also updates Europe's non-financial reporting directive, which governs corporations with headquarters in the EU. Some 6,000 listed companies will be obliged to supply information to shareholders about their carbon emissions, including carbon-exposed revenue or capital expenditures data.
Companies held in European portfolios but located outside of the European Union, which comprise, for example, equity investments, will also be expected to be contacted by managers to outline their carbon emissions, but will be obligated to disclose impact data on a voluntary basis.
Still, financial products or strategies that are not sustainable will need to be clearly marked for investors in fund prospectuses and marketing materials or presentations.
Carlo M. Funk, head of ESG investment strategy at State Street Global Advisors for the Europe Middle East and Africa region, welcomed the decision by the EU leaders to let firms "opt out" of showing how their investments relate to the taxonomy.
"It will force managers to explain (to investors) why they are not looking at sustainable investments," he said.
The taxonomy in the years to come is to be extended to four additional areas, tackling the negative impact of investments on biodiversity, water and pollution as well as progress towards a recycling-based economy. The additional components of taxonomy will be incorporated into the regulation by the end of 2021 and become effective at the end of 2022.
