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Article from ESG Clarity: UK green taxonomy has chance to get 'do no harm' principle right - ESG Clarity

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UK green taxonomy has chance to get 'do no harm' principle right - ESG Clarity GTAG says user issues with the do no significant harm principle in the EU taxonomy can be improved upon in the UK taxonomy View this on ESG Clarity >

The GTAG has set out several recommendations to ensure the DNSH assessment can be executed effectively and improve the ability of the UK taxonomy to stimulate sustainable investment.

In summary the GTAG recommendations for the UK Taxonomy:

o   Start by explaining the purpose of, approach to and definition of DNSH under its taxonomy. This will help investors and make it easier to make different jurisdictions taxonomies compatible (>29 sustainable taxonomies at present).

o   Prioritise quantitative thresholds for DNSH criteria, provide detailed justifications for the use of qualitative criteria.

o   Move away from binary approach to DNSH criteria, adopt reporting that would enable companies with activities that are not fully taxonomy aligned, however meet substantial contribution and some DNSH criteria – disclosure extent to which they meet it.

§  Current EU taxonomy – activities that don't meet all of the DNSH criteria are classified as not-aligned without any nuance. UK approach proposed would allow firms to explain which criteria are not met and why. Allow them to flag planned remediation efforts or data gaps.

§  At present some entities with predominantly 'green' portfolios (theoretically should have high levels of alignment) end up with low levels of alignment due to DNSH under EU Taxonomy. May lead to misdirected capital flows.

What would you like to see from the new Taxonomy?

What are you pain points from the EU Taxonomy?

Would love to hear your thought.

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Francesca Wheble
Responsible Investment Analyst
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Thank you for sharing, Francesca! Looking forward to the release of the UK Taxonomy.

The allowance for partial alignment with Taxonomy contradicts the main purpose of Taxonomy, which is to classify activities into environmentally sustainable and not. The answer to the question "Is this economic activity environmentally sustainable?" should be clear "Yes" or "No" but not "Yes, partially". Partial alignment creates ambiguity. CFA Code of Ethics or Asset Manager Code of Conduct, or GIPS do not allow partial compliance. You cannot claim "I am partially ethical". But for some reason partial Taxonomy alignment will allow to claim "I am partially environmentally sustainable but sometimes I do significant harm". I believe that a rigid approach of EU Taxonomy should remain.

The argument that some entities with predominantly 'green' portfolios end up with low levels of alignment due to not meeting DNSH under EU Taxonomy seems to be weak. If portfolio companies do cause significant harm, they should not be labeled as green (or at least I could not find a reason why they should be). If investors want to know "potential" alignment with Taxonomy if all the DNSH or SC TSC were met, then they can look at the Taxonomy eligibility ratios. Taxonomy eligibility will provide good insights into the proportion of assets that actually should be aligned but for some reasons aren't. 

I do agree, however, that some portfolios may have low Taxonomy alignment because not all of the economic activities are covered by the Taxonomy. For example, portfolios with large exposures to sustainable agriculture will have both low eligibility and alignment because agriculture is not included in Taxonomy. But this problem will be eliminated over time as more economic activities are added to Taxonomy.

Finally, it is not clear how to quantify partial alignment. If you do not meet one DNSH out of five, are you 80% aligned or 90% or some other figure? 

Regarding EU Taxonomy pains, I have had a lot but will mention just a few.

1. It would be great to have a better guidance on the preparation of reporting templates. The EU Taxonomy Disclosure Delegated Act does not provide sufficient guidance on reporting. For instance, credit institutions should separately report exposures to derivatives, sovereigns and trading book. But what if you have sovereign exposures in trading book. Will you report it as sovereign exposure or as trading book exposure? 
2. Investment firms and insurance companies have two sets of Taxonomy alignment KPIs. It is not clear which one to use for assessing alignment of exposures to insurance companies, for example, that report two Taxonomy alignment KPIs.
3. There is no guidance on netting of long and short positions. 
4. Data: it would be great to have one, publicly available data base that collects all the environmental data across countries (at least across the EU). 

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Anastasia Kuznetsova
Associate Business Analyst
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