Why saving the climate requires strict taxonomy: QuickTake


Floods, droughts and food shortages are just some of the effects of climate change, while exploitation and corruption fuel social injustice around the world. Governments tackling these problems realize that to solve them, they must first define and measure them. Some turn to so-called taxonomies that establish which economic practices and products are harmful to the planet and which are not. The idea is that the price of goods and services should reflect the human and environmental cost of production and disposal, which in turn would stimulate much-needed change. But designing code is devilishly difficult. For example, in August 2022, it was reported that a taxonomy focused on social issues had been shelved indefinitely by the Commission.

They are essentially information organization systems and form the basis of corporate codes of conduct and sustainable investment. Those that already exist focus primarily on environmental risks and are based on research by scientists supported by the United Nations. When the 2015 Paris climate agreement was reached, its nearly 200 signatories recognized that action was needed. The average global temperature is already 1.1 degrees Celsius (2 degrees Fahrenheit) higher than it was before the industrial revolution. Scientists say the limit is 1.5 degrees Celsius, beyond which lies climate catastrophe. The taxonomies provide a step-by-step guide to which activities undermine climate goals and which support them.

2. Which jurisdictions have taxonomies?

The European Union set a global benchmark with its taxonomy, which a technical group began working on in 2018. The EU has since been followed by Colombia, China, Japan and members of the Association of Nations of Southeast Asia. The UK is also working on its own version of one. Building on the work of the EU and China, the International Platform on Sustainable Finance focuses on establishing uniformity through a “common taxonomy”, which covers areas such as agriculture and the making. If definitions diverge too much, it could hamper efforts to channel finance to sustainable businesses and achieve climate goals.

3. What does the EU taxonomy cover?

Currently, it deals with climate change mitigation and adaptation. It covers 170 different economic activities which, combined, represent around 40% of EU listed companies operating in sectors responsible for almost 80% of direct greenhouse gas emissions. Four other environmental goals remain to be achieved, including biodiversity, as well as a social taxonomy in preparation. But difficulties in reaching agreement on the environmental taxonomy — in many ways the simplest of the set — seem to put at least some of those plans on hold.

4. What was the conflict?

For several years, there had been discussions about whether certain natural gas and nuclear power plants should be labeled green. The European Parliament’s vote in July to allow this at least for a while to help ease tight energy supplies – a situation made worse by war in Ukraine – has been criticized by some investors and climate activists.

5. What about other taxonomies?

Although the “E” generally receives the most attention in debates around ESG taxonomies, there were plans to also include social and governance criteria in the definition of sustainable economic activities. To some extent, social and governance-related minimum guarantees have already been incorporated into the EU’s environmental taxonomy, which includes some fundamental conventions on human rights and good corporate governance. But to establish an autonomous social taxonomy, the EU should define economic activities that are inherently socially beneficial, contribute to social goals or are socially harmful in all circumstances. Social goals include decent work for direct employees as well as workers in changing the value of a business as well as consumer welfare and contributions to inclusive societies.

6. What happened with that?

The task of defining socially beneficial economic activities has proven even more politically contentious than establishing an environmental taxonomy. Social issues are less quantifiable than environmental goals, and they include issues where there is far less consensus on the need for urgent action, compared to climate change. A first report by the European Commission outlining the main features of a social taxonomy was to be published by the end of 2021, but never came to fruition. Then, in August 2022, it was learned that in light of the deadly fights over nuclear power and natural gas, social issues were on hold.

7. Who would be covered by the environmental taxonomy?

Which businesses or commercial activities will be included and within what time frame are currently under review. Large listed companies are at the forefront in the EU, where companies, including those in the financial sector, will be required to identify what part of their business matches the lists, so that investors can direct their money to those that have the highest degree of alignment. But requiring disclosure from all companies, regardless of size, is currently unrealistic; it is too complex and costly, with the lack of data being a constant obstacle.

8. How do you know which companies are aligned?

It is difficult to calculate the share of sales, operating profit and capital expenditure eligible for alignment with the EU taxonomy. Data are difficult to obtain and financial institutions, for example, cannot use estimates. To help both investors and businesses, the EU is developing a central database of information and the IPSF has created a tool to map eligible sales, although it warns that this is not an environmental performance indicator.

A recent survey by the Network of Central Banks and Supervisors for Greening the Financial System found that of two dozen financial regulators, 20% use taxonomies and 60% plan to use one or are considering using one. Some trade organizations have warned that the regulations are so complex that there is a risk that investors will avoid companies, even weak emitters, depriving them of funding to clean up. But organizations like the UN’s Intergovernmental Panel on Climate Change warn that failure is not an option.

10. How do taxonomies work elsewhere?

There are more than 20 in development around the world, according to the IPSF, and they are beginning to diverge. The EU, for example, has established minimum social safeguards and criteria reflecting the principle of “do no significant harm”, but these are not universally used.

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