Twenty-fourth Report of Session 2019–21 Contents

6Green finance: the EU’s Sustainable Investment Taxonomy (update)24

This EU document is legally and politically important because:

  • it creates a new EU framework for the assessment of the environmental sustainability of any given economic activity. From the Treasury’s latest update, it is still unclear how the Government intends the Taxonomy to operate under domestic law beyond the end of the post-Brexit transition period at the end of 2020.

Action

  • The Committee intends to consider the implications of the Taxonomy further in light of any Statutory Instruments introduced by the Government to amend the legal framework as it operates under UK law.
  • Draw the information the Treasury has provided on the UK’s implementation of the Taxonomy to the Environmental Audit Committee and the Treasury Committee.

Overview

6.1In April 2020, the EU agreed a Sustainable Investment Taxonomy Regulation,25 a new statutory classification system that will be used by European financial institutions, investors and regulators to determine whether a particular economic activity contributes substantially to one of six high-level environmental objectives, such as climate change adaptation or pollution prevention26 (to establish, in turn, the degree to which investment in that activity could be considered sustainable and conducive to that objective, as an aid to environmentally-conscious investors).27 It is part of the EU’s wider Sustainable Finance Action Plan.

6.2As we set out in our Reports of 6 May and 1 July 2020, the core features of the new Regulation require the 27 EU Member States to use the Taxonomy as and when legislating for “any measures setting out requirements [for] […] financial products or corporate bonds that are made available as ‘environmentally sustainable’”, for example when introducing a statutory ‘green bond‘ label.28 In addition, it will require financial companies that sell investment products in the EU to either make regular disclosures to investors about the extent to which their products can be considered ‘sustainable’ under the terms established by the Taxonomy, or include a disclaimer that a particular investment product does “not take into account the EU criteria for environmentally sustainable investments”.

6.3The European Commission is due to publish the first detailed screening criteria that will be used to determine whether an economy activity contributes to one of the six high-level environmental objectives, in stages, from December 2020. The obligations on Member States and financial market participants as described above will only take effect from January 2022 onwards, when those technical rules are in place. Until that time, the practical effect of the Regulation is unclear.

6.4More generally, given the UK’s withdrawal from the EU, there is uncertainty about the application of the Taxonomy under UK law. In spring 2020, we asked the Treasury to clarify if the Government would take the EU’s new system for classifying investments by sustainability as a model for a future UK approach after the transition period ends. In his reply of 28 May 2020, the Economic Secretary to the Treasury (John Glen MP) clarified that the requirement for any statutory green finance schemes to take into account Taxonomy’s six high-level environmental objectives, and how those are defined—would apply from July 2020. Because of the provisions of the European Union (Withdrawal) Act 2018, he said this “effectively means that the UK will retain the framework for the taxonomy” in its domestic law at the end of the transition period.29 However, as noted, the disclosure obligations for financial market participants, which are only due to take effect from 2022, will not form part of retained EU law when the transition ends. Similarly, the requirement to apply taxonomy to statutory labels will only be effective from that point. Therefore, the practical effect of the elements of the Regulation that will form part of retained EU law when the transition period ends appears to be very limited.

6.5As regards the broader policy choice of whether to retain the general Taxonomy under UK law in the longer term to provide a framework for both green finance labels and disclosure requirements, the Minister added that before the detailed implementation of the EU’s new framework—the detailed screening criteria to determine to what an extent an economic activity contributes to one of the high-level environmental objectives—is made public by the European Commission, the Government “cannot comment at this stage on the extent to which we [the UK] will align with the EU after the [transition] period” (our emphasis).30 In our subsequent Report in July 2020 we noted that:

6.6We therefore wrote to the Minister to seek clarification on the nature of the ‘alignment’ under consideration, and in particular whether the issue of the UK operating something akin to the Taxonomy has been raised, or is likely to be raised, in the context of discussions with the EU on ‘equivalence’ for financial services. We also asked the Minister to alert us when the Government has decided its policy with respect to the future of the Taxonomy, and lays any Statutory Instrument to amend the Taxonomy as it applies under UK law beyond the end of the transition.

The Government’s position

6.7The Minister replied to our latest queries on 29 September 2020. His letter failed to provide meaningful answers to our questions. While noting that the UK played “a leading role” in the development of the Taxonomy, which would help ensure “a globally consistent and ambitious approach to sustainable finance”, he provides no further substantive information on the Government’s intentions with respect to its functioning under UK domestic law beyond the end of the transition period.

6.8The Minister only confirms that the Government “will be on-shoring the taxonomy framework as part of our obligations under the EU Withdrawal Act […] and intends to lay a statutory instrument to make the appropriate amendments to the regulation to ensure it operates in UK law”. The Government, he says, is “committed to matching the ambition” of the EU’s Sustainable Finance Action Plan, including the Taxonomy, “but will also ensure that any standards we adopt are appropriate for the UK”. The Government will set out further details on its approach to Green Finance standards beyond the transitional period in due course.

6.9The Minister does not refer to the potential ‘alignment’ with the EU Taxonomy (based on the European Commission’s forthcoming detailed screening criteria in the longer term) in his latest letter, as he had done in his previous correspondence with us.

Action

6.10As noted, it remains unclear what the effect of the EU Taxonomy Regulation under UK domestic law will be from 1 January 2021, given that the key operative parts—the obligation to apply the Taxonomy to any statutory green finance labelling schemes, and the disclosure requirement for financial market participants—will not be retained as UK law because they are not in effect when the transition period ends.

6.11In addition, while the Minister has confirmed that the Government intends to lay a Statutory Instrument to “make the appropriate amendments to the regulation to ensure it operates in UK law”, he has not shared any further information on the Treasury’s preferred approach.

6.12It follows that it is not possible at this stage to determine how the EU’s Sustainable Investment Taxonomy might be applied to statutory green finance” schemes or financial market participants in the UK beyond the end of the post-Brexit transition period.

6.13Given these uncertainties, the Committee has decided to keep the EU’s Taxonomy Regulation under consideration and to seek further information from the Minister in due course with respect to the practical implications of the elements of the Taxonomy that will form part of retained EU law as amended by any future Statutory Instrument. We remain interested in particular in any obligations this will impose on the Government and financial market participants. We also intend to follow up with the Minister with respect to the potential for continued alignment” with the EU with respect to classification of sustainable investments over the longer term.

6.14Given the previous reference to the possibility of UK alignment with the Taxonomy in light of the Commission’s upcoming screening criteria for the different environmental objectives, we will expect the Treasury to deposit the Commission Delegated Acts establishing those criteria—due in December 2020—in Parliament for further scrutiny.

6.15As we noted in our Report of 1 July 2020, there are also a number of other EU policy initiatives which are linked to the Sustainable Investment Taxonomy, and which may also be relevant for the UK in the future (even if only as a comparator for the Government’s future proposals with respect to green finance). These include a series of European Commission reports planned for 2021 and 2022 that will assess when an activity does not contribute meaningfully to sustainability34 and evaluate the “effectiveness of […] this [Taxonomy] Regulation in channelling private investments into environmentally sustainable economic activities”.35 The European Commission also recently concluded a consultation on an EU “green bond” label (which is expected to lead to a proposal for a product label for such investment products, based on the Taxonomy at EU-level, in early 2021).36 The Committee will continue to monitor these related developments and report any relevant implications for the UK to the House, as necessary.37

We draw the Minister’s latest update on the implementation of the EU Sustainable Investment Taxonomy in the UK to the attention of the Environmental Audit Committee and the Treasury Committee.


24 Proposal for a Regulation on the establishment of a framework to facilitate sustainable investment; Council and COM number: 9355/18 + ADDs 1–2, COM(18) 353; Legal base: Article 114 TFEU; Department: HM Treasury; Devolved Administrations not consulted; ESC number: 39806.

25 The Taxonomy is part of a larger package of EU measures—the Green Finance package—that aim to ensure the financial services industry plays its part in the fight against climate change. The overall aim of the proposals is to channel more investment into sustainable activities by incorporating ‘Environmental, Social and Governance’ (ESG) considerations into investment industry practices. The Commission argues this would benefit the environment and lead to more sustainable economic growth (as well as being in the industry’s own interest by reducing insurance claims related to environmental damage and ensuring the viability of long-term investments). The Regulation was formally approved by the Member States in the Council on 15 April 2020 and by the European Parliament on 17 June 2020, and published in the Official Journal of the EU on 22 June 2020 as Regulation 2020/852.

26 The six environmental objectives for which the Sustainability Taxonomy sets criteria to determine whether an economic activity is of benefit are: climate change adaptation and mitigation; sustainable use and protection of water and marine resources; the transition to a circular economy; pollution prevention and control; and the protection and restoration of biodiversity and ecosystems.

27 More concretely, to be classified as ‘sustainable’ under the Taxonomy, an economic activity will have to “contribute substantially” to one of the environmental objectives; avoid any “significant harm” to the environmental objectives; and meet certain “minimum social safeguards” in the form of ILO Conventions.

28 The European Commission launched a consultation on an EU-level framework for green bonds in June 2020. If this results in European legislation it would have to comply with the Taxonomy Regulation.

29 Under section 8 of the 2018 Act, the Government can use Statutory Instruments to correct “deficiencies” in the Taxonomy that will remain part of UK law. While the Minister notes the Treasury intends to use this power to “ensure it is fully operable from the end of the [transition] period”, he did not clarify which actual changes to the Regulation are foreseen in this regard, especially with respect to the establishment of the detailed screening criteria for each of the six environmental objectives set out in the Taxonomy.

30 In our Report of 30 April 2020, we had asked the Minister only “to clarify whether [it] is considering establishing a similar legally-binding Sustainability Taxonomy domestically for investment products”. We did not raise the possibility of alignment.

31 Equivalence arrangements for financial services, which we discussed in more detail in our Reports of 1 April and 20 May 2020, under which the Government is seeking preferential market access into the EU for Britain’s financial services exports after the UK leaves the Single Market. It is not clear if the EU is seeking commitments from the Government that it will retain a version of the Taxonomy under its domestic law, in return for such ‘equivalence’ for the British asset management and investment services industries (nor how any such commitment would be compatible with the Government’s own insistence that the UK “will not agree to any obligations for our laws to be aligned with the EU’s”).

32 The European Commission’s detailed rules for implementation of the new green screening process are not due to apply from early 2022 at the earliest, well beyond the scheduled end of the transition period. It is therefore entirely possible for the Treasury to instead work on its own screening criteria to complement the Regulation as retained EU law, if the Government intends to keep the Taxonomy on the UK statute book. We concluded: “The European Commission’s proposals in this regard may be relevant or helpful, but they are not a precondition for such a policy choice”.

33 In particular, under the EU Taxonomy Regulation, those crucial technical rules would be set by the European Commission, but subject to a veto by either the European Parliament or by a qualified majority of EU Member States in the Council. What process the Government foresees for the establishment of the UK’s own sustainability screening criteria (if, indeed, it intends to retain the Taxonomy in the longer term), including any role for Parliament and the proposed new Office for Environmental Protection, or some other independent body, is unclear.

34 That report will also assess the possibility of introducing more detailed preconditions with respect to social and employment conditions for an activity to qualify as ‘sustainable’.

35 These reviews are also likely to give some Member States an opportunity to push for amendments to the Taxonomy Regulation, given that the legislation is not without its detractors among the remaining 27 EU Member States, with Sweden voting against while Austria, Bulgaria, Hungary and Poland abstained from the final vote. The legislative process to establish the current version of the Taxonomy already highlighted a number of areas of controversy between the EU’s Member States and the European Parliament. Notably, EU countries were divided on whether energy generation from nuclear power and gas should be considered ‘sustainable’, which has resulted in ambiguities in the legal text. The final Regulation also contains a category of “transitional” activities, which could allow activities otherwise classified as non-sustainable, like for example nuclear energy or steel manufacturing, to be classified as ‘sustainable’ if there is “no technologically and economically feasible low carbon alternative” and the activity “has greenhouse gas emission levels that correspond to the best performance in [its] sector or industry”. The extent to which the Regulation defines sustainability in terms of forestry management was also controversial.

36 In June 2019, the EU’s Technical Expert Group on Sustainable Finance published a report on an “EU green bond standard”.

37 The Committee will also continue to pursue the broader matter of “equivalence” with the EU on financial services regulation with the Treasury, especially as regards the extent to which that arrangement could require continued UK regulatory alignment with EU financial services rules more generally.




Published: 14 October 2020