Mirjam Wolfrum of CDP Europe, the NGO formerly known as the Carbon Disclosure Project, says investors should be thinking of a company’s journey rather than purely about divestment. Photo: European Economic and Social Committee (2019)

Mirjam Wolfrum of CDP Europe, the NGO formerly known as the Carbon Disclosure Project, says investors should be thinking of a company’s journey rather than purely about divestment. Photo: European Economic and Social Committee (2019)

This week, Delano examines the widely debated inclusion of natural gas and nuclear power in the European Commission’s green investing guidelines, the EU taxonomy for sustainable activities. The taxonomy, while useful as an informational tool, is unlikely to make a massive impact on investor decisions, according to the investment professionals quizzed by Delano.

This series has previously looked at the , the and the potential themselves. This instalment ponders if nuclear and gas being considered green in the taxonomy will change the decisions made by a lot of investors.

That is a “fair question”, , partner and services leader at the consultancy EY in Luxembourg, told Delano. Much depends on the “different level of maturity of the investors,” she said. “I think if you would ask anyone on the street today, everyone would respond, ‘yeah, it’s important for me to have ESG characteristics and to pay attention to ESG’. But then, who has sufficient knowledge to explain what is ESG? And what really aren’t the objectives that are pursued by that?”

The EU taxonomy may or may not help solve that problem, but “you have to start somewhere,” Müller stated. “It’s important to have a first reference and the first dictionary. For me, the ESG topic is very much about transition. You cannot change everything from brown to green from one day to the other.”

While a portion of investors might be “disappointed” in how the guidelines are written, “this might be the opportunity for some to change their investment decisions less drastically, short-term, because this would be accepted.” If nuclear and gas had been excluded from taxonomy, Müller conceded that certain investors could have “been quicker in terms of getting these type of activities out of their portfolios.” But their inclusion, in her view, is not “drastically a game changer” in terms of investors’ overall ESG goals and their long-term course of action.

Forward looking activity

Investors might discount the EU guidebook if they do not find it particularly useful overall. The taxonomy has oversimplified complex questions, reckoned Rick Lacaille, senior investment advisor at the custody bank and financial data provider State Street. Under the EU classification system, “in order to be a sustainable fund, I need to achieve certain objectives and hold or not hold certain things. Well, investment sometimes isn’t that quite straightforward. Because it might be that the very attractive investment proposition is to buy a business that may not look very good now, but where you have a strong conviction and maybe the board have also indicated that it is actually going to change either by disposal or transformation of the business over some time period. And that’s very hard to measure because it’s a forward looking activity,” Lacaille said.

“Most investment is forward looking, by definition,” he observed. “So what happens in years 5, 10, 15, 20 is the thing that’s really determining the value of the business, and as a consequence, the taxonomy is always going to find it difficult, because defining what the business is going to be doing in 5, 10, 15 years cannot be said with certainty. And so by simplifying the problem of classification... you’ve inadvertently simplified a problem and possibly constrained investment in things which might be beneficial both from a financial perspective and probably in other perspectives as well.”

Today’s data vs tomorrow’s judgement

As an example, Lacaille cited the cement sector. Investors reviewing a cement company could consider, “does the business have a net zero plan, or maybe it does have a very distant one because it’s very hard to deal with. And you don’t know what customers are going to do. If customers will pay more for green cement, it’s a slam dunk. But the fact of the matter is that they may not. So the management or the board may be uncertain about that transition. As a consequence, the business may not look great from a carbon perspective. But it may actually have an intention and a plan that’s clear to get through that process and to be engaging with customers. And I think that’s very hard to register within a taxonomy, which is basically data driven. I mean, understandably, we should be data driven. But forward looking data is very hard to be certain about. And that’s, in a way, one of the things you pay for. Particularly in active management, you’re paying for people to make a judgement about what might happen in the future.”

Investors will, naturally, look at the numbers. Mirjam Wolfrum, director of policy engagement at CDP Europe, an NGO that runs an environmental disclosure system, pointed to a 2017 CDP study of “14 European electric utility companies that found that companies that focus on nuclear at the expense of investment in renewables may limit their growth opportunities in the future.” Such “limited growth prospects” should serve as a signal to investors, regardless of regulatory disclosure requirements, she said.

More broadly, Wolfrum hoped that the way the taxonomy is written “will not hinder [investors] from setting net zero targets for their investment portfolios. And this is a journey, right? It’s not about divesting. It’s about taking companies on a journey by requesting improvement of performance.”

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