Latham & Watkins LLPThe delay may complicate the regulatory landscape for sustainable finance as the EU moves toward a standardized classification system. 

The UK government (government) has delayed a decision on whether it will adopt the EU’s taxonomy of sustainable finance activities (the Taxonomy) as the UK approaches the end of its post-Brexit transition period.

The European Commission’s Technical Expert Group (TEG) on Sustainable Finance, which developed the Taxonomy, published its final report on the document in March 2020. The resulting Taxonomy follows from consultations with more than 200 industry experts and scientists

Background

The Taxonomy provides a standardised means for corporates and investors to gauge how environmentally friendly certain economic activities are by clarifying which economic activities can justifiably be considered sustainable. The glossary-style classification system includes performance criteria. Such standardisation has the potential to significantly reduce practices of ‘greenwashing,’ through which companies falsely convey the sustainability of their products or services.

The Taxonomy aims to direct private investments in support of at least one of six prescribed environmental objectives (for instance, climate change mitigation). The Taxonomy also includes a “do no harm” principle, whereby any contribution towards one (or more) of the six environmental objectives must do no significant harm to any of the other environmental objectives.

The system forms part of the EU’s broader Green Deal announced on 11 December 2019, which outlines the EU’s strategy to become the first climate-neutral continent (as reported in a previous blog post). However, the final technical standards of the Taxonomy will likely only come into force after 31 December 2021, a year after the current close of the Brexit transition period on 31 December 2020.

The UK’s Stance

In a letter seen by the Financial Times, Economic Secretary John Glen told the House of Commons Committee that the Treasury would not at present decide whether to implement the Taxonomy after the Brexit transition period. The letter expressed reluctance to be bound by the regime, when the Taxonomy’s final technical standards are yet to be published.

Nonetheless, as reported by Environmental Finance, Glen recognised the Taxonomy’s “important role in the development of Green Finance and in preventing greenwashing”, which he noted was also “an important UK objective”. Glen also stated that the government was “committed” to “at least match the ambition of the objectives of the EU Sustainable Finance Action Plan”, and highlighted the goal of “strength[ening] the UK’s status as a global hub for sustainable finance”. The UK has already committed to carbon neutrality by 2050.

The government published its own Green Finance Strategy on 2 July 2019, which emphasised the City of London’s role in delivering a green economy (as reported on in a previous blog post). In that document, the government noted its close involvement in developing the EU Taxonomy, as well as its continued participation in Council discussions on the system.

The Green Finance Strategy document further noted that, in order to ensure the government “has the option of onshoring the EU’s proposals into UK law, regardless of the EU Exit outcome”, the Taxonomy would be included as part of the Financial Services (Implementation of Legislation) Bill. However, that bill failed to complete its passage through Parliament before the end of the 2017-2019 parliamentary session, and so did not become law.

Implications

Commentators view the UK’s stance on the Taxonomy as a further example of the government’s reluctance to align with Brussels after Brexit, even in instances where the UK and EU are pursuing similar policy outcomes.

The UK’s delay to decide on the Taxonomy increases uncertainty for global asset managers. In any case, many UK funds will be required to adhere to the Taxonomy in respect of their European operations, meaning asset managers will be concerned about avoiding contradictory UK and EU regimes. Regulators in other jurisdictions (e.g., the US Securities and Exchange Commission) are also expected to introduce their own frameworks to support sustainable investment and guard against greenwashing. Notably, the government is pursuing parallel trade negotiations with the US.

Regardless of the UK’s final decision, the regulatory landscape with respect to sustainable finance is poised to become increasingly complex.

Latham & Watkins will continue to monitor developments in this area.

This post was prepared with the assistance of Emilie Cornelis in the London office of Latham & Watkins.

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