Travelling down the green brick road: a status quo assessment of the EU taxonomy

1 Introduction

The EU taxonomy for sustainable economic activities (“EU taxonomy”) is an important tool used to redirect investments towards environmentally sustainable activities. This article presents the key findings on the impact that the EU taxonomy and related initiatives could have on European financial markets. We find that, currently, only 1% of the European financial markets finance economic activities that are “green”, i.e. aligned with the taxonomy. We estimate that green instruments could reach about 10% of overall debt financing, with even higher growth potential for green finance in sectors such as transport and buildings.

2 The EU taxonomy: legal framework

The Taxonomy Regulation was adopted in June 2020 as part of the EU action plan on financing sustainable growth published by the European Commission in March 2018. The Taxonomy Regulation sets out the conditions that an economic activity has to meet to qualify as environmentally sustainable under EU law. The EU taxonomy will be further developed as part of the Commission’s strategy to achieve climate neutrality in the EU by 2050, which includes a renewed intermediate target to reduce greenhouse gas emissions by at least 55% by 2030.

The EU taxonomy aims to redirect capital towards sustainable activities, providing for a common language and a clear definition of what constitutes a sustainable activity. It is expected to play an important role in helping the EU scale up sustainable investment. The EU taxonomy provides companies, investors and policymakers with appropriate definitions regarding which economic activities can be considered environmentally sustainable. This is expected to help companies shift investments towards more sustainable activities and to facilitate the transition to a sustainable economy. Although several green taxonomies are being developed globally, the EU taxonomy is the first classification system to be included in financial regulation.

Our findings suggest that currently only a very small share of EU securities is used to finance environmentally sustainable activities. We estimate that only 1.3% of EU bond and equity markets, corresponding to €290 billion, are currently financing activities aligned with the taxonomy for the objective of climate change mitigation. At the same time, around 15% of the market currently finances “eligible” activities, i.e. activities which could become green but are not there yet. These activities that need to transition include some which are particularly harmful. Investors’ exposure to activities of this type, as well as to activities generally related to fossil-fuels, carry a so-called “transition risk”. We estimate such exposures to transition risk at around 5% overall.

3 Estimating the greenness of financial markets

The impact of the EU taxonomy on financial markets will be linked to how much additional investment we need to make to achieve the targets associated with the low-carbon transition in the EU. Updated estimates point to increased yearly green financing needs of around €400 billion compared with the 2011-2020 average for climate objectives only.

The impact of the EU taxonomy on financial markets will also depend on where we start from, i.e. the extent to which EU financial markets are currently aligned with the EU taxonomy. To estimate the greenness of euro area capital markets we use confidential security-by-security data on corporate bonds and equities. The share of investments currently financing economic activities aligned with the taxonomy is estimated at 1.3%, corresponding to around €290 billion.

Based on the economic sector of the issuer, unsurprisingly, the sectors attracting the largest green financing shares are electricity production, construction and water supply, sewerage and waste management. The taxonomy-eligible share of outstanding securities for the market as a whole is estimated at 15.1%. A related issue is the share of financing currently going to economic activities that will need to be progressively abandoned in the transition, such as those related to fossil fuels, which is estimated at 5.5%.

4 Outlook for green finance

Finally, we estimate the potential growth of European green financial markets. The EU taxonomy will help redirect financial resources towards sustainable economic activities and aims to contribute towards filling the investment gap in the relevant sectors. Our analysis estimates the impact that this could have on financial markets. Overall, additional green bonds and loans amount to 10% of outstanding bonds and loans, with even larger growth potential for green finance in particular economic sectors.

The increased financial investment needed in the relevant sectors appears to be feasible considering the amount of outstanding loans to NFCs and recent green bond market developments. The largest share of the investment gap is expected to be funded each year by €316 billion in new green loans, together with €76 billion in new green bond issuance.

5 Conclusion

Our findings suggest enormous growth potential for green finance, particularly in certain sectors. Still, the increased financial investment needed in relevant sectors appears to be feasible. Several policy actions are being implemented, which will make it easier for financial market participants to channel their investments to taxonomy-aligned activities.

References

Alessi, L., Battiston, S., Melo, A.S. and Roncoroni, A. (2019), “The EU Sustainability Taxonomy: a Financial Impact Assessment”, Technical Report, European Commission – Joint Research Centre.

Alessi, L. and Battiston, S. (2021), “Two sides of the same coin: Green Taxonomy alignment versus transition risk in financial portfolios”, Working Paper, European Commission – Joint Research Centre, forthcoming.

Battiston, S., Mandel, A., Monasterolo, I., Schuetze, F. and Visentin, G. (2017), “A climate stress-test of the financial system”, Nature Climate Change, Vol. 7, pp. 283-288.

Born, A., Giuzio, M., Lambert, C., Salakhova, D., Schölermann, H. and Tamburrini, F. (2021), “Towards a green capital markets union: developing sustainable, integrated and resilient European capital markets”, Macroprudential Bulletin, Issue 15, ECB.

Canfora et al. (2021), “Substantial contribution to climate change mitigation – a framework to define technical screening criteria for the EU taxonomy”, EUR 30550 EN, Publications Office of the European Union, Luxembourg.

European Central Bank (2021), “Climate-related risks and financial stability”, ECB/ESRB Project Team on climate risk monitoring, July.

SDGs, Targets, and Indicators

1. Which SDGs are addressed or connected to the issues highlighted in the article?

• SDG 7: Affordable and Clean Energy
• SDG 9: Industry, Innovation, and Infrastructure
• SDG 11: Sustainable Cities and Communities
• SDG 12: Responsible Consumption and Production
• SDG 13: Climate Action
• SDG 14: Life Below Water
• SDG 15: Life on Land

2. What specific targets under those SDGs can be identified based on the article’s content?

• Target 7.2: Increase substantially the share of renewable energy in the global energy mix.
• Target 9.4: Upgrade infrastructure and retrofit industries to make them sustainable.
• Target 11.3: Enhance inclusive and sustainable urbanization and capacity for participatory, integrated, and sustainable human settlement planning and management.
• Target 12.2: Achieve sustainable management and efficient use of natural resources.
• Target 13.2: Integrate climate change measures into national policies, strategies, and planning.
• Target 14.2: Sustainably manage and protect marine and coastal ecosystems to avoid significant adverse impacts.
• Target 15.1: Ensure the conservation, restoration, and sustainable use of terrestrial and inland freshwater ecosystems.

3. Are there any indicators mentioned or implied in the article that can be used to measure progress towards the identified targets?

Yes, the article mentions several indicators that can be used to measure progress towards the identified targets. These include:

• Share of EU securities financing activities aligned with the EU taxonomy for climate change mitigation.
• Share of market financing eligible activities that could become green but are not there yet.
• Exposure to transition risk in investments related to fossil fuels.
• Share of green loans and bonds in total debt financing.

Table: SDGs, Targets, and Indicators

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Source: ecb.europa.eu

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