The rise of green taxonomies, particularly the ambitious framework laid out by the European Union, has been a watershed moment in the fight against climate change. These classifications aim to establish clear and robust criteria for what constitutes a “green” investment, helping to combat greenwashing and steer capital towards truly sustainable activities. However, while these taxonomies are a vital step forward, it’s crucial to recognise their limitations. They are a study aid, not a pass mark, and companies seeking genuine environmental impact need to look beyond simply ticking the boxes.
One of the key pitfalls lies in the very nature of classification. Taxonomies, by design, categorise activities into “green” or “not green.” This binary approach can lead companies to focus on divesting themselves of assets deemed “non-green” rather than actively investing in solutions that reduce their overall environmental footprint. Divesting from a coal mine, for example, might improve a company’s score on a green taxonomy, but it does little to address the existing emissions from that mine or the need for a clean energy transition.
While labels like “green” or “ESG” offer a quick reference point, true impact requires a deeper commitment. Labels can become limiting, focusing on achieving a specific designation rather than driving meaningful change. A fundamental focus on outcomes allows companies to navigate shifting opinions, such as the recent ESG backlash among some Republican held US states.
The impact of the ESG backlash saw US fund clients withdrew a net $5.1bn in the final three months of 2023, according to Morningstar making last year the first in history where ESG funds saw net outflows.
Understanding of sustainable investment has continued to grow despite the controversy, with sustainable practices becoming more deep-rooted in the process and purposes of firms, transcending labels and ensuring long-term impact and resilience in the face of evolving perceptions.
The enemy of progress
This is why the recent introduction of an “improver” category in the UK’s Financial Conduct Authority (FCA) taxonomy is a welcome development. This acknowledges that companies on a genuine sustainability journey may not yet meet all the stringent criteria for a fully “green” classification. The focus should be on progress, not perfection.
Furthermore, achieving a green taxonomy classification doesn’t equate to making the maximum positive impact. A company might narrowly fit the criteria for a “green” investment but could still be missing opportunities to create significant environmental or social good. Conversely, a company that falls short of the taxonomy’s standards might still be actively pursuing innovative and impactful solutions. Green taxonomies should never be used as an excuse for inaction.
However, where taxonomies truly shine is in their ability to standardise language and facilitate analysis. By providing a shared framework, companies can compare their environmental performance on a level playing field. This allows for more transparent reporting and facilitates communication with investors and stakeholders. This common language is particularly valuable in analysing a company’s entire operation, including its supply chain. Understanding where environmental impacts lie within the value chain is crucial for developing effective sustainability strategies.
Green taxonomies also serve as a valuable tool for managing a transition plan. By outlining low- and no-carbon options, they can help companies map a clear path towards net-zero emissions. This roadmap provides much-needed direction and allows companies to prioritise investments and initiatives that will have the most significant environmental impact.
Powerful tool, but not a panacea
Ultimately, green taxonomies are a powerful tool, but they should never be a substitute for a company’s core purpose and values. Companies that truly want to achieve the most significant environmental impact need to go beyond simply meeting external criteria. They need to engage in deep reflection on their role in the world and how their business practices can contribute to a sustainable future. This requires a fundamental shift in thinking, moving away from short-term gains and shareholder primacy towards a long-term vision that integrates environmental responsibility into every aspect of the company’s operations.
The same caution applies to investors. While taxonomies can be a valuable screening tool, they should not be the sole determinant of an investment decision. Investors need to delve deeper, understanding the company’s overall sustainability strategy and its commitment to continuous improvement.
Both companies and investors need to be wary of the dangers of reductive thinking. Green taxonomies are a powerful tool, but they are not a magic bullet. They can help guide decision-making and promote transparency, but they should never be a substitute for critical thinking and a deep commitment to environmental responsibility. By using taxonomies as a springboard for deeper analysis and strategic planning, companies and investors can work together to make a real difference in the fight against climate change.
