EU taxonomy - what can we expect?

Between a bureaucratic monster and practicality

The COVID-19 pandemic has turned our world upside down, radically affecting our day-to-day lives both at home and at work. It has also altered priorities at the political and regulatory level. At once, important topics such as European implementation of Basel III have either been postponed, put on hold or even struck from the agenda completely. This does not, however, seem to apply to climate policy. While some key stakeholders are calling for the planned green/sustainable finance measures to be postponed, the European Commission has so far officially adhered to its roadmap.

It has announced, for example, that its “Recovery Plan” to rebuild the EU economy after the COVID-19 pandemic is to be green at heart. On 7 April, as planned, it launched a consultation on the renewed sustainable finance strategy¹ . It also intends to go ahead with the Green Deal announced at the end of 2019, while continuing to work on the EU taxonomy for sustainable activities. After the “trilogue” talks on the EU Taxonomy Regulation between the European Parliament, the Council of the EU and the European Commission reached a successful conclusion at the end of December 2019, before the outbreak of the COVID 19 pandemic and following protracted and politically challenging negotiations, the Regulation has been published in the Official Journal of the European Union in June this year².

First and foremost, the Taxonomy Regulation states that financial market participants offering certain green financial products have to publish the percentage of taxonomy-compliant assets in the green financial product concerned. These rules do not cover bank lending business or Pfandbriefe. Just before the trilogue negotiations were concluded, however, a provision was introduced which requires companies, including credit institutions, that are subject to disclosure requirements under the CSR Directive, to also use product-independent, broad taxonomy-based reporting. Furthermore, credit institutions offering green real estate financing and green Pfandbriefe might consider it worthwhile to meet the taxonomy criteria voluntarily.

On 9 March, the Technical Expert Group on Sustainable Finance (TEG)³ published its final proposals for technical evaluation criteria that aim to define specifically when an economic activity will be considered “green” within the meaning of the taxonomy. The TEG’s proposals are to be incorporated into delegated acts in the course of the year.
The TEG’s technical evaluation criteria⁴ span almost 600 pages, and these only cover two environmental objectives: “climate change mitigation” and “climate change adaptation”. However, the EU taxonomy also addresses four other objectives (“sustainable use and protection of water and marine resources”, “transition to a circular economy”, “pollution prevention and control” and “protection and restoration of biodiversity and ecosystems”) for which the – yet to be established – Platform on Sustainable Finance is to develop evaluation criteria in the course of next year. This suggests that the EU taxonomy threatens to grow into a real bureaucratic monster.
For Pfandbrief banks operating in the field of real estate finance, the evaluation criteria for environmentally sustainable activities in the building sector are of particular interest. The main focus is on the objective of “climate change mitigation”, as the building sector is responsible for around 40% of energy consumption and approximately 36% of carbon emissions within the EU. The TEG has defined four environmentally sustainable economic activities in this area:

1.  Construction of new buildings if the primary energy demand is 20% lower than the level mandated by national regulation for a “nearly zero energy building”. In Germany, this would be 20% less than the statutory requirement under the ENEV (German Energy Saving Ordinance) 2016 standard.
2.  Energy-efficiency renovations if they lead to at least 30% savings in primary energy demand compared to the baseline energy performance of the building before the renovation work.
3.  Individual refurbishment measures aimed at reducing energy requirements and/or carbon emissions in buildings.
4.  Acquisition of existing properties if they rank among the top 15% of the national stock in terms of primary energy demand. The criteria that apply to new construction are to apply to existing buildings built after 2021.

The initial assessments conducted by Pfandbrief banks suggest that it will not be easy either to meet these requirements or to demonstrate compliance with the criteria.
Another problem is that economic activities must not have any significant negative impact on the other defined environmental objectives. To check this, so-called “do no significant harm” criteria have been developed and must also be met. With regard to the objective of “protection of water resources”, for example, steps must be taken to ensure that all fittings installed in a new-build property fall into the two best EU Water Label categories. As there is no corresponding statutory basis in Germany, however, it will be virtually impossible for a financing bank to furnish the necessary proof at present.

Given the emerging practical difficulties in meeting the requirements proposed by the TEG, the vdp will lobby the European Commission to make the technical evaluation criteria more workable in practice when converting them into delegated acts. We also want to ensure that Pfandbrief banks will in future be able to fund green real estate loans by issuing green Pfandbriefe and green unsecured bank bonds that comply with the possible EU Green Bond Standard (GBS). The proposals for the introduction of a voluntary EU GBS label, also published by the TEG on 9 March, set out a number of requirements, the fulfilment of which should be largely unproblematic, since most of them are already established market standards. Only the proposal that all assets underlying such a bond should be taxonomy-compliant could prove impractical for the reasons mentioned above.

Although the COVID-19 pandemic is also having a huge impact on credit institutions and real estate finance, Pfandbrief banks want to continue helping to achieve climate targets by granting discounted green real estate loans and issuing green Pfandbriefe to fund them. Fulfilment of the taxonomy requirements and use of the planned EU GBS label would not only help Pfandbrief banks, but would also contribute to the European Commission’s objective of closing the gap in financing climate protection using private capital. In order for this to happen, however, it is crucial that the EU taxonomy does not mutate into a bureaucratic monster, but is rendered practicable.