The EU taxonomy is a key component of the EU’s sustainable finance agenda and has become something of a buzzword in the world of ESG investing as one of the leading attempts to define green investments consistently and comprehensively. The EU aims to mobilize some €1 trillion in public and private investment over 10 years as part of its “Green Deal” to help it achieve its ambitious climate targets. And there are an estimated €3.3 trillion in ESG assets under management in the EU – so changes to the framework could sway investment decisions for large fund managers and their customers.

How could having nuclear power and natural gas in the taxonomy affect asset managers?  

In April 2021, the European Commission published the rules establishing which economic activities could be defined as green under the taxonomy, but it delayed deciding whether to include natural gas and nuclear power. 

The bloc was under pressure not to make countries dependent on fossil fuels feel they were being left behind in the renewable energy transition. Some EU countries rely heavily on fossil fuels and want to use gas as a bridge fuel. France uses nuclear for most of its electricity needs, while Germany is closing its nuclear power plants. At the same time, sustainable investors, activists and the EU’s own expert advisory group argued the European Commission was drifting too far from a science-based approach to the taxonomy. Critics also feared the EU could tarnish its reputation as a global leader in sustainable finance regulation if it allowed a fossil fuel in the taxonomy. The taxonomy’s finalization is also taking place as Europe struggles with soaring power prices.

The taxonomy debate came to a head in early January after the European Commission began consultations on including natural gas and nuclear power in the taxonomy. Austria and Luxembourg threatened to sue the EU, while the Institutional Investors Group on Climate Change, or IIGCC, which represents investors with more than €50 trillion of assets under management, wrote to EU member states and the European Parliament to call for gas to be excluded from the taxonomy. 

“To call gas green under the provisions of the taxonomy would be very misleading,” Rachel Ward, IIGCC’s policy programme director, told S&P Global Sustainable1 in an interview for the ESG Insider podcast. Other countries developing taxonomies may be tempted to include gas, keeping the fossil fuel in national energy plans for longer than is necessary, according to Ward. Under the current proposal, gas will be included in the taxonomy until 2030 and considered sustainable only if it replaces coal generation.

The inclusion of nuclear, meanwhile, complicates one of the key components of the taxonomy regulation. The framework has six environmental objectives, and progress on any objective cannot come at the expense of another. This is known in the taxonomy as the “do no significant harm” principle. So while nuclear can be claimed to be positive for two taxonomy objectives — climate change adaptation and mitigation due to its low greenhouse gas emissions — some argue that the unavoidable creation of nuclear waste hinders the taxonomy objective of pollution prevention. The European Commission has attempted to answer those concerns by only allowing permits for nuclear plants if countries can safely dispose of toxic waste. Despite this, the plan is facing stiff opposition.

“Nuclear waste is an unresolved issue. So for that reason, [for] the remainder of the taxonomy agenda, the classification of economic activities will be more complicated,” Alexander Lehmann, head of the Sustainable World Academy at the Frankfurt School of Finance and Management, told us in a podcast interview.  

A simple majority vote in the European Parliament is needed to approve or reject the proposal to include nuclear and gas in the taxonomy. If it passes in the parliament, at least 20 of the 27 EU member states would have to vote against it to veto its adoption.

What triggered the debate over gas and nuclear in the taxonomy? 

It all depends how much a particular asset manager, owner or fund manager focuses on ESG. If funds already exclude gas or nuclear, the EU’s decision may be unlikely to sway portfolio managers toward allowing exposure to those industries. 

Many investors already exclude fossil fuels, and nuclear has been excluded from many portfolios, especially since the 2011 nuclear disaster in the Japanese city of Fukushima, Matthias Fawer, a senior analyst for ESG and impact assessment at Vontobel Asset Management, told S&P Global Sustainable1 in the podcast. 

But the decision could also create “a kind of two-tier taxonomy,” in Fawer’s view. Asset managers can offer clients products that are aligned to the taxonomy and include nuclear and gas, but they could also propose taxonomy-aligned funds that exclude them. That could create confusion for investors, where funds both with and without nuclear and gas exposure are advertised as green or sustainable. 

How might the EU’s taxonomy decision impact public funding and capital allocation? 

The debate has shined a light on the challenges of managing the energy transition and the role of sustainable finance taxonomies in getting there. 

“It opens this debate about the current difficult and delicate transitional period or bridge period … until the renewables can fully take over electricity power production in many countries of the world,” Vontobel’s Fawer said. Gas can act as a bridge fuel and provide storage capacity, especially in times of need, he told us in the podcast. But building new nuclear plants takes many years, meaning nuclear would be less effective as an energy source that helps transition the world to renewables, according to Fawer.

The taxonomy’s stamp of approval might encourage governments to put public funds into gas projects, which could influence where investors direct their capital in the future, IIGCC’s Ward said.

What impact will the decision have on other EU sustainable finance regulations? 

Under the EU’s Sustainable Finance Disclosure Regulation, or SFDR, asset managers, pension funds and insurers must disclose how they consider ESG risks in their investment decisions. Investors managing ESG-related funds will have to explain how they use the taxonomy to determine the sustainability of their investments. SFDR disclosures vary depending on the objectives of a particular investment product, and those are defined in the regulation’s numbered articles. 

An SFDR Article 9 product has the most demanding disclosure requirements and “has a reduction in carbon emissions as its objective,” according to the SFDR regulation. The product also needs to conform to the Paris Agreement on climate change, which set the goal of limiting global warming to 1.5 degrees Celsius above preindustrial levels. Article 9-conforming investments are often referred to as “dark green.” Lehmann believes the “quite demanding targets” of Article 9 funds would preclude gas and nuclear exposure.

Article 8 funds, referred to as “light green,” promote environmental and social characteristics but do not seek lower emissions as an objective, so gas exposure could be higher. According to a report by auditor and consultancy PwC, 92% of the €3.3 trillion assets under management among EU-domiciled ESG funds were classified as Article 8 as of June 30, 2021, while the remaining 8% were classified as Article 9.  

But with the EU taxonomy’s inclusion of gas and nuclear, the kinds of investments that qualify for Article 8 and Article 9 could be subject to change. 

In November, Eurosif, a European forum that promotes sustainable investment, warned that putting nuclear and gas in the taxonomy “would require rethinking the SFDR reporting.” Following the EU’s announcement, Eurosif said in February the decision will probably "adversely impact both the credibility and usefulness of the framework for sustainable investors.”  

This piece was published by S&P Global Sustainable1 and not by S&P Global Ratings, which is a separately managed division of S&P Global