Addressing the ‘Winner-Takes-All’ Character of Sustainability Taxonomies

Sustainability classification systems (or ‘taxonomies’), of which the EU environmental taxonomy is the most important example, often result in a binary approach whereby best-in-class economic activities are qualified as sustainable, while all other activities are grouped together into one catch-all category irrespective of their contribution to, or potential for, furthering the transition towards a sustainable economy.

Such binary approaches are likely to result in under-investment in both crucial transition activities and innovation with the potential to further pro-environment transition. Making taxonomies easy to apply, consistent, open to innovation and comprehensive at the same time is imperative if the world’s economies are to achieve net zero, even when this dilutes technical precision in the process.

In our new article, we introduce and discuss the upsides and downsides of various classification systems. Based on that analysis we argue in favour of expanding classification systems to include information on transition and potential transition activities and strategies, and present a scorecard approach to meet that objective.

Under our scorecard approach, economic activities are scored based on a more granular system of environmental technical screening criteria. By assigning scores to information providers, which are the issuers of a financial product, it could be possible to distinguish between (the already existing concept of) substantial contribution to an environmental objective, and the new concepts of contribution to an environmental objective and harmful impacts on an environmental objective. Furthermore, for neutral activities, such as education and legal services, their neutrality can be displayed by assigning a separate score, indicating that no impact has either been claimed or achieved.

In our scorecard system, the EU’s technical screening criteria for determining the extent to which an economic activity contributes to (or negatively affects) an environmental objective provide the basis for the scores, which are broken down as follows.

• ‘Environmentally harmful’ activities: score of 0.
• ‘Environmentally neutral’ activities: score of 1.
•  ‘Environmentally beneficial’ activities that make contributions to an environmental objective, albeit not to a significant extent: scores between 2 and 5.
•  ‘Best-in-class’ activities: scores between 6 and 9.

The scores also provide information as to why a given activity falls short of being best-in-class: failing the “do no significant harm” (DNSH) test reduces the score by one (resulting in scores of 8 or 4 respectively), while failing the “minimum legal and social safeguard” (MLSS) test reduces the score by two (resulting in scores of 7 or 3, respectively), and failing both the DNSH and MLSS tests would result in a score of 6 or 2, respectively.

The given score could also indicate whether the information provided is static (indicated by an B) or whether the issuer has adopted a transition strategy (indicated by an A) that should push the current level of environmental performance towards best-in-class. This information is important for impact investors seeking to make a change through their investments.

Our scorecard sheds significant light on meaningful (though not substantial) contribution to environmental objectives, including as to whether they pass the DNSH and MLSS tests. This information is provides the strongest signal of potential for change. The adoption and implementation of the proposed scorecard approach is further detailed in our article.

Dirk A Zetzsche is a Professor at the University of Luxembourg.

Marco Bodellini is a Research scientist at the University of Luxembourg.