Fire, water, earth and air.
From ancient Greece to the Aztecs, many cultures believed the universe was built from just four elements... but there are always exceptions. The Dagara people of Burkina Faso added a fifth element nature, while traditional Chinese cosmologies distinguish between metal and wood.
As delegates gather round the COP26 table, there's a risk of same thing happening with climate disclosure rules. They're all trying to describe the same thing - but with everso slightly different concepts. The firms that have to comply with the rules - especially banks, insurers and asset managers – will have to hope that global regulators can agree on what counts as ‘green’. It's not just that consistent definitions are essential to combat ‘greenwashing’; they also underpin data management and the drive to channel capital sustainably.
The EU was the first to show its hand in 2020 with its Taxonomy Regulation, adding progressively more detail announced ever since. In September, China revealed it was working with the EU on a common set of green standards – to be finalised by year-end. Now the UK has joined in. On 18 October, HM Treasury released Greening Finance: A Roadmap to Sustainable Investing, which includes a section on how the UK will develop its own Green Taxonomy.
The indications are the UK will align with the Brussels-to-Beijing approach. For a start, the UK Roadmap’s frequent references to consistency, comparability and what it calls “international interoperability”. Our detailed analysis supports that impression. We compared the EU and the UK taxonomies across ten major dimensions and found full alignment on three dimensions, significant alignment on five, and two where it’s not yet clear.
EU: The ‘Sustainable Finance Disclosure Regulation’ (SFDR) applies across financial market participants (defined broadly). The ‘Corporate Sustainability Reporting Directive’ (CSRD) is expected to apply to over 50,000 companies based on size and public status.
UK: ‘Sustainability Disclosure Requirements’ (SDRs) are intended to apply across the whole of the economy: business, the financial sector and investment products.
Upshot: Significant alignment looks likely although we're yet to see the detail of the UK Taxonomy.
2. Double Materiality
EU: One notable feature of the EU’s Corporate Sustainability Reporting Directive (CSRD) is the concept of ‘double materiality’ which expects firms to take into account: (1) the effects of ESG risks on a company’s bottom line; and (2) how the company’s activities impact people, society and the environment.
UK: The SDR regime is designed to equip investors and businesses with the information they need to understand the full range of environmental risks they face and create. The information should be a key component of every investment decision and the strategy of every business. That’s double materiality in a nutshell.
Upshot: Full alignment
3. Objectives of the taxonomies
Upshot: Full alignment on environmental objectives (it’s hard to escape the conclusion that the UK’s wording has been designed to dovetail with the EU’s). That said, the EU is also developing a Social Taxonomy, but we haven’t yet seen the UK announce anything similar.
4. Testing alignment with Taxonomies
EU: In order for an investment or a company’s activities to align with the taxonomy, they must make a ‘substantial contribution’ to one of the six environmental objectives, whilst doing no significant harm to any of the other five objectives, and meeting a range of minimum criteria (including adhering to OECD Guidelines for Multinational Enterprises and UN Guiding Principles on Business and Human Rights).
UK: The UK’s tests are essentially the same: (1) make a ‘substantial contribution’ to one of the taxonomy’s environment objectives; (2) do no significant harm to any of the others; (3) and meet a set of minimum safeguards (referencing the OECD and UN). This is the Technical Screening Criteria (TSC).
Upshot: Full alignment. The UK has said that TSCs for the climate change mitigation and adaptation objectives will be based on those of the EU Taxonomy, which the UK supported the development of whilst still a Member State.
5. Reliance on the International Sustainability Standards Board (ISSB)
EU: The ISSB should be formally constituted by the end of 2021 or early 2022. It’s the fruit of international cooperation between the IFRS9 Foundation and several international standard setters including IOSCO, GRI, SASB, IIRC, CDSB and CDP . As such, it was still under development when the EU published its draft taxonomy and there is no explicit mention of the role of the ISSB. That said, the EU normally converts IFRS Foundation rules into EU law. Moreover, the European Commission has mandated the European Financial Reporting Advisory Group (EFRAG) to develop EU sustainability reporting standards in tandem with other international initiatives such as the GRI, TCFD, SASB, IIRC, CDSB and CDP. Germany has also applied to host the ISSB as it chooses a permanent home.
UK: The government expects that ISSB standards will form a core component of the SDR framework, and the backbone of its corporate reporting element. To deliver this, the government will create a mechanism to adopt and endorse ISSB-issued standards for use in the UK Green Taxonomy (the UK has also applied to host the ISSB).
Upshot: Significant alignment is likely, if not yet established.
6. Third-Party Assurance of ESG Disclosures
EU: The EU has already proposed to bring in mandatory independent, third-party assurance of ESG disclosures under the CRSD and certain aspects of SFDR.
UK: While the UK’s Roadmap does not commit to mandatory third-party assurance, it does point out that the FCA is working with HM Treasury on a sustainable investment labelling regime. The goal is to help consumers select investment products based on sustainability characteristics – supported by the SDRs. The FCA will launch a Discussion Paper in the Autumn.
Upshot: It’s too soon to say whether the EU and UK will be aligned, but the FCA’s ‘labelling regime’ would need strong governance to be credible. By 2023, the EU has said it will assess the needs and merits of a general framework for labels for financial instruments financing the transition of the economy.
7. Regulation of ESG Rating and Data Providers
EU: The European Securities and Markets Authority (ESMA) is currently considering the main challenges in the regulation of ESG ratings and assessment tools. Comparability, transparency and potential conflicts of interest seem to be the main areas of focus.
UK: The UK government is considering bringing firms into scope of FCA authorisation and regulation.
Upshot: Neither the EU nor the UK have made up their minds on this matter, but they both seem to be asking themselves a highly aligned set of questions.
8. Transition Plans to Net-Zero
EU: The EU’s Platform on Sustainable Finance is currently consulting on the appropriate disclosure obligations for transition plans (either toward net zero emissions or away from causing ‘significant harm’ to one if the six environmental objectives). It has recognised the need for such plans to be a part of the CSRD. While not explicit, the TSC of the Taxonomy has declining emissions thresholds that are aligned with the net zero emissions trajectory of the EU climate agenda. The exact scope and nature of the activities to be considered as transitional or enabling (e.g. nuclear energy and manufacturing for energy efficiency) still remains contentious in Brussels.
UK: The UK Roadmap acknowledges the current lack of a standard ‘templates’ for a good transition plan but says this is rapidly changing (citing the TCFD’s guidance as well as the work by Climate Action 100+, the Institutional Investors Group on Climate Change and the Glasgow Financial Alliance for Net Zero). SDRs will require disclosures on transition plans; as standards for transition plans emerge, the government and regulators will look to incorporate these into UK disclosure rules. These plans must include targets to mitigate climate risk, interim goals between now and 2050, and measures to meet them.
Upshot: Likely to be significant alignment if the EU and UK both draw on similar international standards. The ECB's Frank Elderson has also called for a legally binding requirement for banks to adopt transition plans.
9. Sectoral Classifications
EU: The EU’s approach relies on the sectoral classification of companies by using the four-digit NACE codes, the EU’s standard industry classifications which have been in place since the early 1970s . NACE codes in practice define what is in scope – out of 24 NACE macro sectors, only seven are in scope of EU climate agenda regulation, as they account for 93.5% of the bloc’s direct emissions .
UK: While all UK companies would have had a NACE code (when the UK was an EU member ) that can no longer be assumed, and the US and UN both have their own industry classifications through the International Standard Classification of All Economic Activities (ISCI). It remains to be seen which system the UK will adopt, watch this space.
Upshot: Some EU firms have struggled to combine the NACE code system with the EU taxonomy, so it wouldn’t be a surprise if UK firms did so too. Though it may seem like a small technical detail, the correspondence of industry classifications is likely to cause comparability gremlins.
EU: Between now and early 2024, the EU will publish standards for corporate sustainability disclosures, progressively applying all six objectives of the EU Taxonomy delegated acts, and requiring further disclosures under the Sustainable Finance Disclosure Regulation (SFDR). While there is some legroom for specific asset classes where requirements still need to be developed (e.g. high-frequency trading), financial market participants should consider 2025 as the hard deadline for disclosure.
UK: The timelines set out in the UK Roadmap for consultation and implementation are generally consistent with the EU’s timelines, albeit slightly longer or later (delayed?). This should mean that UK regulators will have full sight of the EU’s approach before considering their own.
Upshot: The UK’s timelines seem well aligned to the EU’s.
Upshot of the upshots
UK firms can plan their compliance and disclosure strategies knowing that the regime here places a high value on comparability. There’s even a workstream under the UK’s Green Technical Advisory Group called ‘International Interoperability’, with a remit to study how the different taxonomies can best work together and avoid fragmentation. While EU firms have a head start on implementation, UK firms can learn from their lessons and aim to reach the same goal more quickly.
 To impress people at dinner parties, here’s what each abbreviation stands for: IFRS – International Financial Reporting Standards; IOSCO – International Organisation of Securities Commissions; GRI – Global Reporting Initiative; SASB – Sustainability Accounting Standards Board; IIRC – International Integrated Reporting Council; CDSB – Climate Disclosure Standards Board; CDP – Carbon Disclosure Project.
 NACE is a French abbreviation: “Nomenclature statistique des Activités économiques dans la Communauté Européenne”
 These are mainly Energy, Transport, Buildings, Industry and Land Use related activities.