An Opportunity for Differentiation?

Rachel Richardson, Head of ESG at Macfarlanes, outlines the next steps and potential implications of a UK Green Taxonomy.

On 14 November 2024, HM Treasury issued a consultation following the Green Technical Advisory Group’s (GTAG) work in developing a UK Green Taxonomy for financial and non-financial firms.

The GTAG is an expert group, chaired by the Green Finance Institute, which provides non-binding advice to the UK Government on market, regulatory and scientific considerations for developing and implementing a UK Green Taxonomy to facilitate more informed investment decisions.

What is a green taxonomy?

The consultation paper defines a taxonomy as “a classification tool which provides its users with a common framework to define which economic activities support climate, environmental or wider sustainability objectives”.

It is designed to apply at the level of economic activities, relating to individual activities and processes, rather than at an entity level, such as the frameworks provided by the International Sustainability Standards Board (ISSB). Taxonomies are not static frameworks and can be adapted to expand sectoral coverage.

Why do we need a UK Green Taxonomy?

The government committed to net zero in the Climate Change Act 2008 and is under a legal obligation to deliver on the carbon reduction targets therein.

In order to deliver on the legal targets, alongside acceleration of growth, the government has stated that they need to mobilise an additional £30 billion (US$37.6 billion) of investment into the transition each year into the 2030s (as estimated by the Climate Change Committee).

This capital will need to primarily come from private capital sources (alongside smaller amounts of public funding). Policy and economic levers will therefore be required to incentivise capital deployment. A green taxonomy is seen as one of the tools for achieving this.

In addition, a robust regulatory framework is seen as improving the investible universe of climate transition assets, enabling the private sector to realise the economic opportunities of the transition.

The approach of other nations

Globally, around 20 jurisdictions have a government endorsed taxonomy with over 30 more considering developing one. Many UK-based companies and funds are subject to overseas taxonomies, such as the EU’s Taxonomy Regulation.

Global taxonomies are constantly evolving, and some have caused controversy. In 2022, the EU’s Taxonomy Regulation was criticised by environmental groups for its inclusion of natural gas and nuclear energy.

Purpose of the UK consultation

The consultation is relatively limited in scope. For example, it is not seeking feedback to determine what should be considered ‘green’ and/or ‘sustainable’ within the future taxonomy.

HM Treasury is seeking feedback on the following use case questions, among others:

whether there are specific UK Taxonomy use cases;
whether a UK Taxonomy is a suitable tool for supporting the mobilisation of transition finance and how it would sit alongside transition planning;
whether a UK Taxonomy is a suitable tool for prevention of greenwashing;
what types of organisations would benefit from a UK Taxonomy; and
what concerns or practical challenges might be faced by the introduction of a UK Taxonomy.

In addition, feedback is sought on the following key design related questions:

how UK-based companies currently use existing extraterritorial taxonomies;
how much interoperability would be most helpful, including in relation to structure, format, naming, thresholds and metrics;
any useful lessons learnt from other jurisdictional taxonomies which could help inform the UK Taxonomy;
what environmental objectives should the UK Taxonomy focus on and in what order of priority;
what design features would be most useful to maximise the potential of the UK Taxonomy to achieve its investment goals;
what sort of timeframe for updates to the UK Taxonomy would be most beneficial; and
what governance and oversight should be established for ongoing maintenance and updates to accompany the UK Taxonomy.

Learning from the EU

The UK government has been clear in this consultation that they propose nuclear energy should be classified as green in the future UK Green Taxonomy. This is potentially to avoid future debate and controversy further down the line, which occurred with respect to the EU’s Taxonomy Regulation. The UK consultation however remains silent with respect to natural gas (which is of course a fossil fuel), reserving this for debate in due course.

The concept of ‘do no significant harm’ was introduced by the EU’s Taxonomy Regulation. It is a mechanism to ensure that progress against one environmental objective doesn’t cause significant harm to other environmental objectives. However, some have found this tricky to interpret and manage in practice. The UK government has therefore requested feedback on the benefits of the inclusion of the DNSH principle and the balance between being user friendly and environmentally robust.

Challenges posed by a UK Taxonomy

In November 2022, the UK government first announced that it would implement a UK Green Taxonomy. Given the long-term thinking that has gone into the taxonomy and the environmental ambitions of the current government, we expect that the current government will follow through and implement one.

However, there are various challenges facing the government in drafting a taxonomy. Many UK funds and businesses that have already designed ‘sustainable activities’ in the absence of a taxonomy could find that their activities do not fall within the set criteria, despite being determined as sustainable by their own proprietary framework, or via independent assessments. This could bring with it accusations of greenwashing and/or changes to the operation of existing strategies, which could be costly and cause disruption to existing investments.

In addition, the proposal to amend the future UK Taxonomy periodically could lead to uncertainty in a market which has lacked certainty for a number of years. An investor and a fund need the confidence to know that what is considered “sustainable” isn’t going to cease to be so in three years time.

Many market participants are seeking a strong degree of interoperability with the EU Taxonomy Regulation, given some UK entities have been aligning their activities with the EU iteration for some time. However, the UK may see this as an opportunity of differentiation and therefore potentially a UK Green Taxonomy may add additional costs to processes and systems that are already complex, as many will be in a position where they are aligning with activities in both the EU and UK taxonomies.

Next steps

The consultation is open for responses until 6 February 2025. In addition to the UK Taxonomy consultation, we are expecting to see a consultation on the ISSB’s standards application in the UK by way of the future UK Sustainability Reporting Standards, and in the second half of 2025, we are expecting to see a consultation on mandatory transition planning following the work of the Transition Plan Taskforce.

This article was co-authored by Emily Batchelor, Associate at Macfarlanes.

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