Skip to content
Site search
Air pollution
Markets & Geopolitics

Speaking the same language on sustainable finance

The development of a workable and holistic EU-wide taxonomy on sustainable finance seems to be in sight. What will it mean for the built environment?

Fabrizio Varriale, World Built Environment Forum
29 April 2021

In 2018, the EU Commission action plan on financing sustainable growth became the starting point for a series of related policy initiatives. Among these was the development of a Taxonomy for sustainable finance, designed to classify economic activities on the basis of their contribution towards six environmental objectives. The Taxonomy will serve as a reference point for other EU regulation on sustainable finance. It does not, by itself, mandate investment in particular activities, but rather provides criteria and thresholds by which to define activities with positive environmental impacts.

RICS joined the EU Commission’s Technical Expert Group on Sustainable Finance (TEG) in July 2018. The TEG was established to develop criteria for economic sectors identified as having potential for positive climate impact. RICS coordinated the development of activities relating to the built environment. Identifying market-ready criteria and fair thresholds for these activities proved particularly challenging. Complications included inherent differences in asset performances across climates, inconsistent approaches to building stock classification, and unreliable carbon datasets – particularly in relation to embodied carbon.

The TEG published its final report for the Commission in March 2020. Contained within were recommendations on the design and use of the EU Taxonomy, as well as criteria for 70 climate change mitigation and adaptation activities. For the other four environmental objectives, the plan is to finalise the Taxonomy in early 2022, to be applied in 2023. The Platform on Sustainable Finance, the successor of the TEG, is currently developing the relevant screening criteria.

Defining climate change mitigation in the built environment

  • The below table summarises the evolution of the criteria for economic activities with a Substantial Contribution to Climate Change Mitigation relevant to the construction and real estate sectors.

    Economic activity

    TEG criteria (March 2020)

    EU Commission criteria – first draft (Nov 2020)

    EU Commission criteria – second draft (March 2021)

    EU Commission criteria – final version (April 2021)

    New constructions

    The new building must be 20% more efficient (in terms of primary energy demand) than the applicable NZEB level (which is mandatory for new buildings).

     

    Introduced an additional requirement for large buildings to test building performance and calculate embodied carbon.

    No change

    The threshold for efficiency was lowered from 20% to 10%.

    Renovations

    The renovation must either comply with the ‘major renovation’ requirements set in national regulations implementing the EPBD, or achieve at least 30% energy savings.

    No change

    No change

    No change

    Single measures

    The measure must comply with specific technical requirements (such as energy efficiency for boilers).

    Minor additions and refinements.

    No change

    No change

    Acquisition and ownership of buildings built after 2020

    The same criteria as for new constructions apply.

    Additional requirement for large non-residential buildings to have energy management in place.

    No change

    No change

    No change

    Acquisition and ownership of buildings built before 2020

    The building must be within the top 15% of its local stock in terms of energy performance (i..e primary energy demand).

    Additional requirement for large non-residential buildings to have energy management in place.

    The building must have EPC rating A.

    No change to the additional requirement.

    The building must have EPC rating A.

    In alternative, EPC rating B is sufficient, provided that a study not older than 12 months demonstrates that the building is within the top 15% of its local stock in terms of energy performance.

    No change to the additional requirement.

    The building must have EPC rating A. In alternative,

    a study which demonstrates that the building is within the top 15% of its local stock in terms of energy performance.

    No change to the additional requirement.

The Taxonomy Regulation entered into force in July 2020, though the Commission had yet to establish the technical screening criteria – the first drafts of which were published in November. By December, the Commission had received over 45,000 replies to its public consultation. Additionally, 10 Member States submitted a joint letter urging that the Commission permit the use of gas as a transition fuel in countries currently reliant on coal. This, they noted, would represent a pragmatic means by which to drive significant reductions in carbon emissions in those markets.

And the reservations did not end there. A study commissioned by Germany’s environment ministry warned that only a small number of major blue-chip companies would be considered sustainable by the Taxonomy. The study’s authors thusly warned that any consequent investor rush on those companies could lead to the creation of a ‘green bubble’. The potential consequences would be manifold and unpredictable. Lobbyists for the hydrogen industry also argued that proposed carbon thresholds remained too low. And reactions in the real estate sector have also been mixed, with praise for the Commission’s use of EPC ratings far from unanimous. Mindful of the possibility that unhappy member states could wield their veto, the Commission has asked the Platform on Sustainable Finance to rework the controversial criteria.

In late March 2021 a new draft proposal was circulating, which made some concessions to the points raised against the first draft. Most notably, gas-fuelled plants would qualify as sustainable if they replace a carbon-intensive plant by 2025, and cause a 50% reduction in carbon per kWh of energy generated.

A study commissioned by Germany’s environment industry has warned that only a small number of major blue-chip companies will be considered sustainable by the EU Taxonomy. The report warns that any consequent investor rush on those companies could lead to the creation of a ‘green bubble’.

In late March 2021 a new draft proposal was circulating, which made some concessions to the points raised against the first draft. Most notably, gas-fuelled plants would qualify as sustainable if they replace a carbon-intensive plant by 2025, and cause a 50% reduction in carbon per kWh of energy generated.

Nonetheless, dissatisfied Member States announced their opposition to the new draft, with environmental groups warning that concessions to fossil fuel would open the door to greenwashing. The criteria used to define sustainable activities in agriculture and forestry also remained controversial.

Last week, the Commission published the finalised Delegated Act for the Taxonomy. The Act will be formally adopted at the end of May and enter into force in January 2022. To avoid further obstructions, the Commission has decided to remove the most controversial stipulations relating to nuclear and gas energy generation, and the agricultural sector. These will be covered in a complementary Delegated Act to be delivered later this year, following another review of the criteria by expert groups.

The most contentious aspects of the criteria, which relate to sustainable acquisition and operation of assets built before 2020, have been streamlined. Such assets constitute a large part of the real estate market and, as such, many vested interests are at play. Regional differences add a further layer of complication. The final version introduces a relaxation of criteria by comparison with previous Commission drafts. The overarching requirement is that all buildings achieve EPC A-rating. However, buildings failing to make that grade will be considered compliant if it can be demonstrated that they are in the top 15% of local buildings for energy performance. This qualification was designed to recognise that most European markets boast only a negligible number of A-rated buildings. In some member states – Italy and Spain, for instance – the total number of A and B-rated buildings combined would probably account for less than 15% of overall stock. However, in some markets, A-rated buildings alone account for much more than 15% of the whole. As such, while EPC ratings are useful, well-established instruments, they do not yet provide a fair means of establishing performance thresholds across the bloc.

While EPC ratings are useful, well-established instruments, they do not yet provide a fair means of establishing performance thresholds across borders.

It is notable that the final version of the Taxonomy restores the top 15% rule as originally proposed by the TEG in March 2020. In fact, very limited changes have been made to the TEG recommendations across the board. This, it must be said, represents at least tacit acknowledgement of the sound rationales employed by the expert group.

Two points of particular interest to the built environment are:

  • The requirement that new buildings achieve 10% greater efficiencies than Near Zero Energy Building levels – now mandatory for new buildings across the EU. It makes little sense to direct finance towards new buildings that do not perform better than mandatory levels. Moreover, new buildings come with a significant upfront ‘investment’ in embodied carbon – yet to be covered by the Taxonomy criteria.
  • The requirement that renovations comply with ‘major renovation’ rules set out in national law, or achieve at least 30% energy savings. The first threshold paves an easy route to compliance in the EU, since most ‘major renovation’ requirements are based on analyses of cost-effectiveness. The intent is to facilitate investment in renovation projects across Europe. The 30% energy savings rule allows for a reasonable alternative, and is the only building-related criterion that can be easily applied in non-Member States.

But not all the aspects of the Taxonomy have been streamlined in the Delegated Act. In addition to the criteria for Substantial Contribution to Climate Change Mitigation, sustainable activities also must comply with Do No Significant Harm criteria for the other environmental objectives. These criteria are meant as minimum safeguards, but their definition has proved particularly challenging. Throughout the process, the Commission has introduced additional rules to those recommended by the TEG; the Delegated Act mandates several criteria which will prove difficult to monitor and verify.

Once the Delegated Act is formally approved, what will be the market reaction? How will the criteria apply to portfolios including a mix of EU and non-EU assets? Are construction and real estate firms ready to measure their activities against Taxonomy thresholds? Can we expect a shift in demand from clients and investors towards Taxonomy-aligned activities? These are just some of the crucial questions that remain unanswered.