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How Managers of real assets should respond to the EU taxonomy

By Roger Lewis
30th July 2020

Following our introduction to the upcoming EU Taxonomy regulation and progress towards it becoming law by December 2020, we now cover how it can be used as a labelling system for investments, from background climate impacts through investment committees to actual application.

Several months into what the UN has called the ‘decade of delivery’ for its 17 sustainable development goals, one in particular is rapidly becoming one of the most pressing issues of our time: # 13 Climate Action.

Complementary to this are universally agreed standards for ESG – similar to those the CFA Institute has achieved with the Global Investment Performance Standards. Three are emerging as potentially de facto standards: SASB for sustainability accounting, TCFD for climate disclosures and the EU Taxonomy labelling system for sustainable finance (noting the first two are global and this is unlikely for the Taxonomy).


The very nature of Real Assets means they have a significant impact on climate.

The very nature of Real Assets means they have a significant impact on climate. These can be positive (offshore wind, hydrogen) or negative (carbon-heavy buildings). Understood and applied correctly, the EU Taxonomy can play a material role in Real Assets investors’ contribution to the Paris goals of 2 degrees above pre-industrial levels and efforts for 1.5.

To illustrate the impacts of climate change, estimates of the total cost to business are $50tr for a 1.5 degree scenario rising to $70tr for 2 degrees (source: FT, Jan 2020) – this can range from increased pay-outs by insurers for climate-related weather damage, increased inflation and in turn interest rates, and negative income & asset valuations for economic activities that do harm.


Applying the EU taxonomy to real assets investment decisions

In a typical pecking order, investment committees consider cash flows & Internal Rates of Return, credit risk, fund / mandate impacts (such as concentrations & liquidity), location and who the counterparty (buyer, seller, tenant, borrower or co-investor) is.

You can introduce Environmental, Social & Governance factors to the investment decision, and then to ongoing asset management by using a spread-sheet based tool. This should follow any ESG Policy in place, including negative screens, exclusions, positive impacts and high risk ESG factors. The deal team score the asset 1-5 on a series of questions to get an overall score. Questions include green certifications, carbon emissions, labour management, health & safety, data security, board diversity & tax transparency. The higher the percentage, the better the asset for ESG. Any low scoring assets or other ESG risks (roads over sacred land or prisons for infrastructure, borrowers with adverse media for debt and tobacco or adult entertainment real estate tenants) require further due diligence and approval.

To incorporate the EU Taxonomy, this tool should map the economic activity of the investment (i.e. agriculture, manufacturing, power, water, transport, IT & buildings) to six areas of climate change: mitigation, adaptation, sustainable use of water, circular economies, pollution prevention & healthy ecosystems. The deal team should look for a positive contribution to at least one of these and no significant harm to the other five. Consider a science-park or similar industrial asset: a take-make-waste single-use plastic manufacturer as a tenant will score poorly according to the Taxonomy; a bio-science firm researching adaptation like desalination of sea water or drought resistant rice crops will score well. All other factors like IRR and lease terms being equal, the latter tenant is preferable from a climate mitigation view for any fund, whether ESG focussed or not.

Carbon Intelligence are working with real estate and infrastructure investors to assess their investment acquisitions and portfolios for climate, carbon and wider ESG factors. Please contact us to discuss.