UK can do without green Taxonomy — if it gets transition right

Since sustainable finance began to be regulated in the late 2010s, it has been axiomatic for most regulators around the world that the centrepiece must be a taxonomy defining what is sustainable. That the US ignores this orthodoxy surprises no one. But the UK’s decision last week to abandon its long-planned Green Taxonomy is like one of the most faithful parishioners storming out of church.

At the most visceral level, a taxonomy appears to make sense — how can you regulate something if you can’t define it? On closer inspection, this argument wilts.

The craving for a taxonomy grew from the green bond market, the first part of sustainable finance to capture the attention of the mainstream — the biggest banks, investment firms and issuers.

The green bond movement that took off in 2013 was led by financiers, not environmental specialists.

They ignored even the long track record of responsible investing before that point. It had centred on the equity market, and was based on investors assessing the environmental, social and governance credentials of companies. But because the sustainable equity funds were small and there was nothing for investment banks to get their teeth into, financial CEOs took little notice.

Green bonds were great because issuers, investors and investment banks could all actively engage in them, and they created colour and attention. But the financial specialists wading deep into green bonds soon realised they needed expert guidance on what was green.

Rather than turn to the wealth of sectoral information and standards developed in individual industries from buildings to chemicals over the past 30 years, they tried to craft fresh authorities within the financial sector.

First came the industry of second party opinions, and then the grand projet: to write One Big Beautiful Book of what was sustainable.

If this could be done perfectly, it would undoubtedly be useful, and even the imperfect version produced by the European Union has many benefits.

But the task is fundamentally impossible. Environmental issues are multidimensional. Building a wind turbine impacts a local ecosystem and uses hundreds of metal, concrete and chemical products with diverse origins and afterlives. Assessing all these is complex, involves judgement that may need to be locally specific, and each element is constantly changing as technology develops. What was the right answer in Bavaria in February may not be so in Ireland by October. How can all this be squeezed into one tome that takes years to draft and legislate?

Faced with this vast labour, the EU has necessarily scaled down its environmental Taxonomy, and the plan for a social taxonomy has been shelved.

Not only was the Taxonomy difficult to write — companies and financiers have found it arduous to use.

Calculating what percentage of a company’s revenue, capital expenditure and operating expenditure come from activities classed as sustainable has proved tedious.

Since last year, the European Commission has gone into reverse, seeking to reduce the burden of compliance for financial and non-financial firms, for example by letting them exclude activities that make up less than 10% of their activities.

This might make the Taxonomy Regulation easier to comply with — it will not necessarily make the information companies report more useful to investors.

Even perfectly implemented, the Taxonomy Regulation is still a blunt instrument. It produces for each company a set of percentages of how much of its activities are sustainable, and how much not — a binary categorisation based on criteria that are necessarily out of date.

When the law was being drafted, greens wanted a rainbow taxonomy showing gradations of greenness, like the energy efficiency rating labels on the sides of washing machines — but politicians nixed that.

So the EU Taxonomy does not even try to tell you how far towards perfection a company’s green stuff is, nor how dire the non-green.

It has taken the UK a very long time to make up its mind on its own Taxonomy — the decision would have been much more valuable seven years ago when the EU began its project. But it has made the right call. A taxonomy has some uses, but they aren't worth the gigantic effort.

Announcing its decision, the Treasury proclaimed: “Growth is the number one mission of this government and sustainable finance can be a key driver of that growth.” To that end, the UK “is delivering a world-leading sustainable finance framework”.

A word to Emma Reynolds, City minister responsible for sustainable finance: the UK’s rivals for leadership in sustainable finance will not see scrapping the Taxonomy as proof of excellence. They will exploit it by portraying the UK as half-baked and half-hearted.

Grandstanding about one country or another capturing growth by leading in sustainable finance regulation is really guff. Politicians have to say this kind of thing, but companies employ bankers based in London to do green transactions because they have the requisite skills — if it is a French company or wants to sell to French investors it will have to follow EU regulations.

Where the quality of UK regulation does matter is to the UK's own economy, its companies and ultimately, the environment that supports human life.

If the UK is to achieve the real purposes of sustainable finance — as Reynolds put it, “to accelerate investment into the transition to net zero and limit greenwashing” — it must make the other parts of its sustainable finance regulation not just serviceable, but world class.

The country has already won points for its Sustainability Disclosure Requirements, the reporting and labelling rules for funds, which is widely seen as an improvement on the EU’s confusing Sustainable Finance Disclosure Regulation.

But the two most vital parts of any green finance architecture are still under construction in the UK. Companies must disclose how sustainable they are now — and then say how they plan to improve.

The Department for Business and Trade is holding a consultation until September 17 on its draft UK Sustainability Reporting Standards. These are based on the IFRS S1 and S2 standards of the International Sustainability Standards Board.

That is a good start — using an internationally agreed standard will help business and investors.

The ISSB standards are focused on what is material for the financial performance of the company reporting. They do not include ‘double materiality’ — the obligation to report outward effects on the environment or society.

This alignment is likely to make the UK SRS popular in the market, as reporters and users will see the point of doing the work.

But to achieve true sustainability, markets — and reporting — will have to move beyond that.

When a small company cuts down a wood to build a second factory, that may be its biggest environmental decision of the year — and will probably count as material. When a huge multinational does the same thing, it’s a footnote. But the environmental impact is the same.

After adopting SRS — ideally for a wide scope of companies — the UK must look ahead to the next step: how to ensure financial markets have a truly clear and complete picture of where environmental harm and progress are happening.

Reporting is just providing the necessary information. The real work is transitioning to a lower carbon economy.

The UK spotted this early, setting up a Transition Plan Taskforce, which operated from April 2022 to October 2024 and produced a wealth of guidance for companies and financial firms on preparing and using transition plans.

Last year another government commission led by Vanessa Havard-Williams produced the Transition Finance Market Review, and a Transition Finance Council has been set up by the government and City of London Corporation to implement its findings.

But although a great deal of knowledge has been gained and disseminated, transition planning remains a work in progress.

Some transition plan disclosure is already required of large listed companies and financial firms. In June the Department for Energy Security and Net Zero launched a three month consultation on how to implement the Labour government’s manifesto commitment to make it mandatory to produce a transition plan compatible with the 1.5°C goal of the Paris Agreement. But it will only apply to financial firms and FTSE 100 companies.

The spirit of transition planning should be tolerant. No company can know what operating conditions will be like in 2030, let alone 2050. Companies will have to admit they are uncertain, and investors will have to accept changes and sometimes reversals.

But this is the central task of sustainable finance: helping companies as they work out how to achieve the transition to sustainability.

That means understanding company performance and evaluating transition plans — are they ambitious enough, and are they realistic?

The old ethical equity investors knew this. They looked at whole companies, living and breathing, and did not dissect them as a mass of disparate activities at a point in time, as a taxonomy does.

UK policymakers have an opportunity now. The green finance movement that could begin in 2025 — better called a transition finance movement — could be led by real experts.

The UK has as many of them as any rival, and they are well known to the government and financial world, through groups like the Transition Finance Council and the many sectoral trade bodies already working to make industries more sustainable.

They have been working for years on the right problem, and are ready to create a new investment culture of comparing transition plans.

But the government has to make the market do it. Education is a wonderful thing, but children don’t go to school without being told.