A Green Taxonomy#

In order to be able to determine the degree of greeness of issuers based on their activities, one needs a green taxonomy to determine what is deemed to be green or not.

In this part, we will first briefly describe the EU green taxonomy and its main drawback. Then, we will discuss the meaning of choosing a mixed taxonomy rather than a green or brown-only taxonomy.

The EU Taxonomy#

To provide a shared definition of green activites, the EU Commission has introduced the EU Taxonomy for sustainable economic activities, based on NACE codes. Activities are defined as green if they provide a contribution to a least one environmental objective (among six, even if technical screening critera have been developed for the two climate objectives only so far [Com21a] [Com21b]) while at the same time do not significant harm to other environmental objective. Furthermore, the activity must comply with minimum social safeguards (such as the UN guiding principles on business and human rights for example).

The main drawback of this initiative is that underlying data simply doesn’t exist at the issuer level yet (Alessi and Battiston, 2022 [AB22]), at least as long as the Corporate Sustainability Reporting Directive (CSRD) is not implemented yet.

Green, Brown or Mixed Taxonomy?#

As noted by Roncalli et al. (2022) [IMNT22], a green taxonomy may be restrictive since it tells us nothing about the browness of the issuer. Indeed, an issuer having an exposure to green activities of 30% doesn’t means that 70% is brown, but could be neutral.

Differentiating exposure to green, brown and neutral activities can be helpful for investors. To do so, one needs to define both a green and a brown taxonomy.

The goal of a green-based taxonomy is to identify more striclty green activities to promote them. With a green-based taxonomy, investors have no incentive to disinvest from brown activities, as those activities would be treated as the neutral activities. This is not the case with a brown-based taxonomy, whose objective is to clearly promote exclusion strategies from brown activities.

Finally, a mixed taxonomy would combined both green and brown taxonomies, with neutral activities identified as the remaining ones.

The differences between the three approaches (green, brown, mixed taxonomies) are the counterpart of selection (green taxonomy), exclusion (brown taxonomy) and integration(mixed) in ESG strategies.

Our Approach: A Mixed Taxonomy#

We follow Alessi and Battiston, 2022 [AB22] by adopting the list of green activities from the EU taxonomy (we combine both green and enabling technologies, but exclude transitional activities), as listed in the Annex 1 [Com21a]. However, due to the lack of data, we cannot follow the alignment process recommended by the EU taxonomy. Our approach stops at the first stage: the eligibility.

We recognize the need for a mixed taxonomy stated by Roncalli et al. (2022) [IMNT22]. In the absence of brown taxonomy from the EU Commission, we will follow the approach of the authors by using the activites in oil, gas and coal as a stringent definition of brown activities (we use Energy activities defined by GICS).

In our taxonomy, examples of green technologies are:

  • Electricity generation using solar photovoltaic technology

  • Production of heat/cool from bioenergy

  • Underground permanent geological storage of CO2

And examples of brown technologies are:

  • Oil & Gas Exploration & Production

  • Oil & Gas Storage & Transportation