EU Taxonomy Regulation: will the UK government implement it in full after the Brexit transition period?

In May 2020, the Economic Secretary to the Treasury, John Glen, replied to the House of Commons European Scrutiny Committee, which had asked whether the UK intends to implement the EU Taxonomy Regulation into UK law after the end of the Brexit transition period on 31 December 2020. This Regulation will define the types of activity that are “environmentally sustainable” for the purposes of EU regulated investment activities claiming to focus on sustainability.

The letter from the Treasury states that:

"Under the terms of the European Union (Withdrawal) Act 2018, only legislation which comes into force before or during the implementation period will become retained EU law. This implementation period will end on 31 December this year. The disclosure requirements set out in articles 4-8 of the final text will only apply in respect of the two environmental objectives after 31 December 2021 and after 31 December 2022 for the remaining environmental objectives. Therefore, as you note, these requirements will not form part of retained EU law.

However, given that the Taxonomy is due to enter the Official Journal of the EU during the implementation period, most likely within the next couple of months following adoption by the Council and the Parliament, the remainder of the level one file (i.e. except articles 4-8) will become retained EU law. This effectively means that the UK will retain the framework for the taxonomy, including the high-level environmental objectives. Pursuant to the powers under the European Union (Withdrawal) Act 2018 (as amended by the European Union (Withdrawal Agreement) Act 2020), the Government will be addressing any deficiencies in the retained law to ensure it is fully operable from the end of the implementation period.

The UK government committed in the Green Finance Strategy to at least match the ambition of the objectives of the EU Sustainable Finance Action Plan. We recognise that the EU taxonomy will play an important role in the development of Green Finance and in preventing greenwashing, an important UK objective. The UK is also committed to promoting globally consistent standards, and these commitments form a key part of our strategy to strengthen the UK’s status as a global hub for sustainable finance.

However, given that the delegated acts setting out the technical standards criteria (TSC) have not yet been published by the Commission, and we therefore do not have clarity on the final outcome of the file, we cannot comment at this stage on the extent to which we will align with the EU after the implementation period. We will therefore continue to monitor this process as we consider the UK’s approach to green finance standards."

Under the Taxonomy Regulation, an “environmentally sustainable” activity must contribute to at least one of six stated environmental objectives and do no significant harm to the others. Further definition of these objectives will be provided by technical screening criteria (TSC) under future delegated legislation. Although the Regulation entered into force on 12 July 2020, it cannot start applying in practice until the TSC for the first two environmental objectives (climate change adaptation and climate change mitigation) have been adopted. The TSC for those environmental objectives will not come into force until 1 January 2022. And the TSC for the remaining four environmental objectives (water, circular economy, pollution control and biodiversity) will not come into force until 1 January 2023.

The Brexit transition period ends at 11pm BST on 31 December 2020. Under the European Union (Withdrawal) Act 2018, the Taxonomy Regulation itself will form part of EU retained law after the end of the transition period. That means that the framework for the taxonomy, including the high-level environmental objectives, will form part of UK law, but the detailed rules in the TSC of how you define those high-level environmental objectives will not automatically do so. Although the letter from the Treasury does not mention the EU Sustainable Finance Disclosure Regulation, similar issues arise as the first set of requirements under that legislation will start applying from March 20201 (i.e. after the end of the Brexit transition period).

The letter from the Treasury makes it clear that the UK government is reserving the right to come up with different technical rules for the taxonomy. So it is possible that asset managers and other financial market participants in the UK may end up having to follow one set of taxonomy rules for financial products placed on the EU market and another set of rules in the UK. Not surprisingly, this is giving rise to some concern in the financial services market.

In June 2020, the House of Commons European Scrutiny Committee replied to the letter from John Glen, asking the government to clarify why it is considering introducing its own detailed rules for the environmental objectives in the EU taxonomy and whether this has been raised, or is likely to be raised, in the context of discussions with the EU on equivalence for financial services, especially with respect to asset management and investment services.

The UK Sustainable Investment and Finance Association (UKSIF) - whose asset manager, bank and financial adviser members oversee £7tn in assets, including Aviva Investors, Columbia Threadneedle, Hermes Schroders, Standard Life Aberdeen and M&G - has also urged the UK government to commit to the EU’s green finance rules after Brexit or risk falling behind Europe on sustainable investing. According to the Financial Times, UKSIF has written to the Treasury calling on it to publish its regulatory approach to responsible investing “at the earliest opportunity”. UKSIF is concerned that the UK’s inaction on defining its sustainable finance rules could compromise the UK’s credentials as a hub for ESG investing. Asset managers need time to adapt to any forthcoming regulatory change. The Treasury has, apparently, said that while it recognised the importance of a globally consistent approach to sustainability standards, including with the EU, it wanted to ensure that any standards are appropriate for UK-based firms and would set out further detail “in due course”.