EU Sustainable Finance Framework Needs Expansion to Meet Paris Climate Goals, New Research Shows

EU Sustainable Finance Framework Must Go Further to Meet Paris Climate Goals: New Research Urges Expansion

As the global financial system grapples with the urgency of addressing climate change, the European Union’s sustainable finance framework is coming under scrutiny. New research suggests that the current EU taxonomy, a system designed to classify economic activities as environmentally sustainable, needs to expand significantly in order to meet the targets outlined in the Paris Climate Agreement. Specifically, the EU’s framework, as it stands, is unlikely to keep global temperature rise below the crucial 1.5°C threshold.

The EU taxonomy plays a critical role in steering investments towards projects that contribute to environmental sustainability. By defining which economic activities can be considered environmentally sustainable, it seeks to direct capital into sectors that will help achieve the EU’s climate goals. However, as the recent study shows, there are key shortcomings in the taxonomy that must be addressed if it is to effectively contribute to the fight against climate change.

The research, which compares the EU taxonomy to energy scenarios created using the One Earth Climate Model (OECM), reveals that the taxonomy, in its current form, fails to encompass the full scope of economic activities and industries necessary to reach the Paris targets. The OECM is a globally recognized integrated energy assessment tool developed by the University of Technology Sydney (UTS) and the Net-Zero Asset Owner Alliance between 2017 and 2019. The model evaluates the energy transitions of entire economies and provides scientifically robust data to help guide investment decisions in line with climate objectives.

Current Gaps in the EU Taxonomy

According to Associate Professor Sven Teske, a co-founder of OECM and Research Director at the UTS Institute for Sustainable Futures, the current EU taxonomy does not adequately reflect the breadth of industries required for a sustainable, low-carbon future. His team’s findings, based on the OECM methodology, show that the EU taxonomy, if fully implemented across the entire EU economy, would encompass 30% of the EU’s GDP. However, it would only cover 7.2% of all energy-related CO2 emissions from the EU27 region. This represents a significant gap in the taxonomy’s ability to address the core drivers of climate change.

Teske emphasizes that taxonomies need to include all industries, not just those currently deemed environmentally sustainable. In addition to this, the transition finance period—wherein industries shift towards greener technologies and practices—must be factored into the taxonomy. Currently, the EU framework overlooks these critical components, which diminishes its potential impact.

“Taxonomies need to include all industries and must take the transition finance period into account,” Teske said. “The current EU taxonomy does not include both of these points. It needs to be expanded to be truly effective in advancing a sustainable, low-carbon future.”

The OECM, which has been applied to the G20 nations and the EU27 region, is designed to create energy scenarios and establish fair carbon budgets for each country. The model’s detailed analysis has shown that current energy policies in these regions are insufficient to limit global temperature rise to 1.5°C, further highlighting the need for more ambitious and comprehensive action in both national and international climate frameworks.

Three Key Areas for Improvement

The study’s findings identify three major areas where the EU taxonomy needs to be expanded to better align with climate science and the goals of the Paris Agreement.

1. Broader Industry Inclusion
   One of the most notable gaps in the current EU taxonomy is its limited coverage of industries. While sectors like energy, transport, and agriculture are included, significant industries such as chemicals and other high-emission sectors remain excluded. The research argues that a truly comprehensive taxonomy must include all industries and services, particularly those that have a substantial impact on global emissions. The chemical industry, in particular, is a major emitter of CO2, yet it is largely overlooked in the current framework. Including such industries in the taxonomy will help to direct investment to high-impact areas and drive more substantial reductions in emissions.
2. Long-Term Targets for Net Zero Emissions
   Another major gap identified in the research is the lack of long-term targets beyond 2035. While the EU taxonomy sets targets for 2025 and 2035, these do not sufficiently account for the long-term goal of achieving net-zero emissions by 2050. The study recommends that the taxonomy set clearer long-term benchmarks that guide industries and investors toward sustained, incremental progress towards net zero emissions. These long-term goals will be essential for ensuring that investment continues to flow into projects that will have the most significant and lasting impact on reducing global emissions.
3. Support for Transition Finance
   The third area of concern raised by the study is the lack of support for “transition finance” within the EU taxonomy. As industries and sectors move from high-carbon to low-carbon technologies, they require financial support to facilitate this transformation. Without a mechanism to guide transition finance, industries may face financial barriers that prevent them from adopting sustainable practices. The taxonomy must be expanded to support this transition and provide clarity for investors about how to support companies during their shift to more sustainable operations. This includes helping industries make the leap to greener technologies while still generating returns for investors.

Implications for the Finance Sector

For investors, expanding the EU taxonomy in line with the OECM’s recommendations would not only provide a more accurate and effective tool for directing investments into sustainable sectors, but it would also help identify high-impact areas where contributions could drive substantial environmental change and deliver long-term economic returns.

The current EU taxonomy is limited in its scope, which means that it fails to highlight certain industries and sectors where investments could have a more profound impact on reducing emissions. By broadening the scope of the taxonomy and including industries like chemicals, investors would have the opportunity to drive environmental change in sectors that are often neglected, while also positioning themselves for long-term financial gains.

Moreover, the OECM methodology could enhance the rigor of the EU taxonomy, ensuring that investment decisions are based on scientifically grounded, equitable energy transition pathways. This would give investors confidence that their investments are not only aligned with global climate goals but are also contributing to a fairer, more sustainable future.

Looking Ahead: The Role of International Finance

The study’s findings are particularly relevant for the international finance sector, especially as countries and regions outside of the EU, such as ASEAN, Singapore, and Australia, are developing their own taxonomy frameworks. As global investment flows increasingly align with climate goals, these emerging taxonomies will need to address similar gaps if they are to have a meaningful impact on global emissions.

The European Union, as a leader in sustainable finance, has the potential to influence the development of taxonomies worldwide. By expanding its framework to include all industries and by supporting the transition to low-carbon technologies, the EU could serve as a model for other nations seeking to address climate change through sustainable finance.

Associate Professor Teske will be presenting these findings at the upcoming COP29 conference in Azerbaijan, where world leaders, policymakers, and financial experts will discuss how to accelerate global efforts to combat climate change. His research will likely play a key role in shaping the discussions on how to expand the EU taxonomy and other international frameworks to meet the critical climate goals of the Paris Agreement.

In conclusion, if the EU is to remain at the forefront of sustainable finance, it must take decisive action to expand its taxonomy and address the gaps identified in this research. By including all industries, setting long-term goals, and supporting transition finance, the EU can create a framework that better aligns with the global effort to limit warming to 1.5°C and ensure a sustainable, low-carbon future for all.