European infrastructure assets and the EU green taxonomy

This article summarises a new study by EDHECinfra & Private Assets, which indicates that $1.6trn of the European infrastructure asset class (European Economic Area and the UK) by size is likely to qualify as sustainable under the EU Taxonomy for Sustainable Activities, while only $10bn of assets by size is likely to have no sustainable characteristics and could be stranded in the transition to a low-carbon economy. An additional $235bn of infrastructure is not aligned with the EU taxonomy’s definition of sustainability.

New documentation from the European Commission clarifies that EU investments in taxonomy-aligned ‘environmentally sustainable’ economic activities can be automatically qualified as ‘sustainable investments’ in the context of the product-level disclosure requirements under the SFDR (EU Commission [2023]). Using EDHECinfra & Private Assets’ infrastructure universe dataset, which is representative of the European infrastructure asset class, we thus estimate that 88% of infrastructure investments by size can potentially be sustainable investments.

Why EU taxonomy alignment matters for assets

The aim of the EU taxonomy is to help investors identify sustainable investments, to avoid misrepresentation of sustainability (a practice often described as ‘greenwashing’) and to facilitate investment in the transition to a sustainable, low-carbon economy. It can therefore have considerable influence on the perception and approach to assets in the EU, including infrastructure and investment products that include infrastructure assets.

Classification of an investment as sustainable is likely to offer advantages for an infrastructure asset. Green investments often provide access to public sector financial incentives, such as cash grants, soft loans and tax incentives, as well as private sector loans that are easier to access and may have more favourable terms than market standards. Classification as sustainable may also indicate a lower technology risk in transitioning the asset to a net-zero operation that is compatible with many countries’ longterm climate policy objectives. Any accelerated rate at which finance can be acquired for these sustainable asset classes could therefore be expected to drive their growth and contribute to the transition to a sustainable economy.

If an asset fails to be classified as sustainable under the EU taxonomy, this could be a sign of sustainability risk. At the very least, it is likely that such assets will be excluded from green finance mechanisms or initiatives in the EU. It may also be an indication that physical factors – such as the asset’s underlying technology or its location – may hinder or prevent its transition to a sustainable economy. This could include the inability to shift technology away from processes that emit greenhouse gases to the atmosphere or the inability to operate within regulatory requirements.

Methodology and data

Our study aims to classify infrastructure companies in Europe as sustainable or not, as per the EU taxonomy objectives of ‘climate change mitigation’ and ‘climate change adaptation’.

The dataset of this exercise are the 5,500 European (European Economic Area and UK) companies in the EDHECinfra & Private Assets universe, with the breakdown by asset classes presented in figure 1. These are presented by their high-level categorisation in The Infrastructure Companies Classification Standard (TICCS) – a systematic taxonomy developed by EDHECinfra & Private Assets to identify infrastructureowning companies by asset type and economic properties.

Each of these companies tracked by EDHECinfra & Private Assets has a primary TICCS industrial classification. The main activity of each asset subclass is identified and mapped to corresponding Nomenclature of Economic Activities (NACE) activities. NACE designates the standard integrated classification system for European products and economic activities.

The EU Commission provides a mapping of the EU taxonomy activities against the NACE classification system. Thus, the NACE classification system was used as an intermediary to map the Industrial Classification pillar of TICCS to the EU taxonomy activities with the objectives of climate change mitigation and climate change adaptation. This produces a binary classification of each asset subclass as ‘qualified’ or ‘not qualified’.

Results

From the set of 5,500 companies in the EDHECinfra & Private Assets universe dataset, 84% have activities that align with those defined by the EU taxonomy. This translates to a size of $1.6trn, showing that the European infrastructure asset class is highly aligned towards sustainable investment classes. Figure 2 presents the percentage of assets by asset count in each country aligned to the EU taxonomy sustainable activities.

The power sector plays a significant role in the high level of sustainability compliance in the assets considered in this study. Some of the largest superclasses of infrastructure in the TICCS classification system are compliant with taxonomy sustainability requirements. This is especially true of the power market, where renewable energy generation forms an entire investment superclass (IC70) of its own. This superclass includes 54% of all companies in this analysis. Furthermore, most of the non-renewable generation (gas and nuclear) is also classed as sustainable.

However, this high level of compliance also reflects the degree to which investment has occurred in renewables in the European market. Significant incentives have been applied at supranational level, including obligations on the proportion of renewables in power and fuel markets, and through national level policies. These include the Renewable Energy Directive at EU level. The result is that the power market consists predominantly of companies with assets that are seen as being sustainable and that this market also dominates the infrastructure assets used in this analysis.

The EU taxonomy is a list of activities that are green, but it is not a list of activities that are unsustainable. The assets that do not qualify in this exercise thus cover a range of assets that have varying characteristics – from being stranded to simply not being considered.

The Intergovernmental Panel on Climate Change (IPCC [2022]) describes stranded assets as those which “suffer from unanticipated or premature write-offs, downward re-valuations, or conversion to liabilities”. It notes that climate policies, other policies and regulations, innovation in competing technologies and shifts in fuel prices could all lead to stranded assets. In particular, it sees coal assets being at risk of stranding before 2030, while oil and gas assets are projected to be more at risk of being stranded towards mid-century. This means that fossil fuel-intensive asset classes of coal, oil and gas are at the risk of being stranded. Among these three types of assets, the EU taxonomy qualifies natural gas as sustainable, leaving coal and oil asset classes (distribution, storage and power production) to be stranded. Following this logic, this study classifies coal and oil assets as stranded that make up about 4% by size ($10bn) of the total non-qualified assets.

A few asset classes, including social infrastructure such as buildings, do not have activities that match the EU taxonomy. While the taxonomy does not explicitly recognise the activities of these assets as green, in some cases, it is possible that they can qualify based on their characteristics or if they undertake another related activity specified in the taxonomy as sustainable – including a suitable level of renovation and improvement, or by installing on-site renewables generation. As such, compliance is based on when that asset was built and what technology it uses, and it is not possible to qualify these companies as they are not explicitly identified as sustainable in the taxonomy. They are thus classified in this study as ‘un-qualified’.

The EU taxonomy takes an activitybased approach to financial products, rather than an asset-based approach. This leads to some key types of infrastructure assets being excluded but which are essential to enabling other sustainable activities. For example, some asset types, such as facilities to distribute, liquify and re-gasify natural gas, are not classed as sustainable, even though their function is essential to maintaining the supply to gas-fired power stations, which are classified as green under the taxonomy. In cases such as these, these supporting asset classes were ‘qualified’ as sustainable ex-ante in the study.

Some social infrastructure types, particularly those consisting of land, including public parks and sports fields, are not explicitly sustainable activities following the EU taxonomy and yet have little or no adverse sustainability impact themselves. Despite the de facto sustainable operation of such assets, there appears to be no clear way of recognising this in an investment product. This is because, with the exceptions of forestry and wetland development, the sustainable use of land falls outside EU taxonomy activities. Given that these are low-carbon assets, these were also ‘qualified’ ex-ante as sustainable in the study.

Conclusions

This study indicates that $1.6trn of the European infrastructure asset class (European Economic Area and UK) by size is likely to qualify as sustainable under the EU Taxonomy for Sustainable Activities.

This analysis concludes that $245bn worth of infrastructure investments in Europe are not aligned with the EU taxonomy. This consists of $10bn of assets by size that have no sustainable characteristics and could be stranded in the transition to a low-carbon economy and an additional $235bn of infrastructure is not aligned with the EU taxonomy’s definition of sustainability.

Lack of alignment with the two objectives of the taxonomy considered in this study – climate change mitigation and climate change adaption – are likely to strand assets during the energy transition, making carbon intensive assets in the coal and oil sector inoperable without incorporating carbon capture technology. This type of European infrastructure assets in the study is worth $10bn. The remainder of the assets that do not qualify as sustainable cannot be considered green, but also should not be considered stranded. These assets can be decarbonised with interventions, but as they are not explicitly classified as sustainable, they are considered unaligned with the taxonomy.

The EU taxonomy has been established to identify those activities that convey sustainability advantages, rather than those that are unsustainable. An asset’s lack of alignment with the sustainability criteria should not be conflated with it being unsustainable, either economically or environmentally. Alignment (or the lack of it) of an asset class to the EU taxonomy as per this study does not suggest that these asset classes or companies within these asset classes are aligned by default. Rather, it means that these asset classes ‘qualify’ to be assessed against the ‘substantial contribution’ and ‘do no significant harm’ criteria outlined by the EU taxonomy, which are necessary to establish a company’s sustainability classification.

Compared to investments that the EU taxonomy classifies as sustainable, there is little high-level indication in either the taxonomy or the SDFR as to whether exclusion of an infrastructure asset’s main activities from the sustainability criteria represents a real or perceived risk to product and asset value. Nor does it reflect the ability of infrastructure assets to continue to operate as normal. This lack of clarity on sustainability may be detrimental to both product and asset value as a result of perceived risk.

InfraMetrics® by EDHECinfra & Private Assets provides sector-level physical and financial carbon intensity benchmarks that can be used to proxy an asset’s performance against the carbon intensity sustainable contribution thresholds of the EU taxonomy.

References

European Commission (2023) Commission Notice on the interpretation and implementation of certain legal provisions of the EU Taxonomy Regulation and links to the Sustainable Finance Disclosure Regulation 12 June.

IPCC (2022) Climate Change 2022 Mitigation of Climate Change – Working Group III contribution to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change.