Lily Dai on the Green Economy, the EU Taxonomy and FTSE Russell Green Revenues

The Taxonomy aims to help investment firms explain their strategies in a way that is consistent, coherent, and easily comparable for their clients, setting guidelines for identifying environmentally sustainable activities. Investors would benefit from greater clarity around the criteria, metrics and thresholds. The need to build a workable framework for sustainable investment remains a priority for governments, regulators and investors. But the wide range of constituents, all with varying priorities and directions, makes achieving commonality a real challenge. Lily Dai, Sustainable Investment Research at FTSE Russell, shares her thoughts as to how a data provider can alleviate such problems by offering granular datasets to assess company exposure to green business activities.

What are the opportunities and challenges posed by the EU taxonomy?

The EU Taxonomy aims to define sustainable economic activities, and there are clear benefits in finding a common classification system to describe the green economy. Global financial markets rely on such common language to identify green investment opportunities and measure the associated growth and performance. It enables investors to direct capital to these opportunities and facilitates the creation of indexes and financial products through which capital can be deployed at scale. Recognizing the growing number of investors looking to allocate capital to the green economy, companies will seek to set out how their activities are aligned, which will improve corporate disclosure over time.

However, investors face a considerable practical challenge in meeting the EU Taxonomy requirements. While the EU Taxonomy will set out a catalogue of green criteria, it leaves it to markets to assess individual companies against these criteria. Yet our research shows that currently, less than 30% of companies with green revenues provide disclosures that are granular enough to allow investors to systematically break out and quantify companies’ green business activities. Until companies globally, not only those in the EU, provide full transparency on the extent to which taxonomy-aligned activities contribute to their revenues and capital expenditures, it will prove challenging to precisely measure the green exposure of global investment portfolios. These disclosures will improve over time, but this process is likely to be gradual, particularly for non-EU companies.

As a data provider how are you addressing the challenges of the EU taxonomy and what approaches are you using?

FTSE Russell’s Green Revenues (GR) data provides investors with a highly granular dataset for assessing company exposure to green business activities. Over 16,000 equities across 50 developed and emerging markets are evaluated and categorized against the Green Revenues Classification System (GRCS). Approximately 3,000 of these companies are identified as being engaged in providing green products and services. For these companies, the Green Revenues dataset provides a detailed breakdown of green activities and associated revenues, as well as an overall company green revenue estimate. Rigorous estimation methodology has been developed for assessing companies where public disclosure is insufficient to determine exact revenues from individual types of green business activities.

The underlying classification system GRCS covers 10 green sectors and 133 green micro-sectors across value chains. It builds on earlier versions that have been used to track leading companies in the green economy for indexes since 2008. The GRCS is highly aligned with the EU Taxonomy on core activities, providing investors with a practical and transparent tool to assess the exposure of equity portfolios to revenues from EU Taxonomy aligned activities, in a granular and accurate manner.

How do you really measure the Green Economy? What are the Green Revenue Data Models and the methodologies?

FTSE Russell’s Green Revenues Data Model identifies and analyzes listed companies with green products and services; a percentage of revenues derived from these products and services is produced for each company. These percentages are weighted by the company’s investable market capitalization and then aggregated up to generate an overall exposure to the green economy at country/sector level and ultimately an overall, global exposure estimate. Our data shows that the green economy reaches over USD4trillion, representing 6% of the market capitalization of global listed companies.

The data model first identifies companies with potential green products and services through semantic screening with keywords based on the GRCS. For companies where their involvement in green activities is confirmed, the company-reported business segments are analyzed, and microsectors under the GRCS classification are attached to the relevant segments. For the lion’s share of companies, publicly disclosed information is limited on revenues from each green business activity. Therefore further research is undertaken to obtain revenues associated with each green microsector and to establish their share in the company’s overall revenues. FTSE Russell achieves this through requesting additional disclosure from companies, conducting company-specific estimates with data proxy (such as production volumes and market share), and using the quantitative model to extrapolate green revenues at the sector level.

When talking about the green economy how far does this go beyond climate change? What sectors in the green economy are experiencing growth?

The green economy is much broader than climate change or renewable energies. Climate change is part of the seven environmental objectives underpinning our classification system on green products and services (six of them are overlapped with the EU Taxonomy). Through GRCS, we capture green companies and activities across the whole value chain which contribute to the following environmental objectives: climate change mitigation, climate change adaptation, pollution prevention and control, protection of healthy ecosystems, sustainable use and protection of water and marine resources, transition to a circular economy, waste prevention and recycling, and sustainable and efficient agriculture.

Our research shows that energy management & efficiency is the largest, fast-growing green sector driven by technology development and the need for cost reduction. Waste and pollution control sector is also expanding with the increasing awareness of recycling and air pollution issues. Low carbon transport equipment and solutions, albeit relatively small at the moment, is growing due to the evolution of EVs and the digitalisation of the economy. Renewable energy is still playing an important role, though its growth is slowing down.

How can investors use green revenue data models? What other approaches have you adopted when dealing with climate risks, ESG ratings and UN SDGs?

The Green Revenues Data Model can help investors identify companies with green products and services, track their performance and facilitate the construction of financial products that seek exposure to such companies. Investors can use the model to measure portfolio exposure to climate-related opportunities and performance to meet the climate/TCFD reporting requirements. The dataset can also be used as an input into climate risk-adjusted indexes to tilt towards companies offering opportunities in the climate transition. Crucially, the data model provides a granular, robust and transparent solution to assess and report on EU Taxonomy alignment for individual companies, investment products and broader portfolios.

To measure exposure to climate risks, in addition to Green Revenues, we provide carbon emissions and fossil fuel reserve models, sovereign climate KPIs (carbon footprint, physical climate and energy transition risk metrics), and sovereign risk monitoring (ESG-augmented credit risk analysis). In the ESG space, we have ESG ratings, RI consensus (Company ESG performance based on market consensus) and ESG FACTOR-In (linking ESG and country economic performance in a single model). We have also mapped the UN SDGs against our ESG data model. In collaboration with the Dutch pension fund Pensioenfonds Detailhandel and BlackRock, we developed the world’s first sustainable index to align a broad market equity benchmark with aspects of the UN’s SDGS). Company weights within the index are tilted using sustainable investment themes related to SDG 8, 12, 13 and 16. 

To read more on sustainable investment visit the FTSE Russell SI blogs.

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