Jane: [00:00:01] Welcome to the LSEG Sustainable Growth Podcast. I'm your host, Jane Goodland. And today we're in the Green Room segment with our expert Lily Dai, who's a senior research lead in our Sustainable Investment research team. And she's an expert on everything green So we talk taxonomies, definitions, environmental benefits and more. So, without further ado, let's get into the conversation.
Jane: [00:00:26] So, hello, Lily. It's great to speak to you. This is going to be so interesting because I know very little about green taxonomies, and hopefully you're going to enlighten me and everyone else that's listening as well. But before we start, tell us a bit about you. Where are you in the world today, for example? And what's your career been like so far?
Lily: [00:00:46] Thank you for having me. It's great to be here. Hello, everyone. My name is Lily Dai. I'm a senior research lead at Sustainable Investment Research Team at London Stock Exchange Group. I'm focusing on the research regarding green economy, sustainable finance taxonomies and providing IP methodologies and the data solutions and the running data analysis as well. Before I joined LSEG, I was with Climate Bonds Initiative in Non for Profits, focusing on developing standards for the green bond markets. I think that's, you know, my career starts with taxonomy, and I'm working on taxonomy. It's one of my favourite topics. At this very moment, I'm actually in China visiting my family after two years of the lockdown in China. I'm very happy to be here and I look forward to the discussions.
Jane: [00:01:36] I'm not sure your family are going to let you leave after a two year absence, but it's great to speak to you today. Let's start by getting into what we mean by green. So, we talk about green taxonomy. What do we actually mean by green? And also, I'm kind of curious, why do we need the label?
Lily: [00:01:53] Yeah, sure. It's a very good question, and I think it's a fundamental question to our financial market. I think Green represents environmental benefits. It can be climate change mitigation, it can be pollution control, it can be the ecosystem restoration, biodiversity protection. It can be related to product and services like companies providing renewables and water treatment equipment. And we also talk about, you know, green finance and investments, which are financial activities supporting green business. And I think the point of labelling these green products and services fundamentally it is to make our life easier to identify these green products and services and direct capital flows towards the green economy, in particular for investors and policymakers. So, if you think about the first green bond in 2008, it was because a group of Swedish pension funds they called the World Bank actuary. They were like, you know, we want to support climate, but we don't know how to find climate projects. That's how the World Bank started to looking for green projects and then they issued the first green bond in 2008. And they're very similar for equities as well at FTSE Russell we started in 2008 with Impacts Asset Management. We built the Environmental Markets Index series. We select companies with revenues generated from green products and services. And initially it was just for index purpose. And then we realized actually investors and the regulators are looking for the underlying data to see who are the green companies, green products services and how much revenue is generated from them. That's how we started develop the green revenue data to provide more transparency and to label green activities and green companies.
Jane: [00:03:48] So this all sounds very sensible, but something tells me that it's not quite as straightforward as just labelling what products and services or activities are. Green because I'm assuming that everyone has a slightly different view of what constitutes an environmental benefit and therefore how that transposes into a taxonomy or a classification system, right?
Lily: [00:04:11] Yeah. That's very that's a very good point. So, I think in a way that, all the climate and environmental challenges we are facing, it's a global issue we should be looking at very similar environmental and climate solutions. I think we all agree renewables is growing and waste water treatment is growing. However, different countries and regions have their own pathway. They have their own climate commitments. They have different deadlines or contribution to the climate. They have different targets. And of course, the economic development is different. So that makes them have a bit different focus on green activities and the classification systems and taxonomies, for example. I think the starting point for the EU taxonomy is about climate change. So they spend a lot of time on the climate change mitigation, trying to identify activities, making contribution to reduce carbon emissions. Well, in the case of China, for example, the starting point was the air pollution and land contamination, etc. So they are focusing more on the waste management and pollution control. But if you look at, the technologies, a lot of them are very similar. We are doing research mapping different taxonomies, including the EU taxonomy, the China catalogue for green bond issuance, our own classification, green revenue classification system and the Common Ground taxonomy, which was established by the Platform International Platform or Sustainable Finance, trying to improve the standardization of taxonomies. And we found that the majority of the green activities are very similar. But of course, different countries will have different thresholds and criteria. They have different national standards for green technologies, which will have different countries and regions will have different features of the taxonomy, which is the challenge from there.
Jane: [00:06:06] Well that's a problem for an equity investor, let's say, who's running a global portfolio and wants to get exposure to this theme globally, but then has to dissect and kind of sort of understand all of these different jurisdictions. And just that seems that seems like over complication really. How ridiculous is that in terms of could we ever get to a global taxonomy ever?
Lily: [00:06:33] I think that's the goal and I doubt that we're going to have a global taxonomy that every country and every region will subscribe. But what we are trying to push is the interoperability of all these different taxonomies. So, the platform, the international platform of sustainable finance that I've just mentioned, they established the common ground taxonomy drawing from the experience from China and Europe. They are coming up with a framework to compare different taxonomies. And the UK Green Technical Advisory Group, I'm involved. We are also developing a kind of report in recommendations on how to improve, well, first, to recognize this issue and what are the challenges it creates. As you said, corporates are going to have a lot of burden on disclosure. Investors needs to navigate different taxonomies. And what are the approach to improve the interoperability operability of those taxonomies. We discuss, maybe we use a very similar classification system of activities themselves, the technologists and the metrics. We want them to a threshold that we want these activities to meet. And of course, the reporting of regimes, whether there will be equivalence information among different taxonomies, these are all, I think, issues we are we're working on right now.
Jane: [00:07:56] But in terms of things like the way in which companies are even classified into sectors, that's an issue, isn't it? Because one of the things that we see is that effectively green is spread across the economy, right? We don't have a sector called green, and therefore, it's almost like the infrastructure that exists to categorize companies feels really almost a bit out of date, actually, because you mentioned disclosure and how important corporate disclosure is. And I'm assuming correct me if I'm wrong, that's because we don't have a way in our established systems to be able to categorize this. So, we rely on companies to disclose where they're getting their revenues from, whether that's green or not, which feels like a bit of a sticking plaster, really. So, talk to me about corporate disclosure and maybe how we can do something different.
Lily: [00:08:50] I think it's very true that current classification systems focus on the conventional business, that it doesn't really differentiate product and services with or without environmental benefits. I think that's why we are having developing sustainable finance taxonomies. We have our green revenues classification system, but I think it puts the taxonomies aside. Even we have a perfect taxonomy covers a lot of activities with very straightforward criteria that everyone agreed. It's still quite challenging for us to assess companies because of the lack of disclosure at this moment. All these taxonomies are not embedded in the existing accounting standards, reporting standards. Yet. I know the EU Commission is trying to establish more regulation in the reporting regimes. But, at this moment, we haven't seen much disclosure yet. If you look at our data, only 30% of our companies are reporting very detailed breakdown of green products and services. It's very important because we noticed that there are many green companies, but they may not tell you how much revenue is generated from their green activities or they may not break down their green products and services even we know they have they do have a green activity based on our analysts’ assessments, based on our screening process. And if you don't ignore them because they don't have disclosure, then you're potentially missing a very significant investment opportunities.
Jane: [00:10:21] So, investors looking to invest in that growth story in the green economy effectively might be missing those companies. Is that what you're saying that they're not spotting those companies because they can't see those green revenues?
Lily: [00:10:34] Yep.
Jane: [00:10:34] So, from the corporate perspective, the benefit of disclosing in that way would be about trying to appeal to a different mix of investors or investors looking for that theme.
Lily: [00:10:45] Yep.
Jane: [00:10:46] So I guess that makes sense why companies should be open to disclosing. But that, like you say, it's not common practice, is it? So only a third of companies doing that. Can you talk to me a little bit about, I guess, getting back to the why? So, I think it can get quite technical quite quickly. We talk about taxonomies, but fundamentally this is about a way to fuel investment in the solutions of the future. Right?
Lily: [00:11:10] Yep.
Jane: [00:11:11] So how do we not get bogged down in the technicalities of regulation and the taxonomies and none of them agreeing? You know, there's a whole host of challenges here, but how do we get back to that original question, which is fuelling the growth, the green economy?
Lily: [00:11:26] I think we need a bit of a market education as well for corporates to understand why they should start disclosing. I think, when we engage with companies, sometimes we don't get a lot of response because they lack incentives to disclose. If we explain to them that actually it's benefit for them and investors are actively looking at that, I think companies will be more willing to disclose in addition to the requirements under the regulation. And then I also think we should take a step back. The regulation can make it very complicated the EU taxonomy, you have many criteria regarding the substantial contribution the no significant harm and minimal safeguards. And investors, some of them can become quite conservative and a lot of their sustainable fund labels, they have been dropping because they are holding back. But I think we should take a step back and think about, we are looking at climate solutions and we shouldn't just be stopped or be very conservative because of the regulation. And these are green technologies. We should increase our investment. And a lot of analysis have showed that we need to think about 100 to 200 trillion investments by 2050 so we can be on track of the 1.5 degrees. So, I think from an investors and corporates point of view, we should look at the technology themselves, whether they are making contribution to climate solutions or environmental solutions, biodiversity, etc. or not, and increase the transparency of the business activities and connect with international standards. I think regulation is one story or one part of the whole picture but increasing investments and capital flows. I think that's the fundamental thing we should do. As in the financial markets.
Jane: [00:13:20] Focus on really what we're trying to achieve. Let's change tack a little bit here, Lily, because one of the things that I wanted to cover with you is we've talked about green. So, we've talked about the starting point being climate or air pollution, for example, in China. it seems to be very clearly in the environmental camp, but we all know that sustainable development and a sustainable economy and society is not just about environmental protection, actually, it's about social inclusion and progress on that front, too. So, I guess I'm going to ask the really hard question about how come we don't have social taxonomies? And if not, why not?
Lily: [00:14:02] I think sometimes we might forget that taxonomy is one of many tools to address sustainability issues or even the environmental climate issues. Ultimately, it's a classification system. It's a binary system telling you which activity is green or which is not. When it comes to social, I think it's much more complicated than that. We can say solar is green. We can say fossil fuel is not. But for social, we have to look at the impacts, not just the activity itself, but also the around the activity, the community, the ecosystem. What is the impact of that? I don't think taxonomy is the right approach to tackle that, frankly. We have other data, we have ESG data, we have corporate engagements, and we look at how they mitigate the social impact or how they improve the social benefits for their for the company, for the employee, or for the broader community. And for other environmental stuff, we have carbon emissions, we have ESG rating, we have the Transition Pathway Initiative to measure companies transition efforts. I think taxonomy is one of many tools provided for investors to address sustainability issues. So, I guess it’s not the perfect or the right one to address social issues. And we know the EU technical group has been looking at this. And it looks very complicated if you just rely on the taxonomy a classification system. So, I think we should rely and utilize other data that we have as well to address this.
Jane: [00:15:38] And I suppose that really lends itself towards, I guess, a way of allocating capital that is quite thoughtful around the holistic value proposition as opposed to a binary yes or no. It creates social value, for example, which I guess speaks more easily to some investment styles than others. So going back to the green side of the equation, after a short dalliance on the social side, I know that you guys published a report last year about looking to size the green economy and looking at the growth. Is that something you're going to redo this year? And can you give us any little early indications of what some of the outcomes might be? I don't want to put you on the spot, Lily, so please don't give away any secrets. I don't want to get you into trouble.
Lily: [00:16:23] No problem. Yes, this is our I think we're building it as a flagship report that we update every year and every year, in addition to annual updates on the size of the green economy, the growth, the performance, every year we add a bit of discussion. For example, this year we will talk about the volatility in the market. Last year we talked a little bit about that. But I think if you look at the last two years, the market is actually quite challenging or there are many changes due to COVID, due to the energy prices. And we will have a bit of discussion about the performance. We have a deep dive into all this issues related to energy, and I think we will continue the discussion on the revenue versus market capitalization growth. So, if you look at the size market capitalization of green companies, you might notice the size of green economy has dropped due to the overall equity market changes. But I think the revenue growth is still quite stable. And I think we will also discuss some more long-term drivers of the green economy, including I think this year we want to discuss the climate finance, the fund flows, who is investing in climate solutions and where does capital come from. I think for funds and for the capital flows in the rea economy as well, but I'm going to stop here. I don't think I should share with you too much about the reports. But I think the last thing is we're planning to publish the report in Q2 this year. So, I look forward to more discussions with you then.
Jane: [00:18:05] Okay, So, Lily, I won't ask you to reveal any more secrets, but I will keep an eye out for that report, because it does sound really interesting. And I think a really important thing to follow and have the data points. I think the thing that's quite interesting is actually that that report covers just the equity market and doesn't look at the bond issuance side of things. And actually, I think some of the interesting things that you've been talking about is how taxonomies in the bond space and the debt issuance almost feels a bit easier than it does on the equity side. So, any final thoughts about equities versus bonds and the green economy?
Lily: [00:18:42] Like you said, it's almost easier for to apply the taxonomy in the bond space because normally when you want to issue green bonds, you have to select a range of green projects and assets based on a catalogue or a classification system, a taxonomy. So naturally the issuer will report the information on that on the use proceeds. And sometimes they also report the impact of the proceeds, the carbon emissions, etc. But for the equity, it's a slightly different story because, if I'm a company and I'm not actively issuing green bonds, I may not disclose so much information about my underlying assets or projects. And naturally I will have less data points for investors or for companies like us to look at to assess companies. So, I think it's yes, like you said, it's more challenging, I think, in the equity space.
Jane: [00:19:39] I do feel as if I've had a bit of an education today. And thank you so much, because actually this can get quite complicated and technical. So, thanks very much, Lily, for taking us through the journey of understanding the why of taxonomies and actually not to forget the role of good corporate disclosure on this and remembering this is all all to simulate kind of real-world output and outcomes, isn't it? So, thank you very much for your time and your expertise and sharing that with us. Thank you so much indeed and safe journey home.
Lily: [00:20:10] Thank you.
Jane: [00:20:13] So that's it for this week's episode of the LSEG Sustainable Growth Podcast. If you're not already following us, then give us a follow and rate us on Spotify, Apple Podcasts, or wherever you get your podcasts. If you have questions, comments, or someone you'd like us to talk to next, then do drop us a line at fmt@lseg.com, thanks for listening and we'll see you next time.
