While the Paris agreement focused on reducing the global temperature to a threshold of 1.5 degree Celsius by promoting low carbon emissions and providing the impetus for net zero pledges by companies across the world, the general consensus remains that there is a lack of a binding enforcement mechanism to achieve these goals.
The European Commission put forth the European green deal in 2019 to address these issues and set regulations in place with an overarching goal of Europe being the first “climate-neutral” continent in 2050. By adopting this deal, the EU and its member states agreed to climate, energy, transport and taxation policies fit for reducing net greenhouse gas emissions by at least 55% by 2030.
An integral part of this initiative is the EU taxonomy.
What is the EU Taxonomy?
The EU Taxonomy was introduced in 2018 as part of the EU Action Plan on Sustainable Finance, established by the EU Technical Expert Group on Sustainable Finance (EU TEG). The taxonomy is a classification system enabling the categorization of economic activities that play key roles in contributing to at least one of six defined environmental objectives.
The six objectives include:
- Climate change mitigation
- Climate change adaptation
- Sustainable use and protection of water and marine resources
- Transition to a circular economy
- Pollution prevention
- Control, protection, and restoration of biodiversity and ecosystems
To be considered environmentally sustainable under the EU Taxonomy Regulation, an economic activity must meet the technical screening criteria for at least one of these six environmental objectives and must not significantly harm any of the other environmental objectives.
Who does this apply to?
Any company that falls under either of the two buckets.
- Companies subject to the Corporate Sustainability Reporting Directive (CSRD), including those currently subject to Non-Financial Reporting Directive (NFRD).
- Financial Market Participants subject to Sustainable Finance Disclosure Regulation (SFDR), including pension providers, offering financial products in the EU marketed as environmentally sustainable
The EU Taxonomy Regulation applies to a wide range of companies and financial products and services, including bonds, equities, and other types of securities (the taxonomy methodology assesses over 100 different economic activities). The regulation requires companies and projects that fall under its scope to disclose information about their environmental performance, including information about their emissions, energy consumption, and other environmental impacts.
For more information on the Corporate Sustainability Reporting Directive (CSRD) and how it can affect your organization, register for the CSRD Masterclass webinar series today.
What does the EU Taxonomy look to accomplish?
The technical screening criteria under the EU Taxonomy was designed to help businesses effectively adapt their strategies to tackle environmental sustainability while giving a clearer framework to assess a company’s alignment with sustainable economic activities. It provides a clear set of sustainability reporting guidelines and a system to prevent organizations from greenwashing their activities. For a company to demonstrate it has capital expenditure aligned to the Taxonomy, it needs to demonstrate that it has substantial contributions to at least one of six environmental objectives and passes a “do no significant harm” (DNSH) assessment regarding any other.
The EU Taxonomy Regulation is a significant step forward in the effort to promote sustainable finance, sustainable investments, and combat climate change. By providing a classification system for environmentally sustainable economic activities and requiring companies and projects to disclose information about their environmental performance, the regulation will help investors make more informed decisions about where to invest their money. In the long term, this should lead to more investment flowing into environmentally sustainable projects and companies, which in turn will help to drive down emissions, improve energy efficiency, and protect the environment.
When will it pass?
The European Union passed the ‘Climate Delegated Act’, which defined environmental standards around what activities and investments can be labelled green in the following sectors:
- Energy
- Manufacturing
- Transport
- Buildings
This act covers the first two environmental objectives (climate change mitigation and adaptation) of the EU taxonomy and came into effect on January 1, 2022. This means as of today, only 2 of the 6 objectives listed by the EU to ensure sustainable finance are in effect.
The EU has drafted the next act, the ‘Environmental Delegated Act’, which covers the remaining four environmental objectives, entailing economic activities across many new sectors including clothing, food products, recycling, and more.
This latest act currently looks to be passed sometime in 2023.
What does this mean for organizations?
Along with the EU taxonomy acts, organizations must get started with CSRD compliance. As companies that fall under the purview of the CSRD also must follow the EU Taxonomy guidelines, both regulations need to be on organizations’ radar. The CSRD came into effect on January 5, 2023, and applicable organizations need to begin reporting from the start of FY24.
With the Climate Delegated Act approved, the first two climate objectives have started implementation since January 2022, enabling companies to begin reporting against the taxonomy. Asset managers, investors, financial institutions, and financial market participants (FMPs) can now prepare for SFDR requirements, which are in effect for the reporting year 2022. While the taxonomy has been cleared to become law, the classification of some activities remains unclear, like the use of fossil-based natural gas and nuclear energy, for example.
As the regulation is still new and it will take time to fully implement, however it is important for companies and investors to start familiarizing themselves with the EU Taxonomy Regulation and move to be taxonomy-aligned. This will ensure they are well-positioned to take advantage of the opportunities presented by sustainable finance and to meet the challenges posed by climate change.
Companies should assess which of the taxonomy objectives apply to them and create a plan around reporting along these objectives.
