What is the EU Taxonomy?

The EU taxonomy has established an EU-wide classification system that determines whether or not a given economic activity can be considered “sustainable” or “green”. It aims to facilitate and increase sustainable investment and to eliminate greenwashing – whereby a company either misrepresents or provides false information about sustainable products.

It is also one of the first significant efforts to regulate disclosure requirements for non-financial information. Established in the EU Regulation 2020/852, the EU Taxonomy obliges companies to disclose the measures they take on environmental, social impact and governance issues through a common classification system. 

Since it entered into force in July 2020, there have been a number of updates and changes to the regulation, making it difficult for many companies and investors to keep a track of all the new iterations. As such, in this post we will provide an easy-to-understand summary of the Taxonomy and its relevance to you.

Aim of the Taxonomy

The Taxonomy helps companies and investors to navigate the transition to a more sustainable European economic model in line with high-level policy commitments such as the Paris Agreement and the European Green Deal. 

Using this taxonomy, companies will be able to clearly demonstrate how they achieve sustainability in their businesses. This tool allows them to analyse their business model, the impact it has on the environment, and to establish plans with which to carry out any necessary adjustments. This will facilitate the smooth and streamlined implementation of their sustainable activities. 

Companies will be able to check the taxonomy of their economic activity by using a checklist. With access to a reference framework, management will be able to establish the appropriate changes to adapt their company to follow a sustainable model, if necessary. As a result, this will create all kinds of business opportunities, such as attracting investors with an interest in environmentally friendly projects.

Who does the EU Taxonomy affect?

The classification system is aimed at two user groups: the European Union and its members, and the parties involved in the financial markets. In addition, it directly affects companies, who must adapt to the criteria established by the EU. Investors are also involved, especially those seeking sustainable investment opportunities.

What are the benefits for companies?

The main advantage is that they have a legal framework to improve their activity and to make it sustainable. They are presented with a series of objectives to implement, which enables them to make far-reaching changes. In this way, they will be able to clearly demonstrate their commitment to the natural environment. To achieve this, they will have to pay attention to different technical criteria that will demonstrate the sustainability of their business.

In turn, companies can attract a great variety of investors. This variety will create the opportunity to raise capital from new sources: those that are interested in environmentally friendly businesses. As a result, companies will have access to more diversified sources of funding, which will make it easier for them to improve their business and to continue to grow.

They will also improve their internal organisation, as the shared criteria used in the taxonomy will simplify decision-making. Consequently, companies will be able to understand and communicate in the language used by investors and authorities alike, which will benefit society as a whole.

How should the EU Taxonomy be applied?

The regulation considers an activity to be sustainable or green if it complies with a list of six environmental objectives. These are:

• Climate change mitigation
• Climate change adaptation
• Sustainable use and protection of water and marine resources
• Transition to a circular economy
• Pollution prevention and control
• Protection and restoration of biodiversity and ecosystems

Other considerations in line with the objectives above that must be taken into account are to:

1. Contribute to at least one of six environmental objectives listed above; and
2. Do no significant harm (DNSH) to any of the other objectives, while respecting basic human rights and labour standards
3. Meet minimum social safeguards and not have a negative social impact
4. Comply with technical screening criteria developed by the EU’s Technical Screening Group (TSG) which specify the performance requirements to determine 1. and 2.

Companies will have to demonstrate that they meet the technical requirements for each environmental objective. Only details regarding the technical screening criteria for climate mitigation and climate adaptation were outlined in  2021 in the Delegated Act with more information on the remaining 4 objectives expected in 2022. The Act provided 70 criteria for mitigation and 64 for adaptation, grouped into three main categories: low carbon, transition, and enabling. For each objective the TSG have laid out thresholds that determine whether an activity complies with DNSH rules.

These factors allow the company to evaluate its impact, with precision and a holistic view, in relation to specific objectives. In this way, they have a clear roadmap of the appropriate measures required according to their specific needs. They will be equipped with a guide to navigating an uncertain future, with sustainability and care for the environment at its core.

EU Taxonomy Implementation Schedule

The implementation schedule will be developed as follows, which may be subject to change. By 1st January 2022, financial market participants will be required to disclose activities that substantially contribute to climate change mitigation and adaptation. This will involve the issuance of a report covering the entire year of 2021.

On 31st December 2022, technical criteria will be issued for the remaining environmental objectives of the taxonomy and, from the same year, companies will be required to disclose the percentages of turnover, investment and expenditure aligned with climate mitigation and adaptation.

Other considerations

As mentioned above, there have been several supplements to the original regulation including the Non-financial Reporting Directive (NFRD) and the Corporate Sustainability Reporting Directive (CSRD) which require certain corporate entities to provide Taxonomy-aligned disclosures by reporting on the following:

• The proportion of turnover derived from the Taxonomy activities; and
• The proportion of their capital expenditure and operating expenditure associated with Taxonomy activities

The CSRD expanded the scope of the legislation of the NFRD to include all large companies, listed-SMEs and EU subsidiaries of non-EU companies. Investors will also have to disclose ESG-related information from investees.

In addition to the CSRD, the European Commission has introduced the Sustainable Finance Disclosure Regulation (SFDR) which applies to sustainable finance products that have sustainable investment as their objective, and for those with environmental or social characteristics. 

Current limitations of the Taxonomy

As mentioned earlier, the current regulation only contains technical screening criteria for 2 of the 6 environmental objectives. It also only covers 13 sectors with some significant industries such as agriculture left off the current regulations. For those not covered by the Taxonomy, there is very little incentive to report using the framework. This limits the impact that these regulations can have in the near term, and with the looming threat of a warming climate, it is clear that the window for action is rapidly closing. 

If you want to generate reports aligned with the requirements from the EU taxonomy and analyse your corporate sustainability data with ease, APlanet‘s ESG data management tool can help you! Contact us or book a free demo on our website!

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