The EU taxonomy
By Emma van de Sompel
Leading up to 2050, the EU is mobilising all its forces to support its climate and sustainable development agenda. One such force, the EU Taxonomy, is a central element in reorienting investments towards building a zero, resilient and sustainable economy. The benefits of the EU Taxonomy as part of the EU Green Deal are becoming more prevalent to the users and the wider economy. But what does the EU Taxonomy actually entail? Who are the main users and what can they expect in the coming years?
What is the EU Taxonomy?
In the coming years, the EU aims to transform itself into a fair and prosperous society, where everyone can thrive in a modern, resource-efficient, and competitive economy with net zero emissions. The EU hopes to achieve this sustainable economic growth by 2050. To support the sustainable development agenda, ‘The EU Green Deal’ has been created (Figure 1).
In order to meet the 2030 & 2050 climate and energy targets, the EU must mobilise €1 trillion in sustainable investments over the coming decade. In doing so, the financial sector will play a crucial role in attracting private capital (e.g., equity, loans, project finance) that should be invested in climate change mitigating economic activities.
As such, an action plan for sustainable finance was created that sets out the various actions required to support the EU’s climate and sustainable development agenda (Figure 2). The EU Taxonomy is a central tool in realising this vision by 2050. As a new type of classification system aiming to define which economic activities are ‘green’, the EU Taxonomy helps raise the additional investments we need to build a net zero, resilient and sustainable economy. Financial market participants (e.g., investors, asset managers, ...) and companies will be required to disclose their sustainable performance in a comparable way by the start of 2022, creating security for investors from greenwashing, helping companies implement sustainability in their entire supply chain and, ultimately, reorienting investments towards building a climate neutral Europe by 2050.
The EU Taxonomy has recently been a fluctuating topic, leaving many organisations uncertain about the content and implications. Nonetheless, the urgency to jump on the EU Taxonomy train to become a sustainable leader is high.
Who has to report?
The EU Taxonomy Regulation is initially designed for use by three main parties:
Financial market participants offering financial products in the EU (pensions and asset management, insurance, corporate and investment banking).
Large listed or unlisted (non-)financial firms that already fall under the scope of the Non-Financial Reporting Directive.
Member states and EU institutions when setting public measures, standards, or labels for green financial products or green (corporate) bonds.
Currently, the taxonomy will only apply to these particular parties. However, it is expected to be extended across all users in the coming years – thus becoming the norm within the investment sector.
What do you need to report?
The Regulation sets out six environmental objectives to which a company’s economic activity needs to significantly contribute, in order to be considered taxonomy aligned:
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 ecosystem
The economic activities are then assessed on four criteria:
Whether they significantly contribute to one of the environmental objectives
Whether they do not significantly harm another environmental objective
Whether they comply with the technical screening criteria (e.g., standards, thresholds, targets to achieve) as defined by the EU Commission
Whether they comply with the OECD Guidelines and UN Principles for Human Rights
In general, the EU Taxonomy Regulation introduces a requirement to disclose information on how, and to what extent, their economic activities are aligned with the taxonomy. The precise reporting requirements, however, differ per taxonomy user and per economic activity as defined by the EU Commission. In essence, organisations will have to report on the proportion of environmentally sustainable economic activities that are in line with the EUT criteria. A firm’s environmental performance is then translated into financial variables (turnover, CAPEX and OPEX KPIs). Doing so allows financial institutions to make comprehensive financing decisions. Accompanying qualitative information about the calculation, the impact of Environmental, Social and Governance issues on the firm’s ecosystem and its value chain will also be required.
Why do you need to report on EU Taxonomy in your organisation?
By defining the EU Taxonomy on an economic activity level, the EUT regulation supports companies in the entire transition towards a sustainable entity. It assists your firm in financing your transition, mitigates market fragmentation, protects against greenwashing, and attracts additional investment to your sustainable activities. Additionally, the EU Taxonomy examines the capital expenditure associated with your transition plans, giving a comprehensive insight into the taxonomy-aligned investments and a clear alignment with a high sustainability standard, thus benefitting both your firm and investors in the transition towards sustainability. The gradual increasing share of green economic activities in your company will therefore improve its overall environmental performance.
In a similar light, the EU Taxonomy provides your organisation with the chance to go beyond the compliance aspect of the new regulation and embrace the opportunity that comes along with it. A full transition towards sustainability includes embracing sustainability within your firm’s entire operational scope, including its stakeholders and ultimately having an indirect impact on the wider economy. By doing so, you will be unlocking the true value potential of the EU Green Deal. Implementing the sustainable criteria set up by the EU Taxonomy within this scope will generate a more resilient supply chain and provide robust benefits for your entity in terms of costs and time and provide financial institutions with fluctuation-resilient investment portfolios.
Why is the EU Taxonomy a good thing for Europe?
Europe has established itself as a leading endorser of the UN Paris Agreement and Sustainable Development Goals and now also the EU Green Deal. The creation and implementation of the EU Taxonomy, a central element in the finance toolbox, is an important step towards achieving climate neutrality in Europe by 2050.
Most recently, to screen the sustainability of an investment, companies examined the Environmental, Social and Corporate Governance (ESG) criteria. By definition, however, ESG data is qualitative and not readily quantifiable in monetary terms. EU Taxonomy, on the contrary, integrates the qualitative ESG notions into a financial policy framework, creating a quantifiable assessment tool to be used by investors and therefore, mobilising finance for sustainable growth. The tool not only fosters the growth of low-carbon sectors, but also decarbonises high-carbon ones by setting quantifiable thresholds that polluting sectors need to comply with in order to be ‘taxonomy-aligned’ and attract additional ‘green’ investments. Whilst being an obvious incentive for firms to enhance their green economic activities, the EU Taxonomy is also a reliable instrument to assist companies on the roadmap towards full sustainability within their supply chain. It encompasses enough flexibility to allow them to follow and stay up to date on technological and market trends whilst being rigid enough to minimise the ambiguity about an activity’s ‘greenness’. These aspects create a common framework of references for investors and companies.