As the world becomes more focused on sustainability, investment funds are increasingly expected to report on the sustainability of their investments. The European Union (EU) Taxonomy, part of the European Green Deal, provides a common language and framework for identifying and reporting on sustainable economic activities across the EU. Many investment funds that are classified as Article 8 or 9 funds under the Sustainable Finance Disclosure Regulation (SFDR) are required to use the EU taxonomy to report on the sustainability of their investments. 

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In this blog post, we will explore how investment funds can report on the EU taxonomy, including the types of disclosures they need to make and how they can calculate their level of taxonomy-aligned investments. We will also provide tips and best practices for reporting on the EU taxonomy, to help investment funds meet their reporting requirements and demonstrate their commitment to sustainable investing.

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What is an EU taxonomy report for investment companies?

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An EU taxonomy report for investment companies is a document covering the reporting requirements from the EU taxonomy, and disclosing information on their investments based on their environmental performanceThe taxonomy is a framework for classifying economic activities based on their environmental sustainability and aims to help investors identify and invest in economic activities that are aligned with the EU's sustainability goals. The report provides an overview of investments in companies with economic activities that are considered to be sustainable, based on their contribution to six environmental objectives: climate change mitigation, climate change adaptation, sustainable use and protection of water and marine resources, transition to a circular economy, pollution prevention and control, and protection and restoration of biodiversity and ecosystems.

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By utilizing the taxonomy and taxonomy reporting, investment companies can evaluate the sustainability of their investment portfolios and communicate their sustainability performance to investors. Ultimately, the EU taxonomy report for investment companies serves as a crucial tool in promoting sustainable finance and aiding the EU in achieving its environmental objectives.

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Why do investment funds need to consider the EU taxonomy?

Investment funds need to report under the SFDR if they are marketed in the EU. The SFDR is a regulatory framework that aims to increase transparency and promote sustainable investments by requiring financial market participants, including investment funds, to disclose information about the sustainability of their investment products.

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The SFDR has different levels of disclosure requirements depending on the sustainability characteristics of the investment product. Investment funds will fall into one of three categories based on their investment approach: Article 6, Article 8, or Article 9 funds. Article 6 funds are those that do not promote any specific sustainability characteristics (that is, funds other than Article 8 or 9), while Article 8 funds promote environmental and social characteristics, and Article 9 funds have a sustainable investment objective and incorporate ESG considerations into their investment decisions.

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The SFDR requires investment funds classified as Article 8 or 9 to provide information about their investment strategies, including how they integrate sustainability factors into their investment decision-making process. Investment funds must also disclose the environmental, social, and governance (ESG) characteristics of their investments, the proportion of ‘sustainable investments’ made, as well as any potential negative impacts of those investments on sustainability factors.

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In their disclosures, Article 8 and 9 funds are required to report on their sustainable investments. They need to do this in pre-contractual, periodic, and website disclosures to provide investors with transparency and information about the sustainability of their investments.

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One type of sustainable investment that Article 8 and 9 funds might need to report on is taxonomy-aligned investments. The EU taxonomy is a framework of classification criteria that is designed to identify environmentally sustainable economic activities. Funds can use the Taxonomy to determine whether their investments meet the criteria for environmentally sustainable economic activities. Taxonomy-aligned investments are those that meet the criteria of the EU taxonomy.

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Which Article 8 and 9 funds need to report on the EU taxonomy as a part of their SFDR disclosures?

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The following decision tree published by the European Supervisory Authorities (ESAs) provides an overview of when taxonomy disclosures become relevant for different types of Article 8 and Article 9 funds.

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For Article 9 funds, if the fund has an environmental objective and intends to make taxonomy-aligned investments, they should specify a minimum proportion of intended taxonomy-aligned investments in their pre-contractual reports. If they do not intend to make taxonomy-aligned investments, they should indicate 0. 

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For Article 9 funds that intended to make taxonomy-aligned investments, they should report on the actual share of taxonomy-aligned investments made in their periodic report. If they did not intend to make any taxonomy-aligned investments, but did in fact make some during the reporting period, they should report on the actual share of taxonomy-aligned investments made in their periodic report. Determining if the fund made taxonomy-aligned investments requires a screening of the fund and of new investments made during the reporting period.

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For Article 9 funds that have a social objective, if they did make taxonomy-aligned investments, they should report on their actual share of taxonomy-aligned investments made in their periodic report and also update their pre-contractual disclosures. If they did not make taxonomy-aligned investments, they are not concerned with taxonomy reporting. 

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Article 8 funds promoting an environmental characteristic will follow the same process as outlined for Article 9 funds. If they intend to make a taxonomy-aligned investment, this should be stated in the pre-contractual disclosures. If they made taxonomy-aligned investments during the reporting period, they should disclose this in their periodic report regardless of their commitments in the pre-contractual disclosure.

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Article 8 funds only promoting social characteristics are not concerned with taxonomy reporting.

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What data is needed for a fund to report on the EU taxonomy?

To report on their level of taxonomy-aligned investments, funds will need to calculate the percentage of their portfolio that is invested in activities that meet the criteria of the taxonomy. Funds can do this in several steps: 

1. Identifying which of their portfolio companies are eligible under the taxonomy - ie. which of their portfolio companies have eligible economic activities;
2. Getting the taxonomy scores of these companies - this can be done either by accessing the taxonomy report of companies subject to the NFRD, or by gathering data directly from the portfolio companies on their taxonomy scores where such data is not available. The fund will need the KPIs of the portfolio companies in order to calculate their own green investment ratio (GIR);
3. Calculating the share of the fund that is invested in taxonomy-aligned activities - this is done by following the calculation methodology set out in Article 17(1) of the SFDR RTS. Funds will need to divide the market value of investments in taxonomy-aligned/sustainable investments by the total market value of all investments;
4. Funds will also need to disclose which environmental objectives their investment make a substantial contribution to, and the share of investments in transitional and enabling activities.

By reporting on their level of taxonomy-aligned investments, Article 8 and 9 funds can provide investors with greater transparency about the sustainability of their investments. This information can help investors make more informed decisions about where to invest their money and support the growth of sustainable finance.

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Where should the taxonomy report be published?

There are three types of disclosures that a fund needs to make under the SFDR. These are:

1. Pre-contractual disclosures;
2. Periodic disclosures;
3. Website disclosures.

Each of these disclosures will require the disclosure of taxonomy information for funds with taxonomy-aligned investments.

Reporting templates are provided in the SFRD RTS for Article 8 and 9 funds. There are four templates available for product level reporting: pre-contractual disclosures for Article 8 funds; pre-contractual disclosures for Article 9 funds; periodic reports for Article 8 funds; and periodic reports for Article 9 funds. Further information on website disclosures can also be found in the SFDR RTS Articles 23 - 49. 

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These can be found at the following EUR-LEX link: SFDR RTS (Commission Delegated Regulation (EU) 2022/1288)

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These templates provide guidance on the format and content of taxonomy disclosures. In the following section we will dive into what information is required in a periodic report for Article 8 funds. 

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What should the report include?

Example: taxonomy data required for Article 8 periodic reporting

The template itself should be included in your periodic reporting for the Article 8 fund. This template requires both information on taxonomy alignment of your investments, and information on other types of sustainable investments you have made. 

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ESAs states that for periodic reports, Article 8 funds with taxonomy-aligned investments should complete the section “To what extent were the sustainable investments with an environmental objective aligned with the EU taxonomy” based on the actual investments during the reference period.

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Taxonomy related information is relevant in these elements of the template:

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1. A breakdown of the proportion of the investments per each of the environmental objectives (i.e. information on which environmental objectives the taxonomy aligned investments contribute to), how they do no significant harm to the other objectives.

Example: 

• 0% to climate change mitigation and DNSH to the five other objective
• Further comments

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2. A description of the investments in environmentally sustainable economic activities during the period covered by the periodic report, including whether the assessment has been assured, or reviewed by a third party.

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3. A graphical representation of types of sustainable investments, including share of taxonomy-aligned investments

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4. A graphical representation in the form of two bar charts of the degree to which the aggregated investments are in environmentally sustainable economic activities (taxonomy-aligned activities) during the period covered by the periodic report. One should include sovereign exposures, and one should exclude them. 

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5. A breakdown of the proportions of investments in transitional economic activities and in the enabling economic activities, in each case expressed as a percentage of all investments of the financial product.

Example: 

• 1% in enabling activities distributed as followed: 
• A
• B
• C
• Further comments

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6. Share of sustainable investments made with an environmental objective not aligned with the EU taxonomy. Where the financial product invested in sustainable investments with an environmental objective, but which are not environmentally sustainable economic activities under the EU taxonomy, a clear explanation of the reasons for doing so. 

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When aggregating investments in non-financial undertakings, turnover, CapEx and OpEx should be used. When aggregating investments in financial undertaking, turnover and CapEx should be used. 

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Tips for investment funds for EU taxonomy reporting

In this section, you will learn tips for investment companies for EU taxonomy reporting.

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Investment funds have a crucial role to play in supporting the EU’s climate goals by financing sustainable projects. As a part of achieving this goal, investment funds need to report on the SFDR and the EU taxonomy. Here are some key principles to keep in mind for investment funds when preparing for reporting:

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1. Transparency: 

investment funds should ensure transparency in their reporting by clearly communicating the methodology and assumptions used to assess their investments' compliance with the EU taxonomy. Transparency is key because it helps investors understand how investment funds are managing sustainability risks and impacts, but as the SFDR and EU taxonomy are so new, it also allows funds to be clear about any interpretations and assumptions they have made.‍

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2.Share practices: 

the best practices for SFDR and taxonomy reporting are being established now, in the first year of reporting. By sharing practices and methodologies and being open, funds can be at the forefront of developing best practices. 

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3.Reliable data: 

Investment funds should use reliable data sources to assess their investments' environmental performance. In the first years of reporting, there could be issues surrounding data availability on EU taxonomy alignment from portfolio companies that are not required to report under the NFRD. Here it is important to use best efforts to acquire relevant, accurate, and up-to-date data that provide a clear picture of the investments' environmental impact.

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4. Be conservative: 

Funds should use best efforts to gather data from portfolio companies, but in some cases, companies may have difficulty providing data in the detail required. Funds reporting on the SFDR should be conservative to avoid overestimating their investments' environmental benefits and to ensure accurate reporting of sustainability risks and impacts. Being conservative helps to prevent greenwashing and maintain investor trust. 

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5. Guidance for the first year of reporting: 

The EU has recognised that there may be challenges in data collection since funds will need to report before many companies have reported on the EU taxonomy. In this case, the EU Commission has stated that the first year of reporting under SFDR allows for certain exceptions, where funds must report 0% alignment if they fail to obtain the necessary data and should not use estimations or proxies. However, the EU Commission stresses that this only applies to exceptional cases where the fund has used best efforts to otherwise obtain the data. This allows for the transition into the new reporting requirements while ensuring that accurate reporting becomes a priority in subsequent reporting years.

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By following these tips for EU taxonomy reporting, investment funds can ensure that their reporting is transparent and reliable, which can help build trust with investors and contribute to the transition to a more sustainable economy.

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How can investment funds use the EU taxonomy report?

Investment funds can leverage their EU taxonomy report in a number of ways to enhance their sustainability credentials and attract more environmentally conscious investors. 

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Firstly, the report can be used to demonstrate the fund's commitment to sustainable investing and showcase its environmental impact to potential investors. By providing a clear breakdown of how the fund's investments align with the EU taxonomy, investors can gain confidence in the fund's ability to manage sustainability risks and contribute to environmental objectives.

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Additionally, the EU taxonomy report can help investment funds identify areas for improvement and drive better sustainability performance. The report can highlight gaps in the fund's investments and provide a roadmap for transitioning towards a more sustainable portfolio. By using the report as a guide, funds can work towards achieving greater alignment with the EU taxonomy and strengthening their sustainability credentials over time. This can help funds meet the growing demand for sustainable investments and stay ahead of evolving regulatory requirements in the industry.

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Consider Celsia your trusted partner

As sustainability continues to become a top priority for businesses, it's critical for companies to have a comprehensive understanding of the EU taxonomy framework and its reporting requirements. Using Celsia for EU taxonomy reporting can be incredibly beneficial for investment firms, as it provides a streamlined and automated approach to the reporting process.

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We help our clients stay up to date with evolving regulatory requirements, generate accurate reports, and ensure compliance with relevant standards. We also provide advanced data analytics and visualization tools, which can help companies identify sustainability risks and opportunities, and make informed decisions about their investments.

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Using our EU taxonomy reporting solution can also save time and resources, as it reduces the need for manual data collection, processing, and reporting. This, in turn, can help companies focus on more strategic initiatives and drive better business outcomes.

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For example, we work closely with Momentum Partners on their sustainability reporting. Our collaboration helped to

• Reduce the administrative burden of sustainability reporting for both the company and its portfolio companies, allowing them to focus on strategic initiatives.
• Ensure compliance with SFDR regulations by providing a streamlined and user-friendly approach to sustainability reporting.
• Enable the inclusion of EU taxonomy performance in investment screening and due diligence processes, allowing for better decision-making and risk management.

Make sustainability goals and objectives more tangible for portfolio companies, providing them with a clear understanding of their performance and areas for improvement, and helping them identify and plan resolutions to sustainability issues.We can help you too with the EU taxonomy report creation for your investment company. Contact us!

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Conclusion

In summary, many investment funds will have to report on the EU taxonomy to comply with regulatory requirements, provide transparency on the environmental impact of their investments, and demonstrate their commitment to sustainability.

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Taxonomy reporting for an investment company will require funds to gather data from their portfolio companies and aggregate this data to use in their reporting. While taxonomy reporting can increase the burden of data collection and reporting for investment funds, reporting on the EU taxonomy will enable investors to assess the sustainability of the fund's investments and determine whether they align with their sustainability goals. By using the Taxonomy, Article 8 and 9 funds can demonstrate their commitment to sustainable investing and provide greater transparency to investors.

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