EU Taxonomy regulation summary

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Sustainability or finance teams in our companies already must comply with numerous legislations. The EU Taxonomy is yet another one. Let’s be honest how difficult it is to follow and be up-to-date with any legislation. It is especially challenging when the law is in its infancy and subject to continuous review and changes.

We have put together this comprehensive EU green Taxonomy summary to give you an EU Taxonomy overview, why it exists and how you can benefit from it. Let’s dive in.

What is the EU Taxonomy?

The EU taxonomy is a classification system that sets out a list of environmentally sustainable economic activities. It forms part of the EU’s plan to scale up sustainable investment and implement the European green deal. It includes technical criteria that must be complied with in order for an activity to be considered sustainable

EU Taxonomy Summary

In 2019, the European Union presented the Green Deal, a set of policy initiatives aiming at several environmental targets, including a climate-neutral Europe by 2050. To tackle the challenges of greenwashing, with no common definition of a sustainable investment and the lack of sustainability considerations in investment decisions, the EU put forward the Action Plan on Sustainable Finance. The plan included ten measures within three categories:

  • Redirecting capital flows towards sustainable activities
  • Sustainability as part of risk assessment
  • Sustainability included in company reporting

As part of redirecting capital flows towards sustainable activities, the EU has decided to implement a classification system, an EU “taxonomy” of sustainable activities, with criteria for when they may be defined as sustainable. If your business activity is listed in the taxonomy and you fulfill all criteria, the associated revenue, capital expenditures and operational expenses (OPEX) with that activity are considered "taxonomy aligned".

The EU operates with six environmental objectives, where an activity has to:

  1. Make a substantial contribution to at least one objective
  2. Do no significant harm to the five other objectives
  3. Comply with minimum social safeguards

April 21st 2021, the EU published a revised version of the criteria first launched in 2020, based on input from the Union countries. This version primarily addressed climate change and was formally adopted on June 4th 2021. Criteria related to the other environmental aspects in the taxonomy are - as of August 2021 - to come shortly.

What is the EU Green Deal?

As mentioned before, the European Green Deal is a set of policy initiatives from the European Commission that enable the EU to become climate neutral by 2050.

In 2021, the Commission adopted a series of legislative proposals setting out how it intends to achieve climate neutrality and setting a target of at least a 55% net reduction in greenhouse gas emissions by 2030.

The main objective of the EU Green Deal is to enable Europe to become the first climate-neutral continent by 2050. This would lead to a cleaner environment, more affordable energy, less polluting transport, job creation, and improved quality of life.

The European Commission states that the Green Deal will "transform the EU into a modern, resource-efficient and competitive economy" by ensuring no net emissions of greenhouse gasses by 2050, that economic growth is decoupled from resource use, and that no person or place is left behind. This corresponds to the three main pillars of sustainability, covering environmental, economic, and social sustainability through EU social taxonomy.

The policy areas addressed include climate, energy, agriculture, industry, environment and oceans, transport, sustainable finance, regional development, and research and innovation.

Who is behind the EU green Taxonomy?

The taxonomy is an initiative from the European Union. Its framework is set out in a regulation from the European Commission. Whereas the technical screening criteria and additional rules start in delegated acts. The taxonomy is a part of the Green Deal, and it is designed to help the EU meet key 2030 and 2050 climate goals.

The Platform on Sustainable Finance is a permanent expert group of the European Commission set up as a part of the taxonomy regulation. The Platform comprises world-leading sustainability and industry experts representing a range of stakeholders. This includes financial market participants, industry, civil society, and academia.

The Commission consults the Platform before adopting delegated acts on technical screening criteria. The Platform plays an essential role in providing advice and developing technical screening criteria by providing technical and scientific input to the Commission, who later should have an agreement on future proceedings.

How does the EU Taxonomy work?

The EU developed the taxonomy to provide well-defined, harmonised criteria for when economic activities can be considered to be sustainable. It sets out robust, science-based technical screening criteria that activities need to comply with to be seen as green.

The primary objective of the taxonomy is to redirect capital flows towards more sustainable business activities. The EU initiated it after seeing a general lack of sustainability considerations in investment decisions and the need for a common standard for assessing the sustainability of investments.

By providing this common standard, the taxonomy aims to create security for investors, prevent greenwashing, help companies to become more climate-friendly, mitigate market fragmentation, and help investors compare investments across the Member States. This will help guide investments where they are most needed. By directing investments towards sustainable projects and activities across the EU, the taxonomy should help to meet the EU's 2030 and 2050 climate and energy targets. For example, with the EU Taxonomy we can answer the question: is wind power sustainable? Read more about it in the blog.

The framework of the EU Taxonomy is set out in an EU Regulation (2020/852) that will apply to all EU Member States. Regulation 2020/852 sets out the main objectives of the taxonomy and how it will work in practice.

The taxonomy also has several delegated acts that set out more detailed rules on certain areas. For example, the Climate Delegated Act lists economic activities that are eligible for the taxonomy's climate change mitigation and adaptation objectives. This includes technical criteria that must be met for an activity to be considered sustainable.

Companies will be required to assess how their activities perform against the taxonomy criteria and disclose these results publicly. Check out our blog that covers more about what companies will report and how eligibility and EU Taxonomy alignment work.

The EU taxonomy is not the only sustainable finance taxonomy that has been developed globally. Other countries and country groups have also started to work on sustainable finance taxonomies. The EU looks set to be one of the largest and most ambitious. Research is being undertaken to best fit these global taxonomies together and avoid overlap or confusion.

How will the EU Taxonomy impact my business?

In other words, what is the EU Taxonomy meaning in business?
From January 1st 2023, all large companies are required to report their taxonomy alignment, along with relevant information that may help investors assess their ESG performance. In this regard, the EU defines all large companies as companies that are 

not SMEs (SMEs are companies with less than 500 employees, and with a balance sheet less than 43 million euros or a turnover less than 50 million euros). Small and medium sized companies that are listed on the stock exchange, are also required to report.

Small and medium sized companies can report on a voluntary basis, but will be affected by the EU’s upcoming Corporate Sustainability Reporting Directive. Under the directive, all large companies (>250 employees) and all listed companies (except listed micro-companies) will be required to report on their sustainability performance in accordance with the taxonomy.

Investment funds will also have to report on taxonomy alignment, and will be required to collect data required to assess the degree of taxonomy alignment or assess the portfolio companies themselves.

The bottom line is: If you’re a big company you have to report. Also,if you have an investment fund as owner you should report, as the investment fund will anyhow request the relevant data from you.

How will the EU Taxonomy impact small companies?

EU Taxonomy scoring for small companies may positively impact a company's bottom line.

Following the EU Directive on sustainability-related disclosures in the financial sector, in effect from 2021, banks are required to assess their debtors’ sustainability performance.

(With the new proposed Corporate Sustainability Reporting Directive, the EU is also proposing the development of separate, proportionate standards for SMEs, so we anyhow expect also SMEs to be required some level of reporting shortly)

In sum: Reporting on degree of alignment with the taxonomy is a proactive move towards your stakeholders - in particular your investors and creditors - and may lower your cost of capital.

What are the benefits of taxonomy to my company?

A goal of the taxonomy is to provide a clear framework for assessing the level of sustainability of one’s business activities. This way, the Taxonomy gives you an unambiguous score to improve from.

A high taxonomy score may lower your cost of capital. The taxonomy score of banks and institutional investors’ portfolios will affect their cost of borrowing, and most banks already provide lower interest rates to companies that operate more sustainably.  

Companies that fall under the CSRD will be required to disclose whether they have taxonomy-aligned activities or not to the financial markets. Investors will be able to access this information and use it to make investment decisions accordingly. Companies with taxonomy-aligned activities will benefit from institutional investors, retail investors, and banks interested in green investments as the taxonomy will provide a harmonised 'gold standard' on sustainable activities. Therefore, EU Taxonomy for sustainable investments can be a tool to identify truly sustainable companies.

The Taxonomy Regulation, SFDR, CSRD, and other ongoing policy initiatives such as the EU Ecolabel for retail financial products and the EU Green Bond Standard, will ensure that Taxonomy-aligned activities are visible and recognised in investment decisions.

EU Taxonomy explained. Which industries are covered by the EU Taxonomy?

The EU taxonomy covers many industries across three delegated acts. The taxonomy includes technical screening criteria for forestry, environmental protection and restoration, manufacturing, energy, water supply, sewerage, waste management and remediation, transport, construction and real estate, information and communication, financial and insurance activities, education, human health, and social work activities, arts, entertainment and recreation, agriculture, fishing, civil engineering, disaster risk management, and tourism.

More information on the industries and specific activities currently covered by the taxonomy can be found here.

The adoption of the Environmental Delegated Act, expected later this spring, is set to expand the scope of eligible economic activities covered by the taxonomy.

How do I report alignment with the taxonomy?

To report degree of alignment with the taxonomy, you should:

Screen your business' activities against activities in the taxonomy
Map relevant directives and standards referenced to in the criteria per activity
Interpret the collected material to understand meaning
Create a framework for assessing your activities against the criteria
Conduct the assessment

While 5) should be conducted continuously or at least on an annual basis, 1-4 should be conducted when required -this means, whenever there are updates to either the taxonomy or the directives and standards in the references.

As a company, the requirement is to disclose information 'to the extent necessary to understand the development, performance, position, and impact of the company's activities, according to the regulation. This means that a company's activities are disclosed with a level of detail that breaks down and shows specifically where the company is achieving sustainability targets, where shortfalls may be occurring, and where the company can make potential improvements.

How can Celsia help?

We know that you may not have people dedicated to staying up-to-date on all the latest ESG legislature, with the capacity to develop and iterate on reporting frameworks in line with the taxonomy. We believe it's more efficient if we take care of that part, and split the cost among all our clients. The EU Taxonomy isn't perfect, but it has clear criteria that are well-suited for a standardized tool.

Instead of hiring external parties to assess your business against the taxonomy criteria, we give you the tool to do it yourself. From the list above, we take care of 1-4, and set you up to do 5 yourself.

We hope this EU Taxonomy regulation summary was clear and the key takeaways will be of use.

Source: The EU official website