Six Things Business Should Know About the EU Taxonomy

THURSDAY APRIL 15, 2021

By

EILEEN GALLAGHER, Associate Director, BSR

CHARLOTTE BANCILHON, Director, BSR

GIULIO BERRUTI, Director, BSR

#Climate Change, #Financial Services, #Sustainability Management,

The EU Taxonomy is set to be a foundational tool of the European Green Deal and will affect companies well beyond European borders. It is essential for foreign companies and markets that conduct business in the European Union (EU) to be aware of the implications of the Taxonomy.

The Taxonomy is a list of economic activities with performance criteria to assess the activities’ contribution toward six environmental objectives.1 In other words, it describes what can be considered “green” and what can’t.

The Taxonomy will support the EU’s 2030 climate and energy targets as well as the objectives of the EU Green Deal, which offers a roadmap to guide the EU toward climate neutrality by 2050. The Taxonomy’s classification system is expected to shift investments toward a low-carbon, climate-resilient economy and avoid greenwashing.

The Taxonomy establishes a list of environmentally sustainable activities by defining screening criteria. It is neither a rating of “good” or “bad” companies nor a mandatory list of economic activities to invest in or to divest from. It does, however, aim to provide clear definitions of what is green to companies, investors, and policymakers.

Furthermore, the Taxonomy is likely to enable increased investment in activities deemed environmentally sustainable across a range of sectors, including but not limited to agriculture, buildings, ICT, manufacturing, transport, utilities, and finance. Activities in these sectors represent 93.5 percent of the EU’s greenhouse gas emissions.

Companies based in, doing business with, and with investors in the EU will need to pay attention to the Taxonomy and its impact on investments, particularly the following six points:

1. Investors will ask businesses how their activities align to the EU Taxonomy.

The EU Taxonomy is meant to be the bedrock of many financial mechanisms at the European level. European institutional investors and asset managers will have an obligation to disclose how their sustainable fund aligns to the EU Taxonomy. Thus, investors and financiers will be asking companies how aligned their business is to the Taxonomy, if they have not already done so.

Under the Non-financial Reporting Directive (NFRD), large public-interest companies with more than 500 employees are required to disclose non-financial information in annual reports, including sustainability-related policies such as environmental protection. The NFRD is being revised to include the EU Taxonomy.

It is likely that companies that fall under the NFRD will be required to disclose information on how and to what extent their activities are associated with environmental sustainability, aligning with the Taxonomy. Other uses will include the EU Green Bond Standard and Eco-Label for financial products.

2. Companies can get started by assessing whether their activities are Taxonomy-aligned.

To start, businesses can assess whether their activities are in alignment with the Taxonomy’s definitions and criteria. The Taxonomy proposes that economic activity should “substantially contribute” to at least one of the six environmental objectives as defined in the proposed regulation, “do no significant harm” to any of the other five environmental objectives as defined in the proposed regulation, and comply with “minimum safeguards.”2 

Using this Taxonomy, companies with European investors may assess which of their economic activities are considered environmentally sustainable, in accordance with the established criteria—for example, Acciona published an EU taxonomy report and leaflet.

Companies can then consider appropriate interventions to reduce potential regulatory and financial risk from activities that are not aligned with the Taxonomy as well as explore the opportunities associated with adjusting activities to gain Taxonomy alignment.

In Europe, businesses and investors are already engaged in conversations on Taxonomy-aligned activities. To prepare for and anticipate investor requests, European companies can seek to align their reporting with the soon-to-be-revised NFRD. Non-EU stakeholders that conduct business with European companies may wish to engage in conversation on potential expectations and implications of their own economic activities.

3. Other markets are starting to follow suit by establishing their own taxonomies.

While the EU Taxonomy might be considered the world’s first ever “green list certification system,” other markets, including Canada, Japan, Malaysia, Singapore, ASEAN at large, and the UK, among others, are in different stages of consultation and evaluation to establish their own taxonomies.3 

Globally, there has been increasing demand for corporate ESG disclosure. Related to climate-specific disclosure, the Task Force on Climate-related Financial Disclosures (TCFD) has gained momentum in recent years, and investors are seeking data that is consistent and comparable. Definitions of “green” and the related screening criteria that taxonomies offer are considered useful tools to give financial institutions and investors clarity and certainty on the environmental sustainability of different types of investments. They can help to facilitate measurement and monitoring of sustainable financial flows.

The Central Banks and Supervisors’ Network for Greening the Financial System (NGFS) has also called on policymakers, relevant stakeholders, and experts to develop and adopt taxonomies that ensure ESG transparency on economic activities. Announced in October 2020, the International Platform on Sustainable Finance (IPSF) established a working group, co-led by the EU and China, to work toward a “common ground taxonomy” to identify the commonalities between different jurisdictional taxonomies and seek to support the scale up of cross-border green investments.

4. The EU Taxonomy will affect businesses beyond Europe.

As financial markets are global, the EU Taxonomy will have implications for businesses globally. If your business has European investors, they will likely be asking questions about your alignment with the EU Taxonomy. Furthermore, European companies operating globally will be likely to apply the EU Taxonomy lens to their global operations. While the Taxonomy is a European regulation, it will have implications for foreign markets that conduct business with Europe.

5. The EU Taxonomy is not only about environment.

To be aligned with the Taxonomy, businesses must also meet the minimum social safeguards of the OECD Guidelines on Multinational Enterprises and UN Guiding Principles on Business and Human Rights.

6. Mandatory reporting is slated to begin January 1, 2022.

The adoption of the Taxonomy Regulation has been delayed until April 2021. The European Commission is creating an IT tool to facilitate the use of the Taxonomy. It is expected that the tool will be available in the first half of 2021. Investors will need to report on the alignment of their ESG funds for climate mitigation and climate adaptation by January 1, 2022, covering the reporting period of 2021.

While the taxonomies for climate mitigation and climate adaptation have been developed, four more taxonomies will be published by the end of the year: sustainable use and protection of water and marine resources; transition to a circular economy, waste prevention and recycling; pollution prevention and control; and protection of biodiversity and ecosystems.

In sum, by establishing taxonomies, the public sector is striving to accelerate financing to support the transition to a low-carbon and resilient economy. BSR will continue to monitor the developments of national and international taxonomies and inform our members of the associated implications.  

1 The six environmental objectives include climate change mitigation; climate change adaptation; sustainable use and protection of water and marine resources; transition to a circular economy, water prevention and recycling; pollution prevention and control; and protection of healthy ecosystems.

2 The Technical Expert Group (TEG) on sustainable finance published a report in March 2020 with implementation guidance on how companies and financial institutions can use and disclose against the Taxonomy.

3 Canada’s financial institutions and investors have been assessing a voluntary transition-focused taxonomy. The UK plans to establish an advisory group to determine whether the EU Taxonomy’s metrics are right for the UK market. Singapore recently concluded a consultation period to review its proposed green taxonomy that will largely align with the EU Taxonomy. Malaysian financial institutions will start to apply a climate risk taxonomy this year. The Association of Southeast Asian Nations (ASEAN) seeks to establish a framework for green investments in the region to meet the goals of the Paris Agreement.