EU Taxonomy for dummies

by | 9 Mar 2020 | Sustainable Finance

The EU Taxonomy is a tool to help investors, companies, issuers and project promoters plan and report the transition to an economy that is consistent with the EU’s environmental objectives.

The principles of EU Taxonomy

The Taxonomy is based legally on a political agreement reached on December 17, 2019.

(update June 19, 2020 : The text was adopted by the Council on June 10, 2020 , and endorsed by the European Parliament on June 18, 2020)

It sets performance thresholds (referred to as ‘technical screening criteria’) for economic activities which:

  • make a substantive contribution to one of six environmental objectives: climate change mitigation, climate change adaptation, sustainable use and protection of water and marine resources, circular economy, pollution prevention and control, protection and restoration of biodiversity and ecosystems ;
  • do no significant harm (DNSH) to the other five, where relevant ;
  • meet minimum safeguards (e.g., OECD Guidelines on Multinational Enterprises and the UN Guiding Principles on Business and Human Rights and the eight fundamental conventions identified in the International Labour Organisation’s declaration on Fundamental Rights and Principles at Work and the International Bill of Human Rights).

For technical screening criteria, the text requires to take into account the nature and the scale of the economic activity to possibly include “enabling” and “transitional” activities, and to take into account the potential market impact (risk of certain assets becoming “stranded”or risk of bubbles on “sustainable” investments).

The European Commission will develop delegated acts to further specify elements of this regulation in three phases:

  • The first set of technical screening criteria, for activities which substantially contribute to climate change mitigation or adaptation, will be adopted by the end of 2020 and enter into application by the end of 2021.
  • By 1 June, 2021, the European Commission will adopt a delegated act specifying how the corporate disclosure obligations should be applied in practice. The delegated act will consider the differences between non-financial and financial companies.
  • The second set of technical screening criteria, which cover economic activities substantially contributing to the other four environmental objectives, will be adopted by end 2021 and enter into application by end 2022.

The TEG final report on EU Taxonomy

After taking into consideration a second round of feedback, which took place in summer 2019, the TEG published today its final report on EU taxonomy.

It contains recommendations relating to the overarching design of the Taxonomy, as well as guidance on how companies and financial institutions can make disclosures using the taxonomy.

The report is supplemented by a technical annex containing a full list of revised or additional technical screening criteria for economic activities which can substantially contribute to climate change mitigation or adaptation.

The climate mitigation criteria for 72 economic activities have been updated / completed. And for the first time, criteria for climate adaptation have been included, covering 70 economic activities, relying on a risk assessment and a plan to address the risks. “Do No Significant Harm” criteria have also been added for climate change mitigation.

The expanded taxonomy now covers activities in sectors that produce 93% of Europe’s emissions, including activities such as electricity generation, urban transport, crop-agriculture and cement-manufacturing.

The TEG is a temporary body, whose duration has already been extended on numerous occasions. It is due to be disbanded in September. After the publication of this final report, the TEG will continue to operate in an advisory capacity until the new Platform on Sustainable Finance – a permanent body set up under the Taxonomy Regulation – is operational.

What next ?

Actually, the TEG’s mandate was only to consider the four environmental objectives (pollution prevention and control, use and protection of water and marine resources, circular economy, and protection and restoration of biodiversity and ecosystems) in the context of avoiding significant harm.

A full evaluation of economic activities that can substantially contribute to one or more of these four objectives will be completed by this yet to be established “Platform on Sustainable Finance”.

In addition, a “Member State Expert Group” will contribute in an advisory capacity.

Once it is fully developed, EU Taxonomy will have to be used by:

  • Member States and the European Union when they say that public measures, standards or labels concerning financial products or corporate bonds offered by financial market participants or issuers are “environmentally sustainable”.
  • Financial market participants when they offer financial products will be required to disclose information on how and to what extent the investments that underly their products meet the criteria for environmental sustainability under the Taxonomy Regulation. For those products that do not invest in taxonomy-compliant activities, a statement will need to be made by the financial market participant, saying that the relevant investments do not take into account the EU Taxonomy Regulation. Transition finance that does not meet the screening criteria may still reduce harm to environmental objectives, but would not, in reference to the Taxonomy criteria, be considered sustainable.
  • Financial and non-financial companies when they fall under the scope of the Non-Financial Reporting Directive (NFRD) ; they will have to disclose information on how and to what extent the undertaking’s activities are associated with environmentally sustainable economic activities with reference to the Taxonomy. These obligations will be further specified in a delegated act, to be adopted in 2021 (see above).

Member States, the European Union, and the relevant market actors will have to start complying with these requirements from December 2021.

 width=Source : European Commission

Companies that perform activities not yet covered by the Taxonomy could complement their Taxonomy-alignment disclosure with an explanation that the results reflect the fact that their activities are not yet covered by the Taxonomy – as opposed to them being unable to meet technical screening criteria. TEG believes this is an important signal for companies to be able to send.

This classification system can also be used on a voluntary basis by any other market actors, other than those captured by the Non-Financial Reporting Directive. Above all, this system should help companies to raise finance for sustainable activities, by encouraging them to publish the percentage of their turnover or investments that is in line with the “green list” of environmentally sustainable activities.

For example, companies that are not required to publish non-financial statements, like SMEs, may decide to publish information on their website regarding their alignment with the Taxonomy Regulation. This could help raise finance for the relevant investments.

This system will not necessarily replace companies’ existing sustainability policies. Rather, it will make it easier for companies with sustainability policies to raise funding for their projects, if they meet the criteria set out in the taxonomy.

NB : Two linked posts  : “It must be green ! Okay ?”  (Jan. 31, 2018) and The review of the Non-Financial Reporting Directive (Feb 22, 2020)

Iconography : biface taxonomy showcase, Musée de l’Homme, Paris, personal collection