The EU Taxonomy is defined as a “green classification system” which translates the EU’s climate and environmental objectives into criteria for the determination as to what classifies as ‘environmentally sustainable’ or ‘green’. It is part of the EU’s overall efforts to reach the objectives of the European Green Deal and make Europe climate-neutral by 2050. It attempts to define, through science-based transparency, economic activities that make a substantial contribution to at least one of the EU’s climate and environmental objectives.
The EU Taxonomy is not a mandatory list of economic activities for investors to invest in, however it is expected that over time the EU Taxonomy will be a catalyst for the transition toward sustainability. As matters stand today, there is no obligation for companies to be Taxonomy-aligned and investors are free to choose what to invest in.
The EU Taxonomy forms part of a broader sustainable finance network and is one of three disclosure tools. The other two tools are the Non-Financial Reporting Directive (NFRD) and the Sustainable Finance Disclosure Regulation (the SFDR)¹.
Non-Financial Reporting Directive (NFRD)
Sustainable Finance Disclosure Regulation (SFDR)
The Taxonomy Regulation together with the SFDR, the CSRD, the EU Ecolabel for retail financial products and the EU Green Bond Standard are meant to ensure that activities which are aligned with the Taxonomy are immediately recognised in investment decisions.
While disclosures are only mandatory for large companies that fall within the scope of the CSRD, small companies could still voluntarily disclose the Taxonomy alignment of their activities while also taking the opportunity to explain to investors or stakeholders whether they carry out or intend to carry out Taxonomy-aligned green activities.
The Taxonomy Regulation is expected to be more far reaching in scope than is immediately apparent, and as matters stand the EU already requires Member States to use the Taxonomy as the basis of any EU labels for green corporate bonds or financial products that fall within the scope of the SFDR.
Furthermore, the EU Climate Benchmarks Regulation² which determines who can use the labels ‘EU Climate Transition Benchmark’ and ‘EU Paris-Aligned Benchmark’ will be made consistent with the EU Taxonomy by the end of 2022. It is presumed that benchmark administrators will have to select companies that have a certain percentage of their activities classified as green as per the Taxonomy (or that others are excluded because they do not comply).
The Taxonomy Regulation
- Climate change mitigation (Article 10)
- Climate change adaptation (Article 11)
- Sustainable use and protection of water and marine resources (Article 12)
- Transition to a circular economy (Article 13)
- Pollution prevention and control (Article 14)
- Protection and restoration of biodiversity and ecosystems (Article 15)
It further sets four conditions for an economic activity to be recognised as ‘Taxonomy Aligned’:
- Making a substantial contribution to at least one environmental objective
- Doing no significant harm to any other environmental objective
- Complying with minimum social safeguards
- Complying with the technical screening criteria (developed in delegated acts)
An economic activity as contributing substantially to climate change mitigation is defined as one which contributes substantially to the stabilisation of greenhouse concentrations in the atmosphere at a level which prevents dangerous anthropogenic interference with the climate system consistent with the long-term temperature goal of the Paris Agreement through the avoidance or reduction of greenhouse gas emissions or the increase of greenhouse gas removals.
Substantial contribution is further defined as an activity that directly enables other activities to make a substantial contribution provided it does not lead to a lock-in of assets that undermine long-term environmental goals and has a positive environmental impact on the basis of life-cycle considerations.
As part of the activities which substantially contribute to one or more environmental objectives two categories are further included: enabling activities and transitional activities. Enabling activities are those which allow other activities to make a substantial contribution to one or several of the Taxonomy’s objectives and which do not lead to a lock-in of assets which would undermine long-term environmental goals. Transitional goals on the other hand are those for which low-carbon alternatives are not available and that have emissions which classify as the best performing in the sector.
The Delegated Acts
It also provides for specific disclosure requirements for the natural gas and nuclear sectors. The idea behind the Delegated Acts is that the Commission was tasked with establishing technical screening criteria and wanted to clarify further (there is very little specific reference to activities in the Taxonomy Regulation) which economic activities most contribute to meeting the EU’s environmental objectives. To this effect the Delegated Act delivers the first set of technical criteria for defining such activities.
In the preamble to the Second Delegated Act the European Commission specifies that: