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Much has been said and written regarding the Taxonomy over the last year and it’s gotten hard to see the wood for the trees. In what follows, Sustainalize will run you through the most important developments of the past year as well as answer some of the most frequently asked questions by corporates.
The EU Taxonomy constitutes one of the cornerstones for both the European Green Deal as well as the EU Action Plan on Sustainable Finance. The ultimate goal is to help shift the capital flow towards more sustainable investments in the EU. However, to do so, a clear definition of what constitutes “sustainable” is needed. And this is what the EU Taxonomy is aimed at – providing clear guidance on when an activity can be deemed sustainable.
The EU Taxonomy can be seen as a big dictionary.
The focus of the EU Taxonomy lies on 6 environmental objectives:
For each of these environmental objectives the Taxonomy has identified relevant economic activities. Linked to these activities are technical screening criteria that define whether the activity substantially contributes to this environmental objective. Only when these criteria are met can the activity be defined as sustainable. Furthermore, while the activity meets the technical screening criteria, it has to make sure that it does not significantly harm any of the other 5 environmental objectives and has to be compliant with the UN Guiding Principles on Business & Human Rights and the OECD Guidelines.
Financial undertakings that make available financial products, should disclose the proportion in their total assets of exposures to Taxonomy non-eligible and Taxonomy-eligible economic activities (so-called Green Asset Ratio or GAR) , some financial disclosures specific to financial undertakings (art. 7 of the amended Delegated Act of July 6th) and supplementary qualitative information.
SFDR Art. 8 products or financial products that promote environmental or social characteristics will have to disclose the manner in which sustainability risks are integrated into their investment decisions and the impact this might have on the returns.
SFDR Art. 9 products or financial products that have an environmental or social objective will have to disclose the information on the environmental objective or environmental objectives to which the investment underlying the financial product contributes. It will also have to describe how it complies with the technical screening criteria, the DNSH-principle and meets the minimum safeguards.
 The GAR shall show the proportion of the credit institution’s assets financing and invested in Taxonomy-aligned economic activities as a proportion of total covered assets.
From FY 2022 onwards
Non-financial undertakings falling under the NFRD will have to start reporting on the alignment % of their Taxonomy eligible activities.Since Financial undertakings rely on their portfolio companies to provide the information needed, they get one more extra year to disclose the alignment % of their portfolio. For FY 22 they should still only disclose the proportion in their total assets of exposures to Taxonomy non-eligible and Taxonomy-eligible economic activities (so-called Green Asset Ratio or GAR) and supplementary qualitative information.
Only from the FY 2023 onwards will financial and non-financial undertakings have to disclose all KPIs related to the taxonomy. Please note, that non-financial undertakings will be broaden to all companies falling under the scope of the CSRD.
From 2022 onwards the SFDR Art. 8 and art. 9 products will have to periodically report and compare the information disclosed for the FY 21.
Crucial to understanding what needs to be done for the reporting on FY 2021 is to understand what the difference is between eligibility and alignment.
Eligibility of activities implies that an activity is included in the delegated acts on climate change mitigation or climate change adaptation. Whether an activity is Taxonomy-eligible or not says nothing about the (un)sustainability of that activity. Being Taxonomy-eligible is merely an indication that a certain activity makes a substantial contribution to one of the six environmental objectives of the Taxonomy.
Alignment of an activity goes beyond eligibility. Taxonomy-alignment implies that an activity complies with the requirements enumerated specifically for this activity in the Taxonomy. For more information on these requirements we refer to the other questions on the Technical Screening Criteria and the ‘Do no significant harm’-criteria. Put briefly, only when an activity is compliant with the technical screening criteria, the “do no significant harm”-criteria and the minimal safeguards linked to this activity in the Taxonomy is it aligned.
Let’s say for example that company A has two business activities, manufacturing windmills and extracting oil & gas via fracking. Both activities are exactly 50% of the total revenue. Windmill manufacturing is included in the Taxonomy, fracking is not. This means that 50% of revenue of the total operations of company A are Taxonomy-eligible. If the windmill operations of company A comply with the technical screening criteria (TSC) listed in the Taxonomy, do no significant harm (DNSH) to any of the other environmental objectives and meet the minimum safeguards then all the turnover resulting from this activity can be counted as Taxonomy-aligned.
If we build further on the example, let’s say company A has an investment budget of € 100 million. Of this € 100 million it spends € 75 million to expand its windmill operations and 25 million to explore new oil fields. This investment plan would mean that 75% of company A’s CAPEX is Taxonomy aligned (since it meets the TSC, DNSH and the minimum safeguards) and 25% is not, since fracking is not a Taxonomy eligible activity. Finally, the maintenance and restoration of the windmills to keep up with the technical screening criteria in the Taxonomy should be counted as Taxonomy-aligned OPEX. Operational expenditure linked to the oil & gas business unit cannot be counted as Taxonomy-aligned OPEX.
For an activity to align itself with the Taxonomy the first step is to check whether the activity is compliant with the technical screening criteria enlisted in the Taxonomy. These technical screening criteria are generally very elaborate, science based and are based on best practices in the market. A few exceptions are included in the Taxonomy where no actual technical screening criteria are linked to an activity, for instance in the case of electricity generation from wind power or concentrated solar power. The goal of these technical screening criteria is to push companies to have either a substantially positive environmental impact or to substantially reduce their negative impact on the environment and to set sectors on a path to reach the EU Green Deal environmental goals.
Once an activity complies with the technical screening criteria the next step towards alignment is to check whether it does no significant harm to the other objectives. The ‘Do no significant harm’-principles could be seen as the minimum requirements an activity has to comply with regarding the other five environmental objectives. They are generally less demanding than the technical screening criteria. These minimum requirements ensure that the compliance with the technical screening criteria of one of the six environmental objectives does not impede in the progress of reaching any of the other environmental objectives. These ‘Do no significant harm’-principles are usually linked to existing EU regulations linked to the activity in question. The goal of the Taxonomy with this ‘Do no significant harm’-clause is to create coherence between the different environmental objectives.
Broadly speaking there are 3 types of activities that will be included in the Taxonomy;
Has a substantial positive environmental impact on the basis of lifecycle considerations.
Currently the EU Taxonomy has focused on the industries that have the largest impact on the environmental objectives of climate change mitigation and climate change adaptation. Furthermore there are also certain activities (nuclear power, agriculture, natural gas, bioenergy and forestry) that are still being discussed within the EC on whether and how to include these activities in the climate change mitigation and climate change adaptation annexes. The industries activities aligned with the environmental objectives of climate change mitigation and climate change adaptation will be further amended with the publication of the delegated act on the other four environmental objectives at the end of 2021.
Important to note is that some activities can never be eligible for the Taxonomy since they are in essence unsustainable (E.g. oil extraction activities, certain mining activities (conflict minerals), …). Aside from inherently unsustainable activities, there is also a category of activities that only have limited environmental impact and will therefore probably also never be included in the EU Taxonomy’s eligible activity list (E.g. electronical payment services).
At this moment in time the EU has prioritised economic activities that can make the most relevant contribution to the two environmental objectives of climate adaptation and mitigation. The EU Taxonomy will be developed gradually over time, and further delegated acts, or revisions of existing ones, will likely include other economic activities from different sectors and sub-sectors of the economy, as these become relevant and feasible to be integrated into the EU Taxonomy. The assessment of further economic activities will also be based on scientific evidence and broad stakeholder input.
The EU Taxonomy is a living document and will continue to evolve over time, with more activities being added to its scope by means of amendments. It will be subject to regular review and also reflect technological progress. This ensures that new sectors and activities, including transitional and enabling activities, can be added to the scope over time.
It is important to recall that while an activity might not (currently) be in included in the Taxonomy, this does not mean that this activity is necessarily unsustainable. The Taxonomy currently only includes activities that make a substantial contribution to any of the six environmental objectives. However, with the implementation of the Corporate Sustainability Reporting Directive (CSRD) in FY 2023 companies will be forced to disclose information on environmental performance that has not been categorized by law as Taxonomy-aligned. So even if your sector or activities are not included in the EU Taxonomy because it does not significantly contribute to one of the six environmental objectives, the CSRD will enable those industries or activities to disclose their environmental performance to financial market participants nonetheless. Furthermore, the publication of the delegated acts on the other four environmental objectives will certainly add further industries and activities to the list of Taxonomy-eligible activities. Finally, there is also the possible adoption of a social Taxonomy by the EU, which will also imply a broadening of the scope of activities falling under the Taxonomy.
Article 26 of the Taxonomy Regulation calls for a Commission report by the end of 2021 which will analyse whether the Taxonomy Regulation should be extended to cover economic activities with no significant impact, as well as economic activities that do significant harm to the environment. In other words to analyse whether the Taxonomy will be extended to include an activity which does not meet the requirements for substantial contributions in the EU Taxonomy, but the improvement leads to performance levels better than significant harm.
The platform on Sustainable Finance will advise the European Commission on whether and how to recognise a companies’ efforts to improve the environmental performance of its activities harmful to the environment.
The Platform published a draft report by its Technical Working Group (TWG) for a call for feedback on preliminary recommendations on technical screening criteria for the remaining four environmental objectives and a few additional activities with according criteria for the climate objectives of the EU Taxonomy. The draft criteria presented in the report are working documents of the Platform and do not represent a final view of the Platform nor of the EC. They are presented to gather feedback so that the criteria can be further refined and developed before a final set of recommendations on the criteria are agreed by the Platform and proposed to the European Commission in November 2021.The technical screening criteria for the 4 remaining environmental objectives are foreseen to be adopted in the first half of 2022
The criteria in this draft version should thus not be viewed as final. It provides the direction that the EU Taxonomy is taking but the exact requirements enlisted regarding technical screening criteria etc. may still change based on the consultation round and stakeholder input. The draft screening criteria published on water, land, pollution and circularity can thus be used by companies to check for their eligible activities.
If an economic activity contributes to several environmental objectives, the company ought to disclose the turnover, CAPEX and OPEX from that activity as contributing to several environmental objectives; However, to avoid double counting, the company should only count the turnover from that activity once in the numerator of the KPIs.
Normally, the company will choose the environmental objective for which the % of turnover is higher if there is a difference, and/or the environmental objective the company wishes to put forward. Companies are encouraged to provide turnover or CAPEX by the categories of transition and enabling activities when reporting on climate change mitigation.
Yes, climate change adaptation is different from the other five environmental objectives. Regarding eligibility climate change adaptation works the same as the other objectives, but only for enabling activities. If an enabling activity is listed in the annex of climate change adaptation then the turnover, CAPEX and OPEX for this activity are Taxonomy-eligible.
The difference lies with the fact that other activities, which are not listed as “enabling activities” in the climate change adaptation, can still claim their CAPEX to be taxonomy aligned in case the expenditure help increase the climate resilience of the business.
For example, a manufacturing plant which is not listed a being an enabling activity having a substantial contribution to climate change adaptation,is being renovated to improve its resilience against climate change could still count expenditure linked to that renovation but not the turnover linked to its activity as a manufacturer, even after the plant has been made climate-resilient.
The Taxonomy Regulation does not explicitly require any formal verification of Taxonomy-related disclosures. The disclosures must be made as part of the non-financial statement under NFRD, which does not, as a baseline, require verification (although transposition into some Member States may influence this on a case-by-case basis).
In reality however, external verification of eligibility and alignment percentages lies within the near future. As a part of the CSRD, limited assurance on the sustainability reporting will be legally obliged by the end of 2025 at the latest. This will include the eligibility and alignment KPIs pursuant art. 8 of the EU Taxonomy. On top of that, the information for the CSRD will have to be included in the management report which will have to be reviewed by an external accountant as well. At this point is time it remains unclear to what extent the accountant will also do assurance on the Taxonomy eligibility and alignment KPIs for the financial years of 2023 and 2024.
The Taxonomy states that a company should segment its turnover or revenue by eligible activity. The Taxonomy itself uses the NACE-code system to indicate whether or not a companies’ activity falls under a certain Taxonomy activity. However these NACE-codes are only an indication, so a company still has room for interpretation when it comes to defining its activity as falling under the Taxonomy. What remains unclear in the current information spread surrounding the Taxonomy is how far a company has to go in identifying a business activity as theirs. Let’s take for example manufacturer A of food products. Is it only the manufacturing process of the food itself that should be counted as a business activity or is the packaging, transport and selling of the product also a business activity? In other words, how far does a company have to go in attributing a certain activity as their own business activity? Because if a company B manufactures the same product but outsources its packaging and transport, it could have a higher eligibility/alignment percentage, despite in essence having the same business activities?
The Taxonomy dictates for activities that contribute to one of the six environmental objectives the turnover, CAPEX and OPEX has to be disclosed in the templates provided by the EU. But what is the level of granularity regarding this activity. Is there a minimum as to what still constitutes as an activity? If so, is this a relative (%) or an absolute minimum (€)? If not, how will the EC bring determine what constitutes an activity? This still remains unclear.