As part of an ongoing series of guides designed to demystify the confusing world of ESG regulation, we’ve put together this article on the EU Taxonomy: what it is, what it mandates, when it applies, its benefits, and the companies it covers.
To help you navigate through the confusing and acronym-laden world of ESG regulation and corporate sustainability reporting, we recently released our ESG regulation timeline. It provides an overview guide to the regulatory updates expected in 2023 along with explaining what each means for procurement and sustainable procurement functions.
To complement that overview, we’re also providing longer guides to each individual regulation which take a deep dive into why they exist, what they mandate, who they apply to, and when they come into force, in addition to covering some of their key benefits.
After covering the Corporate Sustainability Due Diligence Directive (CSDDD) earlier this month, this time we’re taking a closer look at the EU Taxonomy Regulation.
As a cornerstone of the EU’s sustainable finance framework, the EU Taxonomy (also known as the snappily-named “Regulation EU 2020/852 on the establishment of a framework to facilitate sustainable investment”) is an EU ESG regulation that was originally passed by the European Parliament in 2020.
Designed as a tool to increase the transparency of financial markets, the EU taxonomy establishes a standardised classification system that defines which corporate economic activities can be deemed environmentally sustainable. This helps define more clearly when a company is operating in a “sustainable” or “eco-friendly” way, and provides a “common language” for financial and non-financial companies to discuss the sustainability of economic activities.
The taxonomy came into effect in January 2022, with approximately 12,000 companies required to report against the classification system as of January 2023.
There are six key objective classifications within the EU Taxonomy. In order for any activity conducted by a company to be classified under one of these categories, it must not only contribute to at least one objective, it must also not violate the other criteria, and it must comply with minimum social safeguards.
The six criteria are:
This category encompasses activities, technologies, and practices that contribute to the reduction of greenhouse gas emissions such as renewable energy, low-carbon technologies, and sustainable agriculture.
Practices and technologies which enhance climate change resilience fall under this category. Examples could be new flood management systems, drought-resistant farming practices, or infrastructure which is resilient in the face of extreme changes in weather.
Focusing on activities that promote the protection and sustainability of our water resources and marine ecosystems, this category includes activities which promote sustainable wastewater and runoff management, prevent pollution, and reduce or modify corporate water usage.
This category covers activities that promote a move away from our current linear economic model towards a circular one by emphasising reducing, reusing, recycling, and repurposing in order to preserve value and minimise resource extraction and exploitation. This could include sustainable product design (including ending planned obsolescence), recycling or salvaging materials used in production to manufacture other products, or glass packaging return schemes for reuse.
Encompassing activities that aim to prevent, control, and mitigate pollution across all ecosystems – including fresh- and saltwater, soil, and air pollution. Activities which may warrant this classification include those falling under better waste management, non-combustible energy solutions, and particulate capture technologies.
Covering activities which contribute to the conservation, restoration, and sustainable use of our planet’s ecosystems in order to preserve their biodiversity. This may include activities which promote sustainable forestry, conservation efforts, restoration of damaged ecosystems, and new practices and technologies which enhance how we use land.
The EU Taxonomy applies to organisations who are subject to the Non-Financial Reporting Directive (NFRD) – that means companies and financial market participants based in the EU (or operating a European legal entity) with more than 500 employees.
As of January 2023, approximately 12,000 companies are required to report the extent to which their economic activities are aligned with the six objectives outlined in the EU Taxonomy. By 2028 it’s predicted that this could rise to 50,000 companies after the Corporate Sustainability Reporting Directive (CSRD) is implemented from 2024 onwards.
The timeline of when decisions were made, amendments were added, when certain criteria came into force, and when they apply to companies is complex and confusing. To make it easier, we have simplified it down to the key events below:
March 2019 – the European Commission’s High-Level Expert Group on Sustainable Finance publishes its final report, including a recommendation to develop the EU taxonomy.
December 2019 – the European Commission presents the European Green Deal – a comprehensive package of measures to achieve net zero, with the EU Taxonomy as a key component.
March 2020 – the European Commission publishes the draft EU Taxonomy regulation.
June 2020 – the Taxonomy Regulation is published in the Official Journal of the European Union.
December 2021 – the Climate Delegated Act is published (see more info below), covering over 100 economic activities. Another act, the Disclosure Delegated Act, covers disclosures and transparency – specifying the content, methodology, and presentation of the information that companies disclose regarding the sustainability of their economic activities.
1st January 2022 – The first EU Taxonomy Delegated Act (Climate) becomes applicable, and large companies must report against the climate mitigation and climate adaptation objectives from January 2022 (with 2021 as the first reporting period). To comply, companies must disclose the proportion of taxonomy-eligible and non-eligible activities of their business, including total turnover, capital expenditure, and operating expenditure, in addition to certain qualitative information required in the Disclosure Delegated Act.
July 2022 – the Complementary Climate Delegated Act is published in the EU’s official journal and means that very specific nuclear and gas energy activities are included in the list of economic activities covered by the EU Taxonomy. This is controversial with environmental groups and results in several legal challenges.
January 2023 – the Complementary Delegated Act published in July 2022 – which adds nuclear and gas activities to the list of taxonomy-eligible activities – applies.
April 2023 – a draft Environmental Delegated Act is published by the Platform on Sustainable Finance, covering all the activities that make a contribution under the other four environmental objectives (water, pollution, circular economy, biodiversity).
June 2023 – the Environmental Delegated Act is adopted, introducing 31 activities which fall under the objectives for water, pollution, circular economy, and biodiversity. Amendments are made to add 46 further activities to the list of those which fall under climate change adaptation and mitigation objectives in the EU Taxonomy.
From January 2024 – financial institutions will be obligated to report on the alignment of their activities against the taxonomy’s objectives.
Though the EU Taxonomy is likely to pose challenges in regards to increased compliance costs, necessary updates to internal processes, and the need for expertise in order to interpret, comply with, and report on the regulation, the EU Taxonomy brings numerous benefits to companies that fall within scope:
The EU taxonomy provides a consistent approach to assessing the environmental performance of companies, and provides a shared language around “sustainability” for both financial market participants, and large companies.
The regulation ensures that environmental claims of the organisations who report on their alignment are substantiated – the screening criteria for the EU Taxonomy have been created by the European Commission according to the best scientific evidence with the advice of subject matter experts.
Given that the EU Taxonomy will serve as a reference guide for investors in identifying legitimate sustainable investment opportunities, companies who align a large proportion of their economic activity with the objectives of the taxonomy will make themselves more attractive to the already large and growing number of investors who prioritise sustainable projects.
With environmental concerns rising on the list of consumers’ decision-making criteria and an increased number of companies worried about the environmental impact of their supply chains, B2B and B2C companies alike who can prove their sustainability claims against a scientifically-derived framework will improve their reputation amongst their customer base.
Assessing economic activities in order to declare alignment against the taxonomy will enable reporting companies to more effectively assess, predict, and mitigate their own environmental risks around climate threats, resource scarcity, and more. Early compliance will also enable companies to avoid possible penalties as further regulation emerges in the coming years.
The world of ESG regulation is complex and rapidly-changing – that’s why we’re producing these articles and guides to give you what you need to know, and updating them as we get more information. If you’d like these updates as soon as we get them, sign up using the form below and we’ll email you directly when updates or new regulations emerge:
