The European Union has introduced a sweeping range of measures in recent months aimed at greening the European economy and achieving region-wide Net Zero status by 2050. The objective is to align regulatory measures with incentives, investments, and market signals to drive the rapid growth of sustainable business towards this green transformation. But how will we know we are on the right track?
The EU Taxonomy (the Taxonomy) acts as a central piece to the European Green Deal puzzle to classify whether an economic activity is considered environmentally sustainable. Many investors, companies, and stakeholders involved in sustainable finance have long awaited its arrival facilitating ways in which business activities can be classified as ‘green’. However, what does this mean for companies?
What is it?
The Taxonomy assesses and sets performance criteria for an economic activity’s contribution toward six environmental objectives:
- Climate change mitigation
- Climate change adaptation.
- The sustainable use and protection of water and marine resources.
- Transition to a circular economy.
- Pollution prevention and control.
- The protection and restoration of biodiversity and ecosystems.
The performance criteria are known as the ‘Technical Screening Criteria’, which provides thresholds and other criteria to categorise how environmentally sustainable a specific economic activity may be.
In addition, taxonomy-aligned activities must ’do no significant harm’ to the other environmental objectives – so an activity that contributes to climate change adaptation, for instance, must not inadvertently undermine water and marine environments. There are also minimum social and governance ‘safeguards’ that must be respected, such as the UN Guiding Principles on Business and Human Rights.
Who is affected?
- Many large public-interest companies operating in Europe
It is expected that companies falling under the scope of the Non-Financial Reporting Directive – soon to be replaced with the Corporate Sustainability Reporting Directive – will be required to disclose against the EU Taxonomy. They will be required to disclose: the proportions of turnover and expenditure linked with the six environmental objectives; how they do no significant harm; and how they meet minimum social and governance safeguards. At present, this includes businesses with more than 500 employees in the EU.
- Financial market participants offering financial products in the EU
Financial services firms will be required to disclose how and to what extent they have used the Taxonomy in determining the sustainability of their investments, and what environmental objectives they contribute to, as well as the proportion of investments that are Taxonomy-aligned, expressed as a percentage. Currently, financial products marketed into the EU will be required to refer to the Taxonomy. This refers to market segments such as pensions and asset management, insurance, and corporate and investment banking providing financial products such as equity funds, infrastructure funds, pension products, insurance-based investment products and venture capital funds.
What does this mean for companies?
- Increased scrutiny of their sustainability credentials, risks and opportunities
The Taxonomy provides an opportunity for companies to demonstrate performance and progress towards delivering the six environmental objectives in a comparable manner, using the technical screening criteria. Investors with a sustainable investment philosophy can begin to identify companies with a credible environmental strategy. In this sense, the Taxonomy can act as a useful platform for engagement with companies around their sustainability performance, supporting decision-making on future investments as well as monitoring performance of existing projects against the Taxonomy over time.
Companies that do not fall into scope for mandatory disclosure can use the Taxonomy on a voluntary basis for their environmental sustainability strategies, plans and communications. This allows companies an opportunity to be transparent, intentional and strategic about their Taxonomy alignment, as it can create future investment opportunities and long-term financial benefits with improving sustainable performance.
- Non-EU companies may face mandatory disclosure and could encounter tough investor questions
The Taxonomy will have an impact on non-EU companies as it applies to all products and services that are manufactured and distributed in the EU. Given the globalised nature of business, many companies falling under the NFRD have manufacturing or distribution bases in the EU meaning they are required to comply. Furthermore, if a company receives investment from within the EU, they will likely face questions from investors on what they are doing about the Taxonomy.
- Other markets are already following suit
The Taxonomy has set the stage for a framework to show how a company performs and aligns with its criteria. Consequently, many markets including the UK, China, and ASEAN countries are in different stages of developing their own taxonomies and sustainability disclosures.
For instance, in June 2021, the UK set up the Green Technical Advisory Group (GTAG) to oversee the delivery of the UK’s equivalent Taxonomy. This may prove to allow other sustainability disclosures to be phased out such as the Task Force on Climate-related Financial Disclosures (TCFD) recommendations by the mid-2020s.
While the EU Taxonomy is in its early stages, it is clear that companies are now being signalled more than ever to show their impact on the environment. Acting now can set a company up on their journey to becoming more environmentally sustainable and allowing them to develop a strong competitive advantage with resilience in a rapidly changing world.
If you would like to know more about how your company is affected by the EU Taxonomy and its implications please contact Judy Kuszewski at Judy.Kuszewski@sancroft.com or Ilkka Saarinen at Ilkka.Saarinen@sancroft.com
Important upcoming EU Taxonomy dates for your calendar:
- 31 December 2021: deadline for the EU Commission to adopt Technical Screening Criteria for the other environmental objectives other than climate change mitigation and adaptation:
- sustainable use and protection of water and marine resources.
- transition to a circular economy, water prevention and recycling.
- pollution prevention and control.
- protection of healthy ecosystems.
- 1 January 2022: Company obligations under the EU Taxonomy become applicable for climate change mitigation and adaptation
- 1 January 2023: Company obligations under the EU Taxonomy become applicable for the remaining environmental objectives.
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