March 21, 2022
To fasten a sustainability transition, investments fluxes from the EU must be redirected towards sustainable activities in alignment with its environmental objectives. Therefore, the EU has developed a new tool to define what activities are « sustainable ». This tool is called EU Taxonomy.
The European Union has set up climate and energy targets to reach the European green deal goals and mitigate the consequences of climate change. The first necessary step to fulfil these targets is to have a clear definition of what is « sustainable ». Therefore, the action plan on financing sustainable growth asked the EU Technical Expert Group on Sustainable Finance to define a classification system for sustainable economic activities, known as the Taxonomy.
The Taxonomy is a green classification system of economic activities built on performance criteria and environmental objectives for investment purposes.
Taxonomy-eligible activities must contribute significantly to at least one environmental objective (listed below), do no significant harm to the other five objectives, and comply with minimum social safeguards.
1. Climate change mitigation
2. Climate change adaptation
3. The sustainable use and protection of water and marine resources
4. The transition to a circular economy
5. Pollution prevention and control
6. The protection and restoration of biodiversity and ecosystems
The classification is built using precise technical criteria, both quantitative and qualitative, methodology and guidance described in the EU report on taxonomy made by experts, stakeholders and consultants from around the globe.
The Taxonomy is a transparency tool that introduces mandatory disclosure obligations on some companies and investors, asking them to reveal their share of Taxonomy-aligned activities and allow for the comparison of companies and investments.
Therefore, the Taxonomy would help businesses, investors, policymakers and market participants in a broader measure with suitable classifications of what projects or activities can be considered environmentally friendly. Thus, helping prevent businesses from doing greenwashing and redirecting funds where needed, allowing the transition towards a low-carbon economy. This classification and the results are indispensable in making the EU climate targets implementable in practice.
Everyone is encouraged to use the EU Taxonomy to categorise their economic activities as sustainable, but reporting will be mandatory for three cases:
- Financial market participants and issuers offering financial products within the EU,
- Companies with +500 employees which are already asked to provide a non-financial statement under the EU Non-Financial Reporting Directive,
- The EU and Member States when setting public measures, standards or labels for green financial products or green bonds.
The financial actors reinforced by the EU Taxonomy will be able to examine the sectors in which they invest carefully. So far, the sectors included are agriculture, forestry and fishing, manufacturing, electricity, gas, steam and air conditioning supply, water, sewerage, waste and the related, remediation, transportation and storage, Information and Communication Technologies, construction and real estate activities.
However, the EU Taxonomy is not a mandatory list of economic activities for investors to invest in, and it does not set compulsory requirements on environmental performance for companies. Investors are free to choose what to invest in; nevertheless, the expectations are that financial market actors will look much more carefully at the activities they are investing in and financing.
The EU Taxonomy will have implications for foreign markets that do business with Europe. Investors will need to report on the alignment of their Environmental, Social, and Governance (ESG) funds for climate mitigation and climate adaptation by January 1, 2022, covering the reporting period of 2021. European institutional investors will have an obligation to disclose how their ESG funds align to the EU Taxonomy. Consequently, investors will be asking companies how aligned their business is to the Taxonomy. While the EU Taxonomy is the first of its type, other markets, including Canada, Japan, Malaysia, Singapore and the UK, are discussing their own taxonomies.
Practically, for businesses to assess whether their activities follow the Taxonomy’s definitions and criteria, they can leverage
- the Taxonomy tools,
- frameworks from the Green and Social Bond Principles,
Also, they are requested to meet theminimum social safeguards of the OECD Guidelines on Multinational Enterprises and UN Guiding Principles on Business and Human Rights.
After the assessment, businesses can implement proper strategies to reduce the importance of activities that are not in line with the Taxonomy, as well as explore new opportunities associated with adjusting these activities.
Case studies of already implemented EU Taxonomy policies from various corporates around the globe can be found here.
Thanks to the categorization and characterization of what is « sustainable », the EU Taxonomy allows non-sustainable activities or projects to become less attractive for investors, thus slowly redirecting funds into sustainable activities and actively boosting the economic shift towards a low-carbon and resilient economy. Businesses should anticipate and adapt to this new tool as investors will need to report starting from the 1 of January 2022.
Before the Taxonomy, it was easier to hide unprofitable investments from an environmental point of view. Thanks to this new tool, it would be much more complex, and the constraints such as the need to disclose carbon indicators will make non-sustainable investments less attractive. At Tapio, we can help businesses align with the Taxonomy by performing a full carbon accounting and solid reducing strategies to fit the climate requirements.