What is the EU Taxonomy Regulation?
As a new effort to reduce the critical environmental issues the world is facing, The European Commission formulated the EU Taxonomy Regulation. The Taxonomy tool requires investors, companies, and financial institutions to outline the environmental sustainability of their economic activities and defines technical screening criteria for economic activities.
This is an attempt by the European Commission to prevent market players from supporting greenwashing activities and invest in sustainable solutions instead. Moreover, the Taxonomy Regulation is meant as another spark in achieving the European Union’s net-zero carbon emissions goal by 2050.
The technical screening criteria define performance thresholds for economic activities that have an impact on six environmental objectives. They concern some of the most urgent environmental issues that confront humanity:
- climate change mitigation
- climate change adaptation
- sustainable use and protection of water and marine resources
- transition to a circular economy
- pollution prevention control
- protection and restoration of biodiversity and ecosystems
The EU Taxonomy already came into effect in July 2020. According to the EU Commission, the Taxonomy for climate change mitigation and climate change adaptation ought to be established by the end of 2020, and applied by end of 2021. For the four other environmental objectives, the Taxonomy should be established by the end of 2021 and will apply by the end of 2022.
“The adoption of the general framework for a taxonomy is an important step in clarifying to investors the meaning of sustainability in a language that is useable in a financial markets context.” – Arnaud Van Caenegem, 2020, “Sustainability is No Longer in the Eye of the Beholder: An Overview of the Taxonomy Regulation”
What does the EU Taxonomy mean for your company?
The European Commission encourages all economic agents to use the Taxonomy Regulation to ensure the sustainability character of their investments and activities. However, as of this moment, reporting is compulsory only for the following two groups:
- financial market participants offering financial products within the EU and the UK
- large public interest companies who already need to submit a non-financial statement under the Non-Financial Reporting Directive.
The objective of the Regulation “is to focus the minds of corporates on investing and delivering returns from these activities, and to provide investors with the data they need to be able to direct their capital to sustainable practices.” (Bloomberg Professional Services, 2020, “The EU Taxonomy for sustainable finance: FAQs for financial market participants”).
In the future, the use of eco-labels will define the alignment with the Taxonomy Regulation. Moreover, for investors to accurately report on the extent of Taxonomy alignment of their funds, the EU Commission will also formulate standards for green debts and green loans.
In order to line up with the Taxonomy Regulation, economic activities need to considerably contribute to one of the six aforementioned environmental objectives, and not significantly harm any of the other five. Moreover, the economic activities should comply with the minimum safeguards regarding human rights.
UK’s Taskforce on Climate-related Financial Disclosures
The UK Government has ambitious climate change mitigation initiatives as well. Therefore, in June 2017 the UK Government published the Taskforce on Climate-related Financial Disclosures (TCFD). In November 2020, the UK Government published an Interim Report of the TCFD together with a roadmap towards mandatory climate-related disclosures. The latter sets out an indicative path over the next five years.
As a result, the UK Government will impose TCFD-aligned disclosures for the non-financial and financial sectors of the UK. The roadmap presents a coordinated strategy for 7 categories of organisations:
- listed commercial companies
- UK-registered companies
- banks and building societies
- insurance companies
- asset managers
- life insurers and FCA-regulated pension schemes
- occupational pension schemes
Starting 1 January 2021, premium listed companies in the UK will need to report on how climate change affects their business, in accordance with the recommendations of the TCFD. In the beginning, the disclosure will encompass a ‘comply or explain’ basis, followed by a mandatory approach.
Lastly, the UK is also planning on introducing its own green taxonomy in the following years. This will initially adopt the scientific metrics of the EU taxonomy.
“Compared to the financial crisis and the pandemic, the risks from climate change are even bigger and more complex to manage. And acting now gives us the best opportunity to manage those risks”. – Andrew Bailey, Governor of the Bank of England, as quoted by S. Aionesei, 2020, ‘UK Announces Climate Focused Financial Services Regime’, JD Supra
Advantages and challenges of the EU Taxonomy Regulation
According to Flemming Hedén, Senior Advisor at the Climate policy unit of Sweden’s environmental protection agency, the EU Taxonomy Regulation ensures a “single standard for everyone, which clears confusions and facilitates cross border investment flows towards the green transition” (as paraphrased by Filipe Wallin Albuquerque, 2019, “EU Taxonomy – Room for Improvement”). Moreover, the European Commission will further improv and supplement the Taxonomy tool in time. This ensures the framework’s flexibility, which will enable investors to put the tool into practice.
However, Flemming Hedén also outlines some trade-offs. As the Senior Advisor pointed out, “the ability of the taxonomy to adjust in the future is desirable, but it may also create uncertainty and instability.” (as paraphrased by Filipe Wallin Albuquerque, 2019, “EU Taxonomy – Room for Improvement”). Furthermore, adherence to the Taxonomy Regulation may often differ between countries, depending on the local markets, resources, and conditions. To illustrate this, Hedén gives the example of nuclear energy. This is considered sustainable in e.g. France, while Germany is making extensive efforts towards gradually removing it.
Moreover, reliable green data that supports investors when making decisions may lack or be incomplete in many cases. As with the SDGs, this data deficiency can make it particularly challenging for a framework to be put into practice.
Lastly, as one of the main targets of the Taxonomy framework is to avoid greenwashing, Will Martindale, director of policy and research at the PRI, brings another issue to light. Martindale emphasises that a case of low taxonomy alignment will not automatically imply greenwashing. He also calls attention to the fact that the Taxonomy Regulation does not encompass the so-called ‘neutral’ activities. These are activities that do not have either positive or negative impacts on environmental, social, and governance criteria.
Is the EU Taxonomy Regulation the new challenge for companies?
The Taxonomy Regulation will incentivise companies to invest in a sustainable manner. For now, it represents a set of guidelines for the majority of companies, while reporting is not mandatory for most. However, decision-makers can be one step ahead of the regulation changes. Engaging the Taxonomy Regulation sooner rather than later has the potential to ensure a competitive advantage. Therefore, companies need to understand the basis and implications of the new Taxonomy framework and identify areas of business where it can be implemented.
At 2030 Builders we are determined to use our expertise to help companies overcome the Taxonomy obstacles and put their efforts and resources into the best possible investments towards a more sustainable future. As always, we will bring the power of collaboration, gamification, and digitalization into play for an exciting learning experience. We invite you to check our current modules and subscribe to our newsletter for news about our future Taxonomy module.
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