What is the EU Sustainable Finance Taxonomy? A Guide for Companies

The EU taxonomy for sustainable activities is part of a package of Sustainable Finance regulations that will help to redirect economic investments towards a climate-neutral economy. The taxonomy aims to provide a clear list of criteria defining environmentally sustainable economic activities to help investors and companies understand and measure how green their investments are.

To enable this, companies will need to assess and disclose to what extent their activities are in line with the environmental criteria set out. Being taxonomy-aligned will be increasingly important for businesses to attract financing and assess their overall progress towards meeting environmental goals.

And right now, the EU Commission estimates that less than 5% of companies’ activities are in alignment with the criteria set out by the EU taxonomy.

That means the entire EU business ecosystem should get ready for some major changes. For now, the new taxonomy only mandates obligatory disclosure from large corporate organizations. But with the Corporate Sustainability Reporting Directive and other new legislation underway, it’s likely that sooner rather than later, smaller companies will also need to report under the taxonomy in some form.

This article breaks down the EU taxonomy for companies. All companies that operate or sell within the EU should start examining their business models and ongoing activities in line with the taxonomy. By getting familiar with the taxonomy now, organizations can prepare for the changes and benefit from a first-mover advantage on the investment market.

The first parts of the taxonomy will come into force in early 2022, but there’s a lot that hasn’t yet been finalised. Companies who get informed now can engage with the EU to shape the final criteria. Read on to learn everything you need to know about the new EU taxonomy for sustainable activities.

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What is the EU taxonomy?

The EU Taxonomy is a classification system that establishes a list of economic activities that are considered to be environmentally sustainable. The Taxonomy aims to establish clear, comparable criteria for what is considered sustainable so that companies, investors, and policymakers can speak the same language on green activities.

The taxonomy assesses sustainability by measuring how economic activities contribute to six key environmental objectives:

Climate change mitigation
Climate change adaptation
Sustainable use and protection of water and marine resources
Transition to a circular economy including recycling
Pollution prevention and control
Protection and restoration of biodiversity and ecosystems.

To be considered taxonomy-compliant, activities must meet three conditions:

Make a substantial contribution to at least one of these six environmental objectives
Do no significant harm to the other environmental objectives
Meet minimum safeguards for social and human rights.

These conditions ensure that the taxonomy only includes activities that meet social sustainability requirements and actively contribute to green goals without causing other forms of environmental harm.

What is the purpose of the EU taxonomy?

The EU taxonomy was developed to address the need to be able to distinguish sustainable and non-sustainable financial investments. Without a clear, common framework for measuring the sustainability of investments, there is a danger of misalignment or even “greenwashing” – where misleading sustainability claims are made for unsustainable activities – in financial markets.

The taxonomy addresses this gap by standardizing which economic activities are considered sustainable, which will make it easier to compare the environmental credentials of different potential investments.

The EU taxonomy will re-orient investments towards sustainable projects, which is crucial for the EU to implement the European Green Deal and achieve its goal to become climate neutral by 2050.

How will the EU taxonomy affect companies?

Large companies (for example, public-interest companies with more than 500 employees) will be required to disclose which of their activities are environmentally sustainable using the criteria provided by the EU taxonomy. From 1 January 2022, these companies will need to begin providing data on how their activities align with the first two environmental objectives named in the taxonomy: climate change mitigation and climate change adaptation. Companies are required to report on the share of capex, opex and turnover they derive from their taxonomy-aligned activities.

It’s likely that the taxonomy will soon be extended to a wider range of companies through the Corporate Sustainability Reporting Directive.

But the EU taxonomy will affect companies beyond these legal obligations. As the financial ecosystem shifts, there will be increasing pressure for companies of all sizes to demonstrate how their activities align with the EU taxonomy. To reduce regulatory and financial risk, it’s a good idea for all companies to start shifting their activities towards taxonomy-alignment.

It’s important to note that the taxonomy will apply to all organizations that conduct business in the EU.

How can companies prepare for the EU taxonomy?

Companies can get ready by:

Assessing which of their current activities are considered sustainable according to the taxonomy criteria and aiming to increase the percentage of sustainable activities overall.
Establishing a systemic process of collecting data on the company activities and measure the substantial contributions these activities make to environmental goals and demonstrate that they do not cause other forms of environmental harm.
Checking whether they comply with the social safeguards defined in the taxonomy, which will be mandatory even for companies that do not have to disclose taxonomy alignment.
Staying on top of related policy processes as they comes out and engaging with the EU to shape the final taxonomy (remember, Ohana’s here to help!).

Which policies govern the EU taxonomy?

There are two major acts at play in the EU Taxonomy.

The Taxonomy Regulation entered into force in 2020. The Regulation introduces the taxonomy as a classification system and mandates that relevant organizations disclose the sustainability of their economic activities in line with this taxonomy.

The EU Taxonomy Climate Delegated Acts define the technical screening criteria and set out which activities will be considered sustainable. The first Delegated Act for the EU Taxonomy comes into force on 1 January 2022. The second Delegate Act regulating environmental objectives 3-6 is expected to be published in mid-2022 and to go into force in 2023.

What’s the latest news on the EU taxonomy?

The EU taxonomy’s list of sustainable activities is being prepared in several phases:

Draft delegated act on mitigation and adaptation

In June 2021, the delegated act for the first two environmental objectives of the EU taxonomy was approved by the EU Commission. This act defined specific methodologies and measurement criteria for sustainable activities related to climate change adaptation and mitigation objectives. It shows the EU’s intention to target industries in sectors with the highest CO2 emissions, like energy, manufacturing, and transport. The act sets forth detailed screening criteria for over 70 sustainable economic activities within areas including forestry, environmental restoration, wind and hydropower electricity, and sustainable transportation.

Taxonomy criteria for water, circular economy, pollution control and biodiversity

The second draft delegated act, which will deal with the other four environmental objectives, will be published in mid-2022. In advance of the publication, the EU’s permanent expert group, the Platform on Sustainable Finance (PSF), released a taxonomy pack for feedback in August 2021.

This report proposes a methodology and list of priority economic activities for four environmental objectives:

1) Sustainable use and protection of water and marine resources

2) Transition to a circular economy including recycling

3) Pollution prevention and control

4) Protection and restoration of biodiversity and ecosystems

Here’s a taste of what we’ve learned from the taxonomy draft criteria:

The PSF is seeking to combine “improvement potential” (how much a given sector or activity can substantially reduce negative climate and environmental impact) of each activity in isolation with a life cycle approach.
For the objective on transition to the circular economy, four high-level categories have been developed to define a substantial contribution:

Circular design and production
Circular use, including life extension
Circular value recovery, including capturing value for the secondary raw materials market
Circular support, including enabling digital tools and educational programmes

Offsetting practices will not currently be included as sustainable activities in relation to biodiversity or other goals. “Offsetting” means organizations continue to engage in activities with a negative climate impact but implement another activity to attempt to mitigate that impact.

What’s next for the EU taxonomy – and how can companies have their say?

The delegated act for sustainable activities related to climate change adaptation and mitigation objectives is currently in the final stages of the co-decision process, and will come into effect in January 2022. Organizations should engage with the European Parliament and EU Council to shape the climate change adaptation and mitigation taxonomy before it’s finalised.

The PSF’s report on criteria for sustainable activities for goals including water, circularity, pollution control, and biodiversity restoration was open for comment until 24 September 2021.

On these topics, the final report is expected in November this year. The next step will be for the Commission to prepare a draft delegated act on these objectives, which will be published in mid-2022.

Now is the time for companies to get their voices heard on the EU’s upcoming taxonomy.

The taxonomy will have a huge impact on how investors and companies measure sustainability in all industries.

By engaging with policy makers, companies can push for an effective, impactful, and environmentally ambitious taxonomy that will push the EU’s business ecosystem towards a climate-neutral circular economy.