How sustainable are companies? The EU taxonomy provides orientation

Can nuclear power and natural gas be sustainable? The European Commission’s proposal to include these two energy sources in the EU Taxonomy has generated a lively debate, showing not only how controversial this topic is, but also that the Taxonomy Regulation is already in force.

So, what exactly is the EU Taxonomy? How does it define what can be considered sustainable and what are the consequences for businesses?

Objectives of the Taxonomy Regulation

The European Union’s Climate Law is a commitment to being carbon neutral in all sectors by 2050.  This objective depends on a far-reaching transformation of the economy to move it toward carbon-neutral processes, energy production, and mobility. The EU expects these changes to require investment of at least one trillion euro this decade alone.

According to the EU Action Plan for Sustainable Finance, the funding will largely be provided by private investment from the real economy and financial sectors. However, to effectively steer investments toward sustainable economic activities, investors must first share a common understanding of which activities can be considered sustainable. This is where the EU Taxonomy comes in as a classification system with defined criteria.

When are economic activities considered environmentally sustainable?

To qualify as sustainable as defined by the Taxonomy Regulation, an activity must make a significant contribution to at least one of the six environmental objectives below, without significantly affecting the other environmental objectives:

The decision on whether the activity makes a significant contribution to a particular environmental objective is essentially based on Articles 10–16 of the Taxonomy Regulation. Delegated acts define additionaltechnical screening criteria” for certain industry-specific activities. The delegated acts function as a form of “green list” that defines a range of activities considered “green” under specific conditions. For example, the production of primary aluminum can be classed as making a significant contribution to climate protection if it can be done without exceeding specific limit values for emissions, carbon intensity, or power consumption. This activity can be classed as Taxonomy-aligned and environmentally sustainable if the production process also sticks to the “Do no significant harm” principle and upholds minimum social and human rights standards, such the United Nations Guiding Principles on Business and Human Rights.

The first delegated act that came into force on January 1, 2022 currently sets out the screening criteria for the “Climate Change Mitigation” and “Climate Change Adaptation” environmental objectives for activities from 15 different sectors. The Taxonomy Compass created by the EU provides an overview of the Taxonomy Regulation. In the future, this list will be supplemented with additional delegated acts that cover more activities and sectors.

Who is affected by the Taxonomy Regulation?

The regulation is particularly relevant to financial market participants, such as investment funds, banks, and insurance companies, that are required to disclose their activities or provide financial products in accordance with the Sustainable Finance Disclosure Regulation (SFDR).

In addition, some 11,500 real-economy companies based in the EU that must already submit a non-financial declaration in accordance with the Non-Financial Reporting Directive (NFRD) will now need to disclose their share of Taxonomy-aligned expenditure. The EU Commission expects that this “Taxonomy alignment” will initially account for just 0–5% of expenditure for many companies.

The disclosure is mandated based on the following indicators:

  • The share of revenue generated by products or services associated with sustainable economic activities (turnover KPI)
     
  • The share of capital expenditure related to assets or processes associated with sustainable economic activities (CapEx KPI)
     
  • The share of operating expenditure related to assets or processes associated with sustainable economic activities (OpEx KPI)

The disclosure obligation is expected to be extended to small and medium-sized companies when the Corporate Sustainable Reporting Directive (CSRD) enters into force, which is due for the 2023 reporting year. It will then affect some 50,000 companies in the EU, but businesses not affected by the regulations are free to use the Taxonomy voluntarily. For example, companies may wish to use it for defining and implementing sustainability measures, identifying areas for improvement and potential for optimization, or for meeting business partner requirements.

The EU Taxonomy helps to establish transparency about sustainable activities, channel investment into the right areas, and prevent greenwashing. We can also assume that environmental performance will play an increasingly important role in future decisions by private and institutional investors, as well as being a criterion for awarding funding, which is already the case for the NextGenerationEU funding. EU member states will also be expected to use the Taxonomy Regulation for determining public measures, standards, and labels for green financial products and corporate bonds.

How will activities be assessed against the EU Taxonomy?

The workflow shown in the graphic can be used to assess the Taxonomy alignment of a specific activity. The relevant activities must first be identified and assigned to the environmental objectives of the Taxonomy. The next step is to assess whether the activity makes a significant contribution to an objective without significantly affecting other environmental objectives, and whether minimum social standards are upheld. The assessment must be based on a robust methodology and focus on greenhouse gas emissions for the first two environmental objectives. The activity can then be compared against the technical screening criteria of the delegated act. Based on these conclusions, it is then possible to calculate the required performance indicators and integrate them into a report.

The EU Taxonomy as another driver for sustainability

The combination of financial and non-financial indicators through the new EU Taxonomy is another clear signal that companies can already be analyzed from more than just a financial perspective. Transparency about the environmental and social impact of business activities is becoming increasingly relevant to policymakers, financial market participants, investors, and customers. And instruments like the EU Taxonomy are making these considerations a necessity. To successfully prepare for the stricter requirements and tightening framework conditions resulting from this transformation, companies must recognize that moving to sustainable business models is essential, both in terms of meeting expectations and not losing their license to operate. With this in mind, the question for companies is not whether the “green” transformation of the economy is possible, but how it will succeed. The EU Taxonomy is an initial regulatory requirement for companies of all sizes, and its relevance and importance will increase in the years ahead.

 

For this reason, we recommend analyzing the individual requirements of your business, pinpointing measures as early as possible, and using the regulatory requirements for transparency as a source of business potential. Please contact us if you are interested in discussing the impact of and implementation options for the Taxonomy Regulation at your company!

Infos on the Blogpost

Published on: 10.02.2022
Authors: Anna Fischer, Niklas Brenten, Simon-Alexander Appel

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Anna Fischer
Consultant | Customer Products & Services

A “Better Tomorrow” is not possible without...:

  • Collective responsibility for systemic change
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  • Cooperation on an equal footing

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  • Transformation with purpose

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Niklas Brenten
Consultant | Customer Products & Services

A “Better Tomorrow” is not possible without...:

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  • The interface between the economy, policy and the environment

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Simon-Alexander Appel
Consultant | Customer Products & Services

A “Better Tomorrow” is not possible without...:

  • Seeing the big picture
  • The courage to make systematic change
  • Sustainable innovation

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  • Making a genuine impact

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