EU Taxonomy
In 2019, The European Union presented the Green Deal which is a set of policy initiatives for a climate-neutral Europe by 2050. To achieve the EU’s climate and environmental objectives, the EU introduced the EU Taxonomy, a “green classification system” towards sustainable projects and specific economic activities for companies, capital markets and policymakers.
Tackling the challenges of greenwashing, the taxonomy aims to develop a clear criterion with a clear language for investors, issuers, policymakers, and regulators around green activities. Furthermore, it will support companies that will transform and mitigate market fragmentation by delivering the objectives of the European Green Deal. It also provides a “common understanding of economic activities” that will contribute substantially to the EU’s environmental goals by setting criteria for financial activities that are most relevant for greenhouse gas emissions reduction and improving climate resilience. Therefore, the sectors with the highest contribution to CO2 emissions such as energy, forestry, transport, manufacturing, and buildings are prioritized.
The Taxonomy regulations describe six environmental objectives for green economic activities:
- Climate change mitigation
- Climate change adaptation
- Sustainable use and protection of water and marine resources
- Transition to a circular economy
- Pollution prevention and control
- Protection and restoration of biodiversity and ecosystems
For an activity to be qualified sustainable, it cannot cause any harm to any of the other Taxonomy objectives stated above. The regulations set out four discussions for economic activity to be recognized as Taxonomy aligned:
- Making a substantial contribution to at least one environmental objective;
- Doing no significant harm to any other environmental objective;
- Complying with minimum social safeguard.
- Complying with the technical screening criteria
The use of EU Taxonomy
Although the Taxonomy is essentially a classification tool, it includes other functions. In the Taxonomy regulations, there are both “mandatory disclosure rules” as well as volunteer-based activities that companies are required to use.
From the 1st of January 2022, all large financial and non-financial companies must report their taxonomy alignments which explain to what extent the activities they accomplish meet the criteria set by the Taxonomy. The disclosure information will be achieved by amending requirements in the EU’s Non-Financial Reporting Directive (NFRD) and the Sustainable Disclosure Regulation (SFDR).
Green revenue and green expenditure disclosure will provide information on:
- Companies whose activities comply with the EU taxonomy criteria (through disclosure of share revenue from taxonomy-aligned activities)
- Companies that taking steps to get there (through disclosure of green expenditure)
Taxonomy can also be used voluntarily by market participants. For instance, SMEs can report voluntarily. The market participants can use the Taxonomy as an input to their sustainability and environmental strategies. It could also be used to attract investors to accomplish the green transition.
Conclusion
The Taxonomy is designed to support the EU economy while achieving EU Green Deal objectives that include the 2050 climate-neutral target. It is a transparency tool that seeks to create clarity for companies, investors and policymakers to be more environmentally sustainable. It is also probable that the Taxonomy will be applied in new ways in the future. For instance, the Taxonomy is expected to be used as a benchmark for an EU Green Bond standard in the upcoming EU proposal. It will create a direct connection between the EU and capital markets.
The taxonomy will create an opportunity for the development of further sustainable finance tools and Green Bonds as well as green mortgages. Moreover, it provides a “motivation for companies” to reach a level of environmental performance so that the financial market will be green. The Taxonomy targets to attract investors to seek out Taxonomy-aligned investments so that we can ensure more sustainable finance.
Read "Financing a sustainable European economy - Technical report" here. The report is the final report on taxonomy of the technical expert group on sustainable Finance, published in 2020.
