EU Taxonomy is a tool to help stimulate investment in sustainable economic activities.
It is a green language that organizations must learn over the coming years.
The EU is tightening its emission-reduction target from 40% to at least 55% fewer greenhouse gases (GHGs) in 2030, compared to 1990 (EC 2020).
This requires an unprecedented economic transition. Organizations must transform their economic activities to fit into a low-carbon economy. Taxonomy helps by naming green activities.
Taxonomy is a list of economic activities within sectors with technical screening criteria, to substantially contribute to and not significantly harm environmental objectives. It is essential to implementing the EU Green Deal.
Notably, taxonomy is not a hallmark or eco-label, nor does it cover an organization’s risk profile. Investing in an activity in line with taxonomy can be a financial risk, though.
When a company offers goods or services, it performs an economic activity. The Technical Expert Group (TEG) on Sustainable Finance developed taxonomy’s screening criteria. The TEG distinguishes between economic activities by indicating whether they contribute to achieving an environmental objective. Taxonomy assigns a category – low carbon, transition or enabling – to a contributing activity.
Low-carbon activities are sustainable themselves, such as solar or wind energy production, and contribute to EU emission-reduction targets.
Transition activities help high CO2-producing products and services, such as plastic and steel production, to reduce their emissions.
Enabling activities support transition to low-carbon activities. Examples include constructing an electricity network or energy storage.
Achieving EU climate objectives is more than only reducing CO2 emissions. Recycling plastic, conserving specific animal species and preventing release of toxic substances into the environment are also key to the EU Green Deal. Therefore, taxonomy has a broader view of the environment and assesses economic activities based on six environmental objectives:
Each economic activity is set an upper and lower limit for each environmental objective. These limits vary from a specific emission per unit of product to management practices. An economic activity must substantially contribute to one or more environmental objectives. Contribution is considered substantial if an organization reaches or exceeds an activity’s upper limit.
Furthermore, the economic activity must not significantly damage the remaining environmental objectives, the lower limits. Current lower limits, or Do No Significant Harm criteria, are often based on EU regulations and contain further technical criteria for lower limits where needed. Companies must also show that they meet minimum social safeguards.
Upper and lower limits will be periodically amended based on Platform for Sustainable Finance advice. The aim is to base limits on the latest science and tighten them to achieve a climate-neutral economy.
There is no taxonomy for economic activities that harm environmental objectives. For example, drilling or transporting and storing fossil fuels are “brown” economic activities. To properly distinguish between what does and does not contribute to sustainability, the TEG recommends research into a brown taxonomy.
EU legislation obliges large public-interest organizations with over 500 employees to provide information on their non-financial performance, including concerning the environment. From 2022, this applies to taxonomy.
Organizations covered by the Non-Financial Reporting Directive (NFRD) are expected to declare which parts of turnover and expenditure align with taxonomy. This can be an annual financial report appendix or a separate annual sustainability report. About 6,000 European companies must take part. The NFRD also applies to asset managers and exchange-traded, investment and pension funds, as well as insurance companies and banks. Such organizations must show which parts of their portfolios or loans are in line with taxonomy.
The EU expects taxonomy to be applied more widely voluntarily, but administration can still be a hurdle. Furthermore, several countries, banks and organizations outside the EU want to achieve a climate-neutral economy and expressed interest in fully or partially implementing the taxonomy.
There is little research on the operation of taxonomy. However, the case of the automotive industry, which can substantially contribute through electric car production, is interesting, as 69% of the industry is in scope, but less than 1% can prove they meet the conditions for substantial contribution and no significant harm.
There are a few reasons for large differences between high scope and low alignment percentages, including taxonomy not currently covering all relevant economic activities, unclear and multi-interpretable technical criteria and definitions, and organizational reporting and processes not being in place.
Organizations must prepare for taxonomy by ensuring they have the correct resources and alignment.
We can support you to implement sustainable, safer and efficient processes within your value chain. Our Sustainability Solutions comprise six pillars – Resources, Energy, Production, Infrastructure, Living and Business Practices. This framework aligns with the Principles for Responsible Investment, UN Sustainable Development Goals and will align with EU Taxonomy when the criteria of inclusion is clearer.