To meet the climate and energy targets for 2030 and reach the objectives of the European Green Deal, the European Union believes it is vital to direct investments towards sustainable projects and activities as well as provide a comprehensive definition of the term sustainable. This is why the action plan on financing sustainable growth called for the creation of a common classification system for sustainable economic activities, or an “EU taxonomy”.
The Taxonomy is therefore a regulatory classification system helping companies to define which of their economic activities are environmentally sustainable. In other words it is a tool to "support investors, companies, issuers and project promoters navigate the transition to a low-carbon, resilient and resource-efficient economy”.
At its core, the Taxonomy it sets out four key thresholds to ensure that activities are consistent with environmental objectives:
To be classified as a sustainable economic activity according to the Taxonomy, a company must not only contribute to at least one environmental objective but also must not violate the remaining ones.
While the taxonomy is focused on sustainability in terms of climate, it is also intended to establish rules and other environmentally sustainable objectives and expand into social objectives later on. You can find the full taxonomy regulation here, including recommendations on taxonomy design as well as information about who has to do what, and by when. There is also a shorter summary document available here.
The Taxonomy essentially allows the market to define when a company or enterprise is operating sustainably or environmentally friendly. Therefore, compared to their competitors, companies that align with the taxonomy will stand out positively and thus should benefit from higher investments.
Moreover, the regulation places a reporting obligation on several companies to disclose what proportion of their investments align with sustainable activities. It considers different circumstances and obligations for 3 distinct economic actors:
To comply with the EU Taxonomy and its performance thresholds, companies will need to start disclosing their sustainable investment objectives’. Among other details, this includes the percentage of sustainable economic activity in terms of turnover, capital expenditure (CapEx) and, if applicable, operating expenses (OpEx).
The disclosure requirements start applying on 1 January 2022 in relation to the climate objectives, and on 1 January 2023 in relation to the other four environmental objectives. The reporting will cover the previous financial year respectively, meaning that the first reporting, related to climate change mitigation and adaptation, is due in the course of 2022 for the financial year 2021, while the set of disclosures for the rest of the environmental objectives will be due in the course of 2023 for FY2022.
Disclosures are only mandatory for large companies within the scope of the CSRD, but small companies could find it useful to disclose theTaxonomy alignment of their activities on a voluntary basis – particularly as it relates to their engagement with investors and other key stakeholders.
While the regulation may seem complex, responding to it may be simpler for SMEs. For example, SMEs whose business models are focused on one green activity covered by the Taxonomy will have only one set of criteria applicable to their business model. For instance, a small manufacturer of energy efficient windows could check relatively easily what share of its turnover, capital expenditure or operating expenditure is related to the sale of windows that comply with the Taxonomy criteria.
In our view, companies that want to effectively and efficiently respond to the increasing reporting demands and regulations, such as the EU Taxonomy, will need to:
Author: Gerard Coenen, Senior Manager ESG, Diginex
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