Taxonomy, that is everything you need to know about classifying economic activities as environmentally sustainable under EU law

In the recent years, the European Union has increasingly focused on the issues of sustainability and combating climate change. The EU Taxonomy Regulation is one of the key measures aimed at redirecting investment toward greener projects and businesses.

The purpose of the taxonomy is to adjust climate and energy investments to the EU 2030 Targets, and to encourage investors to invest in environmentally sustainable activity.

In this article you will learn:

– what exactly the EU Taxonomy means

– who must report on it and to whom, and

– what benefits such reporting brings.

Taxonomy is the term commonly used for Regulation (EU) 2020/852 of the European Parliament and the Council, dated June 18, 2020, which aims to create a legal framework to facilitate sustainable investments. In practice, the taxonomy aims to establish clear criteria and principles to determine which investments can be considered sustainable, particularly in terms of pro-environmental actions. This is an important initiative to improve the environment and promote climate-friendly investments and sustainable development in the European Union.

Assumptions of the taxonomy and entities it involves

The EU Taxonomy was introduced as a part of the European Green Deal and aims to define the criteria of environmentally sustainable activities. To be considered sustainable, an activity must make a significant contribution to at least one of six environmental goals, such as climate change mitigation, climate change adaptation, or biodiversity protection. Also, it cannot cause serious harm to other environmental goals and must operate in accordance with minimum guarantees.

The obligation to publish in accordance with the requirements of the EU Taxonomy applies to several groups of entities. These include entities that are subject to non-financial disclosure obligations under Directive 2014/95/EU, financial entities that offer investment products defined as sustainable, and companies covered by the updated CSRD. The reporting requirement applies to macro sectors such as energy, manufacturing, forestry or transportation, which have the greatest impact on climate change.

Taxonomy vs. banks and financial institutions

A separate, but still important issue is to assess, for example, whether the activity of a bank, in terms of its environmentally sustainable business activities, provides to it the opportunity to assess customers against all the environmental objectives indicated in the taxonomy.

At this stage, banks do not have full information about the detailed criteria under which they will assess whether a given activity meets the objectives under Article 9. The European Commission is to prepare technical qualification criteria, which will be issued in stages and will apply from various dates.

Therefore, at this stage, inquiries to customers should concern at least the first two environmental objectives for which qualification criteria have already been issued. Only in the future, when the criteria for the remaining objectives are available, can the questions be supplemented with questions on the remaining goals to enable verification whether the customer meets in full the criteria of significant contribution, i.e. to at least one of the six environmental goals.

It is also worth indicating that the minimum disclosure requirements under Article 8 only apply to non-financial companies, and not to banks. Banks will be required to disclose information, specifically the green asset ratio, according to the model prepared in a delegated act issued by the European Commission,

Sustainability continues to be a highly dynamic issue. The European Commission plans to introduce new delegated acts that will extend the scope of activities that are to be assessed under the taxonomy. The acts are expected to take effect from 2024 and will include the sectors such as maritime transport and food and chemical production. The introduction of the new criteria is expected to make it easier for the companies to comply with the requirements and enable investors to better understand the sustainable actions taken by companies.

Benefits that taxonomy reporting brings to companies

Preparing voluntary taxonomy disclosures can bring many benefits to companies.

Firstly, such reporting enables the investors to better understand the steps a company takes toward sustainability, which in turn can encourage them to invest in a particular company. Secondly, taxonomy reporting can be a useful tool for an organization's senior management, enabling them to monitor the impact of their strategies on the company's operations. In addition, financial institutions are required to report on the proportion of their investment portfolios that qualify for the EU Taxonomy, which can affect the selection of appropriate investments. Another extremely important aspect is the indication of what non-financial information the companies have to disclose under Article 8 of the taxonomy. Article 8 imposes on companies an obligation to publish non-financial information that is subject to Article 19a or 29a of Directive 2013/34/EU. This applies to large entities that are public interest entities that exceed an average of 500 employees during the fiscal year, and public interest entities that are parent companies of a large group that exceed this criterion on a consolidated basis.

Ambitious goals and challenges

The introduction of the taxonomy represents a step forward in the direction of sustainable development and fight against climate change. The European Union has ambitious goals in terms of climate neutrality and environmental protection, and the taxonomy will help monitor progress in these areas.

In addition, the voluntary taxonomy disclosures bring many benefits to companies, investors and senior management, so it is sensible to prepare for its implementation now. The EU Taxonomy evolves rapidly, so companies should follow regulatory changes and adjust their internal processes to the reporting requirements.

Implementing the taxonomy can be a challenge, especially for smaller companies and financial institutions which may need support and guidance in adjusting their processes and operations to the sustainability requirements. It is therefore important for government institutions, industry organizations and business advisors to support these entities in achieving their taxonomy-related goals.