A Simple Introduction to the EU Taxonomy on Sustainable Finance

By Richard Howard

“Rules Control the Fun!” – Monica Geller, Friends

The green and sustainable finance community have been crying out for concrete definitions of what counts as green finance and what does not.

The belief is that being able to label investments and financial products as green will enable investors to act with confidence, and crucially this will avoid ‘greenwashing’. By adding legitimacy to the green and sustainable finance industries, investors will be able to make their decisions contribute towards positive climate action.

What is the EU Taxonomy of Sustainable Finance?

In order to facilitate the climate transition and meet its own net-zero goals the EU has created the ‘EU Taxonomy’.

The EU Taxonomy is a EU-wide tool that will be used to support other green and environmental initiatives. It will standardise the definitions around sustainability and enable a common language on climate related activities across the EU.

If initiatives, investments, or companies meet the criteria set out in the Taxonomy then they are described as being ‘aligned’ with the Taxonomy.

At its heart the Taxonomy defines a list of economic activities which contribute to the following environmental objectives [1]:

  1. Climate change mitigation
  2. Climate change adaptation
  3. Sustainable and protection of water and marine resources
  4. Transition to a circular economy
  5. Pollution prevention and control
  6. Protection and restoration of biodiversity and ecosystems

Furthermore, in pursuit of the six environmental objectives, a Do No Significant Harm (DNSH) clause was inserted. This means that in pursuit of one of the goals no significant harm can be done to the remaining five – e.g. the building of wind turbines to mitigate climate change cannot do significant harm to biodiversity and ecosystems.

The economic activities must also meet minimum safeguards laid out in various other NGO guidelines [7,8].

How Are Economic Activities Analysed? Introducing Technical Screening Criteria

The Taxonomy contains a list of economic activities that are commensurate with the six environmental objectives. These activities are taken from a list of industrial sectors, as defined by the EU’s NACE industrial classification system [6].

Examples of economic activities described in the Taxonomy are manufacture of low carbon technologies, anaerobic digestion of sewage sludge, existing forest management, and production of electricity from solar PV [2].

The Taxonomy also details the technical screening criteria for each economic activity, which must be met for an investment or a company to be considered ‘aligned with the taxonomy’. These criteria contain lists of performance thresholds depending on the activity.

For example, within the Manufacture of low carbon technologies activity, there are many sublists of different thresholds depending on what is being manufactured. The manufacture of passenger cars and light commercial vehicles have to meet the following technical screening criteria:

“Until 2025: vehicles with tailpipe emission intensity of max 50 g CO2/km (WLTP). This also includes zero tailpipe emission vehicles (e.g. electric, hydrogen).

From 2026 onwards: only vehicles with emission intensity of 0g CO2/km (WLTP).” [2]

Who Does This Apply To?

The Taxonomy will be applied to three user groups who will have to disclose whether they or their assets are ‘aligned with the Taxonomy’:

  1. “Financial Market Participants” who offer financial products in the EU
    • This includes: Alternative Investment Funds (AIFs), insurance-based investment products (IBIPs), pension products, pension schemes and UCITS (i.e. collective investment schemes or ‘funds’)
  2. Large companies who have to submit non-financial reports
    • Defined by Non-Financial Reporting Directive, i.e. most companies with more than 500 employees
  3. The EU itself and Member States, when “setting public measures, standards or labels for green financial products or green (corporate) bonds”

When Are These Regulations Coming In?

For Financial Market Participants the first set of disclosures are required by the end of 2021. This covers any economic activities which relate to the Climate Change Mitigation to Climate Change Adaptation environmental objectives. Disclosures against the other four environmental objectives will be required by the end of 2022 [1].

Individual companies will be required to disclose against Climate Change Mitigation/Adaptation sometime in 2022.

Conclusion

The EU Taxonomy has been created to provide a common language and framework to clearly describe what can be counted as sustainable and what does not. It also serves the greater aim of meeting the EU net-zero by 2050 goal by promoting decarbonisation and migration to climate friendly industries and technologies.

A list of economic activities has been created which contribute to six environmental objectives. For each of these activities performance thresholds (technical screening criteria) have been created. Therefore to be considered aligned with the Taxonomy an investment or company must take part in this economic activity as well as meet the relevant performance threshold.

The EU Taxonomy may be a complex body of work, but it has potential to revolutionise sustainable finance.

References

  1. EU Technical Expert Group On Sustainable Finance, TEG final report on the EU taxonomy, 2020, Available: https://ec.europa.eu/info/sites/info/files/business_economy_euro/banking_and_finance/documents/200309-sustainable-finance-teg-final-report-taxonomy_en.pdf
  2. EU Technical Expert Group On Sustainable Finance, Technical annex to the TEG final report on the EU taxonomy, 2020, Available: https://ec.europa.eu/info/sites/info/files/business_economy_euro/banking_and_finance/documents/200309-sustainable-finance-teg-final-report-taxonomy-annexes_en.pdf
  3. PRI, EU Sustainable Finance Taxonomy, 2020, Available: https://www.unpri.org/sustainable-markets/eu-sustainable-finance-taxonomy
  4. FinExtra.com, EU adopts green taxonomy, 2020, Available: https://www.finextra.com/pressarticle/82977/eu-adopts-green-taxonomy
  5. REGULATION (EU) 2020/852 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088, Official Journal of the EU, 2020
  6. Nomenclature statistique des Activités économiques dans la Communauté Européenne – Regulation (EC) No 1893/2006
  7. UN Guiding Principles on Business and Human Rights
  8. OECD Guidelines for Multinational Enterprises

Green Finance Guide

Green Finance Guide is a source of green financial, renewable energy and climate change news and insight

To stay up to date follow us on Twitter

© 2021 Green Finance Guide