The complexities of EU Taxonomy

The EU Taxonomy Regulation is a framework for identifying, classifying and reporting on environmentally sustainable economic activities. In the UK, the government has included some elements of this taxonomy as part of its wider reporting requirements. Here, companies are required to report on their ESG factors, and their climate-related risks and opportunities. This must be done in line with the Taskforce on Climate-related Financial Disclosure (TCFD) recommendations and the Companies Act 2006 – in an attempt to meet the legally binding Net Zero targets under the Climate Change Act 2008.

Read Time

3 mins

Author

Amber Rochette

The EU Green Deal, passed in 2019, promotes an economy “where there are no net emissions of greenhouse gases in 2050 and where economic growth is decoupled from resource use”. Achieving this ambitious reduction requires the equivalent of around $16 billion USD from the private sector. After all, the responsibility to transition to net zero lies with companies as well as governments. Without investors redirecting a significant proportion of their capital into sustainable assets, projects and companies, the targets will remain out of reach.

EU Taxonomy

The decision to ensure the private sector supports the Green Deal led to the creation of the EU Taxonomy Regulation. In its simplest form, EU Taxonomy is a framework to enable the classification of sustainable economic activities within the EU. It intends to provide pathways for large enterprises and investors to navigate the transition to a low-carbon and resource-efficient economy.

The framework objectives are:

Mitigate climate change
Adapt to climate change
Ensure sustainable use and protection of water and marine resources
Transition to a circular economy
Prevent and control pollution
Protect and restore biodiversity and eco-systems

European Taxonomy Framework Objectives

There is no mandatory list of economic activities, but to comply with the regulations private companies and investors must:

Contribute to at least 1 of the 6 objectives
Do no significant harm to any of the other 5 objectives
Comply with minimum social standards [1]

This 3-point performance threshold ensures that businesses are acting responsibly across the board. It leaves no room for focusing on one area of sustainability and forgetting about other significant areas. As a result, it provides the perfect opportunity to demonstrate progress towards resilience.

Who does EU Taxonomy apply to?

Companies with over 500 employees (or any business that falls under the non-financial reporting directive [2])
Companies operating in financial markets

SMEs can report – but purely on a voluntary basis. Though this may change soon, with the tightening of reporting requirements currently in review.

The legal requirement remains for all companies with over 500 employees. This sits under the EU Directive 2020/852 meaning there will be proportionate and dissuasive sanctions applied if an eligible company fails to report on time. Approximately 50,000 businesses in the EU are required to report by law.

Companies with over 500 employees are also required to report on information about their revenue. The percentage of turnover deriving from products or services meeting the 3-point performance threshold; as well as the percentage of capital and operation expenditure relating to assets or processes that qualify on the 3-point threshold, must be disclosed.

When does it apply?

Adopting a staged approach, to help businesses plan and adapt, EU taxonomy came into force partly in January 2022. From the 1^st of January to the 31^st of December 2022 businesses were required to report on the first two objectives (climate change mitigation and climate change adaptation) for their FY year 2022. On the 1^st of January 2023, the requirement to report on the 4 others came into force. But the European Commission is yet to publish the Delegated Acts that explain the technical screening criteria for the 4 other objectives – we’re sitting tight and waiting for the information to be published.

These reports must include information on technical screening criteria, which is defined as the process of classifying the minimum requirements necessary to avoid significant harm to other objectives, whilst significantly contributing to at least one of the 6 environmental objectives. The rules set out in the taxonomy supporting guidance (The Delegated Act) have been implemented to enable companies to translate the technical screening data into quantitative economic performance indicators, or KPIs. It’s these KPIs, supported by qualitative data, that will be publicly disclosed in their reports and available for consumers and investors to see. [3]

So, the time to act is now!

There is no denying that navigating these taxonomy requirements is complicated. However, there are some simple steps you can take to ensure that you are doing everything within your power to be compliant:

Check whether you are in line with a set of globally recognised minimum social standards
Check what your business is already doing in terms of sustainability, and track this against the 6 objectives
Ensure that your business activities don’t cause any significant harm to the 6 objectives
Keep up to date with updates from the European Commission on changing standards with regards to technical screening criteria and how to translate this into KPIs specific to your business

EU Taxonomy – an evolving beast

The requirements of the EU taxonomy regulations are the central pillars within the wider sustainability reporting regime. They underpin the EU’s sustainable finance strategy, as part of the Green Deal. Although already partly in force, the system is continuously evolving and it’s expected to be fully operational by 2026. These standards and reporting requirements will likely continue to change, so it’s important to keep your finger on the pulse and avoid any sanctions for failure to comply. There have also been many recent updates surrounding a possible UK taxonomy, so read our blog post outlining what that may look like here.

[1] https://home.kpmg/uk/en/home/media/press-releases/2022/10/worlds-top-companies-improving-climate-reporting.html

[2] https://financialregulation.linklaters.com/post/102i3ha/fca-seeks-views-on-retail-disclosure-in-a-world-without-uk-priipsh

[3] https://www.simmons-simmons.com/en/publications/clbnur7r900e0twyk9pcto2kw/the-future-uk-retail-disclosure-regime-the-fca-opens-a-discussion

Download our deep dive digestible report along with a handy checklist to get your business on the right track

Your guide to the EU Taxonomy objectives 1 & 2