29 Jun Sustainability taxonomy in the European Union
In March 2020 the European Commission’s Technical Expert Group on Sustainable Finance (TEG) published three documents entitled: EU Taxonomy Technical Report, EU Taxonomy Technical Annex and EU Taxonomy Excel Tool.
These three taxonomy documents are part of the Action Plan for a greener and cleaner economy in the EU and, in particular, its first objective of establishing a common language for sustainable finance.
The TEG defines the EU taxonomy as a tool to help investors, companies, issuers and project developers make the transition to a low-carbon, more resilient and resource-efficient economy. Without this taxonomy, achieving the sustainability objectives of the EU would be quite difficult.
The EU taxonomy identifies six objectives for achieving the transition to a more sustainable economy:
- Climate change mitigation.
- Climate change adaptation.
- Sustainable use and protection of water and marine resources.
- Transition to a circular economy, waste prevention and recycling.
- Pollution prevention and control.
- Protection of healthy ecosystems.
Despite the development of the taxonomy of the first two objectives already having been published, the development of the remaining four objectives is not expected to be completed until between 2021 and 2022. This execution in parts is understandable because of the enormous work required in developing each of the objectives.
The EU taxonomy classifies business activities in accordance with NACE criteria and provides equivalencies with other international activity classification systems.
The EU taxonomy resolves on three main issues:
- In the first, it identifies the activities that are positive to sustainability, the activities that can promote sustainable development and the activities that do not comply with the taxonomy.
- In the second, it establishes the concept of “do no significant harm” (DNSH), as a requirement of not causing harm to other objectives in order to comply with one or several of them.
- And in the third, it establishes the minimum guarantees to be complied with international guidelines such as the OECD Guidelines on Multinational Enterprises and the UN Guiding Principles on Business and Human Rights.
For a business activity to be considered aligned with the EU taxonomy, it must comply with all three issues. Furthermore, the taxonomy distinguishes between activities that help the development of sustainability (substantial contribution) and those enabling activities regarding the first ones (enabling activities). Thus, the taxonomy is favorable to these two types of activities and contrary to the activities that are not aligned with its criteria. In other words, activities which are excluded from the EU taxonomy and which can therefore not be in line with its criteria.
As a company may be involved in several different NACE activities, in order to carry out the alignment analysis with the EU taxonomy, it is necessary to identify each of the company’s activities and the weight they carry in the overall turnover. In this way, the activities and their substantial contribution turnover are 100% eligible for the taxonomy. In contrast, enabling activities and those that do not contribute per se to sustainability require compliance with the DNSH and minimum guarantees of international standards to be eligible (at a certain percentage or 100%).
When there are groups of companies or investment companies with a portfolio comprised of different investees, the analysis of alignment with the taxonomy of the parent or holding company is carried out by calculating the weight of each of the investees in the parent or holding company.
In relation to the first objective (mitigation of climate change), the Technical Annex includes eight mitigation activities which can substantially contribute to it: forestry, agriculture, manufacturing, electricity and other supplies such as gas and steam, water and sewage and waste, transport and storage, information and communications, and construction and real estate. Additionally, in relation to the second objective (climate change adaptation), the Technical Annex also covers nine adaptation activities which can substantially contribute to it: forestry, agriculture, manufacturing, electricity and other supplies such as gas and steam, water and sewerage and waste, information and communications, construction and real estate, financial and insurance activities, and professional and scientific and technical activities.
With the EU taxonomy, investors will be provided with a useful tool to calculate an activities’ level of compliance with sustainability and use it to decide whether or not to invest in a company. Additionally, alignment with EU taxonomy will be the requirement in the EU to issue EU green bonds. This EU green bonds regulation is being approved in parallel with the EU taxonomy.
It is also important to highlight the possibility for companies to execute taxonomy adaptation projects. As we have mentioned, some of the several activities of a company may be aligned with the taxonomy and others may not. Those not aligned can be included in a project of up to 5 years to adapt such activities to the taxonomy and this can also be financed with EU green bonds.
Regarding the Member States and EU legislative powers, compliance with EU taxonomy could also be the criteria for contracting with public administrations, receiving tax benefits and deductions, using certain denominations or green labels, etc.
Consequently, the EU taxonomy is bound to be a key tool for the development of policies and regulations, as well as a regular instrument for private operators in the EU market.
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