The responsibility for this transition lies, not only with governments and individuals, but also within companies. The financial sector has a crucial role to play in enabling the move to a green and sustainable economy.
Responding to this challenge, the EU has committed to become carbon neutral by 2050 and has created the European Green Deal, a system of rules and guidelines to accelerate the green transition.
As part of the European Green Deal, the EU Action Plan on Sustainable Finance was created to help finance the transition and allow more funds to flow from investors into sustainable projects, assets and companies. The EU taxonomy is an essential part of it.
Figure 1. The components of the European Green Deal
What is the EU Taxonomy?
To achieve its climate goals, the EU needs investors to redirect a large amount of capital into the right type of projects, assets and companies.
The EU Taxonomy is being developed to help scale up sustainable investments and combat the greenwashing of ‘sustainable’ financial products1. To define investments that qualify as sustainable, the EU has created the green classification system.
Green, or ‘environmentally sustainable’, economic activities are described as those which: “make a substantial contribution to at least one of the EU’s climate and environmental objectives, while at the same time not significantly harming any of these objectives and meeting minimum social safeguards.”
Figure 2. The six climate and environmental objectives established by the EU
The initial focus has been on defining what is sustainable from a climate mitigation and adaptation perspectives. Further rules on other green objectives are due to be published soon.
The goal of the taxonomy is to create a common classification system for sustainable economic activities.
It doesn’t enable specific accreditation or labelling of activities, nor does it create a mandatory list of economic activities for investors or performance for companies.
Figure 3. An economic activity can be classified as green or or 'environmentally sustainabile' only if it meets the three "performance thresholds" set by the EU
What does it mean for businesses?
This is an opportunity for businesses to demonstrate their performance and progress towards more sustainable business models, enabling financial markets to make more informed investment decisions.
In particular, companies with more than 500 employees are required to disclose:
- the proportion of their turnover derived from products or services associated with economic activities that qualify as environmentally sustainable; and
- the proportion of their capital expenditure and the proportion of their operating expenditure related to assets or processes associated with economic activities that qualify as environmentally sustainable.
For organisations new to this, a good starting point is to assess their business models and how much of their underlying activities qualify as ‘green’. This information will be required by investors and insurers as it will feed into their own disclosures and investment decisions.
A second step would be to consider the company’s compliance with the minimum social safeguards , which is achieved when economic activities are aligned with OECS’s Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights.
It is important to start this process as soon as possible because, depending on the assessment’s result, internal controls may need to be updated or replaced to meet new requirements. In extreme cases, a business model and corporate strategy may need to be adjusted, or even re-considered, to safeguard the company’s future.
There is also a difference between activities ‘aligned’ with the European Green Deal and those ‘eligible’ under new rules. An activity will be ‘taxonomy-eligible’ if it is listed in the EU Taxonomy2, irrespective of whether it meets any of the conditions. If the activity is not described in the regulation, it will be considered non-eligible.
Which businesses will need to comply with the EU Taxonomy regulation?
EU Taxonomy regulation applies to companies subject to non-financial reporting. Based on current rules3, large listed companies will have to disclose to what extent the activities they carry out meet the criteria. This applies to companies with more than 500 employees during the financial year.
SMEs can also use the EU Taxonomy on a voluntary basis to explain to investor or stakeholders whether they carry out, or plan to carry out, taxonomy-aligned green activities.
However, a proposal to amend the non-financial reporting directive is currently in progress.
This is likely to expand the remit of the EU Taxonomy. If approved, the new Corporate Sustainability Reporting Directive (CSRD), will require all large companies to disclose their sustainability impact from January 2026.
The proposed new corporate sustainability disclosure rules also require companies to seek assurance of sustainability information disclosed.
When do they need to comply?
Large companies must report on certain elements from 1 January 2022, covering 2021 as the first reporting period.
From 1 January until 31 December 2022, companies must disclose the proportion of Taxonomy-eligible and Taxonomy non-eligible economic activities in their total turnover, capital and operational expenditure and certain qualitative information referred to in the Disclosure Delegated Act.
The first disclosure of taxonomy-aligned economic activities, which includes the disclosure of key performance indicators, must be done from 1 January 2023, covering 2022 as the first reporting period.
Taking your next steps
The Carbon Trust has been working for over two decades to support organisations as they transition to more sustainable business models. We have an established European team, working closely with a range of businesses on the EU Taxonomy. Read more about our work or contact our client support team to discuss your journey towards EU Taxonomy compliance and sustainability disclosures.
- Explanatory memorandum CSRD
- Within one of the delegated acts.
- Non-Financial Reporting Directive (NFRD) 2014/95/EU