The EU Taxonomy is an essential part of the EU Green Deal that aims to facilitate the flow of funds from investors into sustainable projects, assets, and companies. As a global climate consultancy, the Carbon Trust has supported over 3,000 organisations across finance, food and beverages, manufacturing, packaging and the public sector to measure, reduce and report on their emissions. Building upon our expertise in carbon reduction and green finance, our EU Taxonomy series delve into the taxonomy and what it means for businesses and financial service providers.
What does the EU Taxonomy mean for financial institutions and corporates?
“Until 2020, the EU lacked a universal method that defines what makes up a green activity in the first place,” explains Noor. “Before, corporations could communicate their environmental efforts or market their activities as sustainable without clear criteria to substantiate their claims. The EU Taxonomy seeks to address this gap, so corporates can strengthen their claims and attract external investment,” she adds.
Financial institutions on the other hand should use corporates’ disclosures to steer their investment and lending decisions. “The EU Taxonomy serves as a framework. It informs financial institutions as they expand their green finance offerings,” Carolina explains.
While not perfect, the taxonomy should enhance transparency, both within the organisation and with external stakeholders.
How are companies disclosing the alignment of their activities against the taxonomy?
Companies have been disclosing different levels of eligibility. 2023 is the first year in which companies are required to disclose the alignment of their activities against the EU Taxonomy (based on 2022 data) For 2023 disclosures, we expect a very low percentage of revenues to be reported as taxonomy aligned.
Figure 1. For alignment, activities need to fulfil the criteria of one of the EU’s environmental objectives.
What may influence this low alignment?
Organisations have grasped the rationale behind the EU Taxonomy, yet uncertainty exists about achieving alignment, according to Noor. “The language within the taxonomy is open to misinterpretation. As such, there remains uncertainty on how organisations can prove taxonomy alignment. We need to ensure that organisations feel confident in their understanding of the taxonomy criteria and the evidence they need to support their claims, so they can be recognised,” Noor adds.
“The technical screening criteria also has a very high threshold,” explains Carolina. “Often, organisations must show an environmental impact assessment and a robust risk assessment. Providing all this evidence is no easy task. It requires manpower and budget, which may be one of the reasons why alignment may remain low in the next year or two.”
What are some of the reporting hurdles?
Through industry conversations, the Carbon Trust has identified four key challenges:
- Understanding compliance requirements - Demonstrating how activities are taxonomy eligible or taxonomy aligned can be challenging due to a lack of understanding of the taxonomy’s terminology, e.g., ‘eligibility’ and ‘alignment’. Organisations need to ensure that their employees understand the terminology and requirements before they disclose their activities.
- Large volume of data requirements - The EU Taxonomy requires companies to disclose the percentage of turnover, capital expenditure, and operational expenditure that is taxonomy eligible and aligned. Identifying and collecting this amount of data is complex and time-consuming.
- Internal governance, staffing and resource - Internally, organisations must work across teams, so they capture the right data and are consistent in their approach. Organisations need to decide who has ownership of this reporting to avoid working in silo.
- Implementation - Implementing reporting processes.
How can organisations strengthen their disclosures on alignment?
Regulations around disclosures – EU Taxonomy, CSRD, SFDR amongst others – are advancing at such a pace, it can be hard to keep up. As countries raise their climate ambitions, it is important that organisations do not fall behind.
A key to unlock action is to establish a compelling business case for compliance and beyond. “Business leaders need to sit down and actively look at how the EU Taxonomy and its objectives fit into their sustainability strategy. Likely, they will already have a few initiatives in place that support climate change mitigation, but the missing piece often lies in the documentation to validate their efforts,” explains Noor. “This is an opportunity for businesses to proactively collect the evidence, identify areas for improvement and bolster their communication around climate action.”
From a financial institution's standpoint, considering an investee's taxonomy alignment can support decision-making. "Financial institutions rely on information the borrower or investee provides to assess alignment," argues Carolina. As such, financial service providers must check that they receive accurate and sufficient data on an investee's taxonomy alignment.
Touching upon the Carbon Trust's work with a UK asset management firm, Carolina explains that by developing a bespoke tool "the firm can now undertake a high-level assessment of the percentage of revenue that is taxonomy aligned before an investment is made, aiding decision-making. This sets the footing for more informed decisions that will ultimately drive investment and financing in sustainable activities forward."
How can financial service providers and corporates work together to improve reporting in line with the EU Taxonomy requirements?
Corporates and financial institutions are interconnected and accountable to their respective stakeholders. “They are two sides of the same coin,” Noor explains. “Corporates need to be transparent on why they are a sustainable investment choice. Conversely, financial institutions must be transparent about why they invest in or lend to a particular activity or company. The two need to work together to justify that money flows in the right direction. They benefit from using the same language and criteria provided by the EU Taxonomy.”
Financial institutions whose portfolios are made up of businesses with significant taxonomy eligibility, but low alignment can support businesses to improve their taxonomy alignment through active ownership and stewardship, argues Carolina. “Investors can support the companies they invest in and identify avenues for greater taxonomy alignment,” Carolina explains. On the lending side, “if a borrower seeks to replace its machinery with a more energy-efficient, low carbon solution to meet the EU Taxonomy criteria, lending provided towards this capital expenditure should improve the borrower's and the bank’s taxonomy alignment.”
How we can help
We have an established European team working closely with a range of businesses on the EU Taxonomy. Our experts in climate change mitigation can support you in simplifying the requirements, understanding the documentation you need, cutting through the taxonomy language, and highlighting how you can improve your alignment to subsequently support you on wider regulatory environmental impacts. With over 20 years of experience in climate action, the Carbon Trust has accelerated financing greener solutions and greening finance in addition to working with over 3,000 organisations. With our dual expertise, we can help ensure your financial KPIs and impact are integrated with those in sustainability.