As part of the European Green Deal, the EU Action Plan on Sustainable Finance was created to allow more funds to flow from investors into sustainable projects, assets and companies. The EU Taxonomy is an essential part of it.
Designed to supplement the disclosure requirements in the Sustainable Finance Disclosure Regulation (SFDR), the EU Taxonomy is the main tool for investors and issuers to assess to what degree an investment or portfolio is sustainable. Consequently, it allows financial institutions to assess how much of their assets under management (AUM) are truly sustainable.
We have covered the basics in our previous blog post, The EU Taxonomy explained. In this post, we cover how the taxonomy applies to the financial services sector.
Which financial institutions will need to comply with the EU Taxonomy regulation?
Regardless of location: If a financial institution offers products in the EU—such as bonds, funds and pension products—it must comply with the EU Taxonomy. This means that, for those products pursuing a sustainable objective or that have environmental or social characteristics, the financial institution must disclose how much a product aligns with one of the EU's environmental objectives.
If the financial product does not promote or pursue sustainability-related objectives, the financial institution must issue a statement. This statement needs to stress that investments do not consider the EU criteria for environmentally sustainable economic activities.
Currently, only two of the six environmental objectives are regulated under the taxonomy and need to be reported on: climate change mitigation and climate change adaptation. However, a delegated act for the remaining four objectives is expected to be published in the coming months.
Figure 1. The six climate and environmental objectives established by the EU:
What do they need to consider?
An activity will be ‘taxonomy-eligible’ if it is within the EU Taxonomy list of activities that substantially contribute to an environmental objective1 irrespective of whether it meets other technical conditions. If the activity is not described in the regulation, it will not be considered eligible (non-eligible).
Taxonomy alignment goes beyond eligibility. Aligned activities contribute substantially to at least one of the environmental objectives and fulfil the technical screening criteria. (See ‘When do they need to comply?’)
Other things to consider:
- The EU Taxonomy requires highly granular data to assess whether an activity is taxonomy-aligned.
- Financial market players need to liaise closely with investees to fill the data gaps between EU Taxonomy requirements and available information.
- Financial market players need to allocate time and resources to assess, monitor and report on the percentage of underlying activities that are taxonomy-aligned.
- The EU Taxonomy is in constant development. A second delegated act for the remaining four environmental objectives is expected to be published in 2022. Financial market players need to stay on top of any reporting changes and adapt.
- The list of activities that contribute to regulated environmental objectives—climate change mitigation and adaptation—is likely to expand as new sectors and activities are added.
When do they need to comply?
From 01 January 2022, financial market participants must disclose the proportion of their taxonomy-eligible and non-eligible economic activities. This needs to be done by disclosing the percentage of underlying financed activities that substantially contribute to climate change mitigation or adaptation, based on total turnover and capital expenditure figures. This first disclosure must cover 2021 as the first reporting period.
The first disclosure of taxonomy-aligned activities is due by 01 January 2024, covering 2023 as the first reporting period. An activity is taxonomy-aligned if it meets all the below criteria:
- It contributes substantially to one of the environmental objectives and complies with the relevant screening criteria. What qualifies as a ‘substantial contribution’ varies across each individual environmental objective. (See Articles 10-15 of the EU Taxonomy for further guidance.)
- Does no significant harm to the remaining environmental objectives.
- Meets the minimum safeguards established by the EU Taxonomy regulation.
Figure 2. Reporting timeline of the EU Taxonomy regulations for the finance sector
Taking your next steps
At the Carbon Trust, we have been working for over two decades to support organisations as they transition to a decarbonised future. As such, we understand the growing role sustainable finance plays in this transition. From TCFD guidance to EU Taxonomy requirements, our established European and Green Finance teams help financial institutions align their reporting, increase transparency, and ensure that green finance delivers genuinely green outcomes.