10 take-aways: What we learned from working with EU Taxonomy alignment
Green transition 28 September 2021 Patrick Moloney Meike Verhey Mads Østerby Anne Sofie Trolle
Confusion, uncertainty, and even disillusionment. Emissions of despair prevails with respect to the EU Taxonomy alignment process. In this thought-piece, our taxonomy experts present key lessons learned - so far - from their hands-on experience helping clients navigate in the EU Taxonomy journey.
The deadline for EU Taxonomy alignment is now fast approaching, yet there seems to be a “wait and see” approach from many financial institutions and non-financial companies.
There is lack of clarity about the key steps to take in the alignment process through to company disillusionment when it is understood that a company’s activities are not eligible for screening or that the actual percentage of alignment could be extremely low. In summary, confusion, uncertainty, and disillusionment prevail with respect to the whole alignment process.
But why is that - and what is our take on how to navigate in this complex field? This article should leave you more informed in some minutes, so let us now consider the first of the 10 lessons we learned. We hope our main pointers will be helpful to you and your organisation.
1. Define and communicate the purpose
Compliance versus brand, reputation versus strategic direction. The driver or purpose behind an entity’s taxonomy alignment will very much dictate the attention the process is given as well as the investment in both time and money - yet the purpose remains unclear. If compliance is perceived as being the only purpose, the entire taxonomy process will fall far short of its overall ambitions to guide billions of euros of private sector investment into the Green Transition.
The rationale beyond mere compliance and “value” has yet to be clearly communicated and for companies, in particular, it is unclear, apart from compliance issues, why taxonomy alignment should be prioritised. The Taxonomy needs to be sold as an “opportunity” and the value proposition to both financial institutions and non-financial companies alike explained in tangible terminology.
It is important that the purpose of alignment is clearly mapped, understood and communicated from the outset. The purpose needs to go beyond that of compliance with a focus upon value creation and opportunity.
2. Ambiguity leads to hesitation
The text of the published delegated acts is strewn with ambiguity which breeds uncertainty which results in hesitation. Terms like “may include” or “involving” leaves much to interpretation, terms which invariably will require detailed technical foundation and evidence to justify how such terms are interpreted by each aligning entity. Interpretation of such ambiguous terms could significantly impact overall alignment score, positively or negatively.
3. Your data needs to be evidence based
The entire taxonomy process is science driven and evidence based. All decisions in the process, be it eligibility for screening or the screening process itself requires evidence e.g. life cycle assessments, design documentation etc. Some activities require much more evidence that others. Within the first week of commencing the alignment process, gaps in the data begin to appear. Filling these gaps can take considerable time but also effort e.g. commissioning new studies. There may be certainty about eligibility or passing screening but if this cannot be backed up with the requisite technical and scientific evidence, then the activity will either be deemed ineligible for screening or not pass the screening process.
However, it is not just the technical data that maybe a challenge. Allocations for the KPIs i.e. CAPEX, OPEX and revenue will be needed but it is rare that data currently available within a company is sufficient for these types of allocations, e.g. for overhead costs, thus companies will often have to build a separate allocation model for the Taxonomy and input the data accordingly.
All decisions, technical or financial, need to be evidence based and in line with the regulatory requirements.
4. Technical expertise is a requisite
These is some confusion as to whether the alignment process is more an accounting exercise than a technical one. Yes, accounting skillsets are required, but first and foremost, technical expertise is needed. Determining whether an activity is an eligible activity, to start with, is a technical exercise and not necessarily a straightforward one. The technical screening is also a technical exercise, one that can get very complex very quickly. Only then do the financial KPIs come into play.
Furthermore, the process requires assumptions to be made. Assumptions that need to be based upon a firm scientific and technical foundation. Understanding of national versus EU legislation is also required ensuring, for example, threshold consistency e.g. how EU legislation relates to national standards and codes with respect to construction & real estate.
Depending upon activity, combined with legislative ambiguity but also each company’s unique operations, strong technical capacity is key as it is upon technical screening that the financial KPIs are calculated.
5. Financial complexity is high
Navigating the language of the Taxonomy around the financial KPIs is a complex exercise. Each aligning company needs to invest the sufficient time in understanding how it fits into a particular company and its many stakeholders. Furthermore, those leading the process really need to understand the finer details of the Taxonomy, really get to the heart of it, to understand the relation between the technical elements and the financial KPIs.
As mentioned above, with respect to data, allocations for the KPIs will be needed, however, it is rare that data currently available within the company is sufficient for this type of allocations, e.g., for overhead costs, thus companies will often have to build a separate allocation model for the Taxonomy. Companies will need to make assumptions regarding the allocation model, and it will have to be documented thoroughly.
For some company types it is difficult to determine what the actual cost-objectives are. There is a big difference between companies selling projects (e,g. construction companies), products or services but the Taxonomy activities do not take this into account. If, for example, a company is selling projects and these projects differ in nature, then what is the cost-objectives and how does that particular company group them in relation to the Taxonomy activities?
At a more practical level, the whole process is new and complex and is falling into financial departments that already are overloaded particularly in the run up to the financial year-end. Initiating the process as soon as possible as well as ensuring early engagement/collaboration between the technical and financial arms of the company is really important.
6. Difficult to document ‘Doing No Significant Harm’
With five take-aways under the belt, we made it halfway. Now, let us consider the notion of “do no significant harm”. Nearly all activities that are eligible for screening with respect to significantly contributing to climate mitigation will require a robust climate risk and vulnerability assessment. Do not let this be an after-thought!
Much emphasis currently is being placed upon the Climate Mitigation objective as this is where the majority of non-financial companies will have eligible activities. “Significantly contributing” draws most attention and in most cases significantly contributing to climate mitigation. It is only after this focus does attention turn to “do no significant harm (DNSH)” where Climate Adaptation lies waiting “in the long grass”!
Virtually all activities that are eligible for screening for significantly contributing to climate mitigation need to demonstrate doing no significant harm to climate adaptation.
Yet a pattern is emerging that many companies do not have the necessary information to illustrate doing no significant harm to climate adaptation. This will have significant negative consequences.
Either the company will not be able to illustrate this, or the company will have to commission a separate study to do so. A climate risk and vulnerability assessment is essentially a mandatory requirement although this is not explicitly stated anywhere.
7. Be prepared for ‘enterprise disillusionment’
Having a high percentage is great. Shout it from the roof tops. But many will have very low percentages. Bury it in small print somewhere? This is a challenge that the entire process will face.
More activities are excluded from the taxonomy than included. This is of particular relevance for companies with mixed activities, some are eligible for screening, but some are not. Companies find it frustrating and indeed disillusioning that they get very low scores, yet they are making huge strides to make their processes and products more sustainable.
The disillusionment is more pronounced, however, when an activity is included but the ability to have a high score is prevented due to unrealistic thresholds or, even more commonly experienced, significant lack data to support a company’s alignment and thus the default score of 0% needs to be assigned.
The more companies feel that they are being “left behind”, even if they are legally obliged to align, the less relevance the overall Taxonomy process will have. It is important that companies clearly communicate the challenges they face with the process so that interested parties are provided with a clear rationale as to why scores are low and not just promoting scores that are high.
8. Don’t forget the ‘other’ objectives
The other four objectives need to be taken into consideration now. ”Doing no significant harm” pushes the agenda of the other four objectives to some extent but not enough. A draft of the other four objectives is now available (albeit a very difficult document to navigate – the EU does itself no favours in how the other four objectives are presented!).
Organisations can commence both alignment and communication around the other four objectives now maximing the opportunity they may provide. The eligible activities differ to the climate activities which may provide further opportunity. So, companies that struggle to align their activities with the climate objectives may find that their activities align with the sustainable use & protection of water & marine resources; the transition to a circular economy; pollution prevention & control and, finally, the protection & restoration of biodiversity & ecosystems.
We recommend that, although in draft form, the other four objected become part of the overall process, especially with respect to identifying information gaps but also with respect to defining purpose and identifying opportunity as we move into 2022, when screening against these four objectives becomes obligatory.
9. Think long and hard about communicating results
Having a high percentage is great and should be communicated strongly. But many will have low percentages. This is a challenge that the entire process will face. Obligatory reporting is only one element of communication. Understanding how the results can be used but also how to communicate in a relevant language is unique to each company.
There are obligatory reporting requirements which need to be followed. But reporting is only one form of communication. How to promote great scores or explain lower ones is an integral part of the process but there is no guidance on how to communicate, as apart from obligatory reporting requirements.
When defining the overall purpose at the start of the Taxonomy alignment process, it is important that preferred communication and the “why” should be thought through. There is a story to tell when communicating results, to provide context, explanation, but also to outline and communicate future taxonomy ambition. Take control of the communication agenda within your sector by being a front runner with respect to communicating not only the results, but broader context and ambition.
10. Put results to good use
Do entities merely align for the sake of it? Purely obligatory reporting or actually see it as a catalyst to aid in overall strategic sustainability direction setting? If results are low, how can they be improved upon? If high, how to utilise this to access finance? Enhance brand etc?
In certain instances, the results will be “what they are“ and provide little guidance, in other instances, however, the guidance that the results can provide may be invaluable with respect to realigning a strategic course. They may make some decisions very clear. When it is CAPEX, OPEX and revenue as KPIs there is attention to the process from CFOs and CEOs that may not be garnered when speaking in scientific KPIs. Every ounce of opportunity and insight needs to be squeezed from the alignment process to drive sustainable change through a companies’ processes.
This was our pot of 10 golden nuggets. Lengthy yes, but if you are working with EU Taxonomy, you will probably agree that this was an easy and straight-forward read about a cumbersome topic. But an important topic, and one that can propel your sustainability efforts if you get it right.
We find it of utmost importance that you and your organisation do not park the process until “next year”.
Break down the results, do internal cost benefit analysis with respect to where emphasis should be placed to increase scores to maximise the taxonomy opportunity for 2022 and beyond. In our view, the process will present a company’s sustainability status in a different fashion than before and shed light on different areas of a company. Use this to see your company in a more holistic lens and then more holistic sustainability pathways can be followed.
Please do not hesitate to reach out to any of the authors in case you need help. If you are not ready to speak just yet, read more articles below or take a look at our EU Taxonomy Quick Guide.
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