A circular economy taxonomy

Patrick Moloney, Astrid Lilja

February 27, 2024

Speaking the same circular language is essential for fostering a cohesive and effective transition to a circular economy. A standardised circular taxonomy should serve as a common framework that enables clear communication and understanding among diverse stakeholders, including businesses, investors, policymakers, and consumers. It should also eliminate ambiguity and misinterpretation, facilitating more accurate assessments of circular practices and promoting collaboration.

So far, the EU taxonomy has struggled to make a significant impact and to be truly relevant albeit the emphasis thus far has very much been upon climate change mitigation. In the following paragraphs what the circular economy taxonomy entails is explained, the key sectors that are included are outlined along with some key observations.

EU Taxonomy overview

The EU Taxonomy is a classification system established by the European Union to define and categorise economic activities based on their environmental sustainability. Introduced as part of the EU's broader sustainable finance agenda, the Taxonomy Regulation came into effect in July 2020. It provides a standardised framework for identifying which economic activities can be considered environmentally sustainable.

The EU Taxonomy covers six environmental objectives contained in two different delegated acts – Climate and Environmental. Environmental objectives are criteria that economic activities need to meet to be considered environmentally sustainable under the taxonomy framework.

In the context of the EU Taxonomy Regulation, a delegated act refers to a legislative act delegated by the European Commission to supplement or amend certain non-essential elements of the regulation. Specifically, the climate and environmental delegated acts provide additional technical screening criteria and further guidance on the environmental sustainability of economic activities.

How does the EU Taxonomy work?

When reporting on the EU Taxonomy, companies must assess and disclose to what extent they carry out economic activities that are covered by the EU Taxonomy (eligibility) and following that, to what extent these activities comply with the set of robust technical criteria that defines when an economic activity can be deemed sustainable – hence contributing to one, or more, of the six environmental objectives. Specifically, for an economic activity to be aligned with the EU Taxonomy, it is required to:

Substantially contribute to at least one of the six environmental objectives, as defined in the technical screening criteria.
Do no significant harm to any of the other five environmental objectives, as defined in the technical screening criteria.
Comply with minimum safeguards, namely ensuring compliance with principles on responsible business conduct as outlined in the OECD Guidelines on Multinational Enterprises and the UN Guiding Principles on Business and Human Rights.

Taxonomy alignment is presented in the form of three EU Taxonomy KPIs, namely Capex, Opex and Turnover, meaning that it is expressed as a percentage of the Capex, Opex and Turnover of aligned economic activities.

Why is it we need to speak the same circular language?

Speaking the same circular language is essential for fostering a cohesive and effective transition to a circular economy. A standardised circular taxonomy serves as a common framework that enables clear communication and understanding among diverse stakeholders, including businesses, investors, policymakers, and consumers.

This shared language ensures that everyone involved in the circular economy ecosystem interprets terms, goals, and strategies consistently. It eliminates ambiguity and misinterpretation, facilitating more accurate assessments of circul^ar practices and promoting collaboration. Without a standardised language, the potential for confusion and misunderstandings will continue to hinder the development of cohesive strategies and impede progress towards a circular economy.

A taxonomy in relation to the transition to a circular economy is necessary for several key reasons:

Standardisation and clarity: providing a standardised framework and clear definitions for what constitutes a circular economy activity to help eliminate ambiguity and ensure a common understanding for all stakeholders.
Guidance for decision-making: helping businesses and investors identify economic activities that align with circular economy principles.
Promoting sustainable finance: offering a systematic way to categorise and assess investments based on their contribution to the circular economy.
Preventing greenwashing: establishing clear criteria that all activities must meet to be considered circular to ensure that claims of sustainability are substantiated and that businesses genuinely contribute to the circular economy transition.
Policy alignment: aligning with and reinforcing broader policy objectives related to the circular economy, e.g. EU Circular Economy Action Plan.

It is important to note that these advantages depend upon how particular sectors actually buy into the Taxonomy – how relevant it is deemed to be and how achievable it is. This is further elaborated upon later, as part of the “Key challenges facing the circular economy taxonomy” section.

Explaining the EU Circular Economy Taxonomy

The EU has provided previous guidance about where the emphasis needs to be placed with respect to accelerating the transition to a circular economy, in particular to the EU’s Circular Economy Action Plan published in 2020. This pattern continues with respect to a taxonomy for the transition to a circular economy. How a particular economic activity may substantially contribute to the transition to a circular economy is based upon four key principles as outlined below.

The EU Circular Economy Taxonomy focuses upon five sectors and 21 economic activities. However, when looking into the details, many more than the five sectors and 21 economic activities are actually included. Some economic activities encompass a much broader array of sectors and activities in themselves, especially within the “Services” section as outlined below.

The sectors and associated economic activities have been targeted as they either generate large amounts of waste or stand the potential to accelerate the transition to circular business models – essentially focusing upon the problem and those that can help solve tit. This, however, means that huge swathes of the economy are not included. In time, it is assumed that the circular economy taxonomy will be expanded upon.

The sectors and economic activities are summarised below, with some general observations for information.

1. Manufacturing

Economic activities - i) Manufacture of plastic packaging goods ii) Manufacture of electrical and electronic equipment

Focusing on manufacturing, this section is probably where the circular economy taxonomy lacks the most in that it focuses upon only two economic activities. But this will be expanded upon by the EU over time.

To show substantial contribution to the circular economy for the manufacture of plastic packaging goods, one criterion relates to the use of circular feedstock, i.e. until 2028, at least 35% of the packaging product by weight needs to consist of recycled post-consumer material for non-contact sensitive packaging and from 2028 this should be at least 65%.

In line with the emphasis being placed upon the manufacture of electrical and electronic equipment by the EU, the list of criteria is lengthy. Focusing primarily on design, the criteria includes designing for long lifetime, for repair and guarantee, for reuse and manufacturing, for dismantling and for recyclability.

2. Water Supply, Sewerage, Waste management, and Remediation activities

Economic activities - i) Phosphorus recovery from waste-water ii) Production of alternative water resources for purposes other than human consumption iii) Collection and transport of non-hazardous and hazardous waste iv) Treatment of hazardous waste v) Recovery of bio-waste by anaerobic digestion or composting vi) Depollution and dismantling of end-of-life products.

Both water and wastewater are included, primarily from a treatment perspective. These economic activities are familiar and widely practiced. To date, water intensive industry is missing from the Taxonomy which is an oversight.

There is a focus upon the more “traditional” components of the circular economy, such as resource management and recycling, as these sectors are critical to a successful transition to a circular economy. The Taxonomy provides clear definitions, enabling such economic activities to classify themselves as sustainable, as well as setting clear boundaries for other activities within these sectors.

3. Construction & Real Estate

Economic activities – i) Construction of new buildings ii) Renovation of existing buildings iii) Demolition and wrecking of buildings and other structures iv) Maintenance of roads and motorways v) Use of concrete in civil engineering

The criteria for buildings is both specific and ambitious. Emphasis is very much placed upon construction and demolition waste, global warming potential of the entire lifecycle, circular design techniques, the use of raw materials and the use of electronic tools.

But it is the use of raw materials that really stands out and raises the “circular bar” very high indeed. For example, the use of primary raw material in the three heaviest material categories needs to comply with very specific maximum total amounts used, e.g. for the combined total of brick, tile, ceramic, a maximum of 70% of the material comes from primary raw material. It is the emphasis of integrating secondary raw material that will pose the greatest challenge for the construction and real estate sector.

The use of concrete in construction and in the maintenance of infrastructure such as tunnels and bridges is also addressed specifically, with focus on minimising the use of primary raw materials through using of secondary ones. For concrete, a maximum of 70 % can come from primary raw materials or a minimum of 30% needs to come from secondary raw material. This poses a significant challenge to the construction sector.

4. Information & Communication

Economic activities - i) Provision of IT/OT data-driven solutions

This activity places emphasis upon digital enablers that are crucial to the transition to a circular economy. Companies that design and develop such software and solutions are now provided with the opportunity to illustrate their relevance both to the circular economy transition but also to sustainability as a whole.

This activity is defined as one that manufactures, develops, installs, deploys, maintains, repairs or provides professional services, including technical consulting for design or monitoring of a) software & IT or similar built for the purpose of remote monitoring and predictive maintenance b) tracking and tracing software c) lifecycle assessment software d) design and engineering software e) supplier management software f) lifecycle performance management software g) lifecycle performance management software.

5. Services

Economic activities - i) Repair, refurbishment and remanufacturing ii) Sale of spare parts iii) Preparation for re-use of end-of-life products and product components iv) Sale of second-hand goods v) Product-as-a-service and other circular use- and result-oriented service models vi) Marketplace for the trade of second-hand goods for reuse

It is important to note that a much broader array of economic activities is brought into focus here. For example, within “repair, refurbishment and remanufacturing”, over 20 NACE codes are listed, ranging from textiles to furniture and also including refurbishment and remanufacturing of machinery for a broad range of economic activities.

”Preparation of reuse” is defined as an activity that prepares for re-use of products or components of products that have become waste, so that they can be re-used without any other pre-processing. This could incorporate numerous sectors and industries.

Under Services, product-as-a-service is also included. It is defined as providing customers with access to products through service models, which are either a) use-oriented services, where the product is still central but its ownership remains with the provider and the product is leased, shared, rented or pooled or b) result-oriented, where the payment is pre-defined and the agreed result, i.e. pay per service unit is delivered.

“The Taxonomy eliminates ambiguity and misinterpretation, facilitating more accurate assessments of circular practices and promoting collaboration. Without a standardised language, the potential for confusion and misunderstandings will continue to hinder the development of cohesive strategies and impede progress towards a circular economy.”

Patrick Moloney

Market Director, Sustainability Consulting, Ramboll

Key challenges facing the Circular Economy Taxonomy

There are numerous challenges which the Circular Economy Taxonomy will face, some of which are summarised below.

Taxonomy disillusionment The initial taxonomy excitement has now turned to overall taxonomy disillusionment. Companies find it challenging to fully embrace and find its value. When it comes to climate change mitigation eligibility, the excitement quickly turns to alignment disillusionment, as the percentages are so low and differ so greatly that its overall worth is being questioned and many companies are simply choosing to disclose zero alignment. Disillusionment with the Circular Economy Taxonomy is particularly relevant to sectors that also form part of the Climate Delegated Act, where the disappointment will seep from one objective to the other.
Substantial contribution criteria The criteria are very challenging, with some sectors arguing that it is nearly impossible to achieve. For instance, having a minimum of 30% of a building to be made from recycled, reused, or renewable content is not deemed to be achievable as a standard by the buildings industry in the short to medium term. Therefore, there is the potential for such an economic activity, as a whole, to simply ignore the criteria and disclose zero alignment.
Investor buy-in The SFDR is currently under revision. What is deemed to be an article 9 investment may not be deemed so in six months (who knows..). But, moreover, the relevance of Taxonomy is also being questioned. Many investors are being advised as part of Annex III drafting, not to allocate funds to EU Taxonomy. For the circular economy taxonomy to be meaningful and gain traction, it is imperative that the investor community use it and incorporate it into article 9 investments. It is, after all, for the investment community that the EU Taxonomy has been introduced. If the investment community opts to ignore it then the private sector will follow suit.
EU (lack of!) guidance The EU Taxonomy is riddled with ambiguity and inconsistencies. In its defence, it is an enormous undertaking, and it can only improve via application. But it is lacking overall guidance, especially when it comes to understanding how best to work with the circular economy taxonomy and make it truly meaningful. Circular economy has been crying out for a consistent definition, making the Taxonomy invaluable as it provides this for multiple economic activities. Yet it lacks the accompanying guidance on interpretation, application and, above all, integration.

It could also be more “readable”! The EU really does itself no favours in this regard. Why not have each objective in a reader-friendly volume? One has to trawl through the overall environment delegated act. A small thing, but sometimes it is the small things that matter the most!

Moving forward

A circular economy taxonomy, here at last, is welcome, but its application will be challenging, as outlined above. The language and terminology are relatively new in comparison to, for example, climate change mitigation – and, again in comparison with climate change mitigation, measuring circular economy performance does not have a CO2eq “equivalent”. Metrics and indicators are numerous and vary from economic activity, and the technical screening criteria are ambitious to say the least.

Aside from a 12-month disclosure cycle, the substantial contribution should be considered as a strategic journey. For many economic activities, the criteria are perhaps more aspirational - a strategic ambition, rather than criteria that can be met in the short term. Both the investment community and private enterprises with eligible activities need to embrace the circular economy taxonomy as a much-needed, long-awaited common language. It has flaws, it has inconsistencies, and in many instances, criteria will be very difficult to achieve. However, without it, investments will not flow into the circular economy transition and company CFOs and CEOs will not prioritise it.

The adopted texts for the environmental delegated act were published in the Official Journal of the EU on 21 November 2023 and apply as of January 2024. EUR-Lex - 32023R2486 - EN - EUR-Lex (europa.eu)

Want to know more?

Patrick Moloney
Director, Sustainability Consulting
+45 51 61 66 46
Deborah Spillane
Global MarComm Lead
+45 53 67 10 43

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