Why the EU Taxonomy Regulation is about much more than climate
Green transition 9 February 2021 Meike Verhey Veronika Abraham
The “EU Taxonomy Regulation” will require most European financial institutions and non-financial companies to outline the environmental sustainability of their economic activities. Given that the first EU Taxonomy disclosures are due by the end of 2021 and throughout 2022 it is important to act now.
There are six key objectives in the The “EU Taxonomy Regulation”. The first two are climate change mitigation and climate change adaptation. They represent the current priorities and as such take centre-stage. Not just with the Commission but equally so for member states, local authorities, companies, and the likes.
In this article, we place an emphasis on the other four objectives outlining why these are no less important and indeed may prove more complex than the two climate specific objectives. The four remaining objectives are: sustainable use of water & marine sources, circular economy, pollution prevention, and healthy ecosystems & biodiversity.
The pollution of our oceans, resources scarcity and, indeed, biodiversity loss are enormous challenges that we as both an economy and as a society face.
Take for example the 13 million tonnes of plastic flowing into the oceans annually, or the fact that 1 million species already face extinction within decades. Other examples include that the amount of fresh water available for each person has plunged by a fifth over two decades, and if we maintain our current use of resources, we will need the equivalent of almost three planets by 2050.
These are only a few of the many issues related to the remaining four objectives. Therefore, the Taxonomy will play a significant role in combating all of these challenges whilst in tandem combating climate change.
The EU Taxonomy Regulation in brief
The European Commission has ramped up its green ambitions of achieving the Paris Agreement objectives by 2030, by setting a new target of reaching net-zero greenhouse gas emissions by 2050 with the European Green Deal. To finance the green transition and the European Green Deal, the EU is in the process of developing the EU Taxonomy. This is a classification system to identify truly sustainable economic activities.
On the 12th of July 2020, the Taxonomy Regulation entered into force, specifying alignment with the EU Taxonomy for financial institutes and non-financial companies.
Furthermore, a delegated act on the reporting of the EU Taxonomy alignment will be adopted by June 2021. It will specify the information companies will have to disclose on how, and to what extent, their activities align with the EU Taxonomy. The first disclosures are due as of the 1st of January 2022.
This pressing timeline, and the expectation that it is a quite complex and extensive framework, leads to the understanding that it is key to start aligning with the
EU Taxonomy as soon as possible. Reasons to align and the general implications and structure of the EU Taxonomy Regulation have been detailed in a previous article here.
So far, the European Commission has emphasised and prioritised climate objectives in the Taxonomy, and for good reason. However, this has caused for limited attention towards the remaining four environmental objectives. In the following paragraphs we will give insights on the implications of these environmental objectives and emphasize the importance and benefits of bringing these into scope sooner rather than later.
The six environmental objectives
For an economic activity to align with the Taxonomy Regulation, a company must indicate how the activity substantially contributes to one or more of the six environmental objectives, does no significant harm to the other objectives, and meets minimum social safeguard standards. The criteria for substantial contribution and significant harm are given in the Technical Screening Criteria for each environmental objective.
The Taxonomy Regulation established the following six environmental objectives:
So far only the screening criteria for the first two environmental objectives have been established and will soon be passed as delegated act. Financial institutions are to comply with the associated criteria as of the 1st of January 2022, and non-financial companies throughout 2022. The remaining four criteria are to be established by the end of 2021 and will apply as of January 1st, 2023.
The initial focus of the European Commission on the climate change mitigation and adaptation objectives is also seen in the EU’s pressing climate policy and targets. Economic activities mitigating and adapting to climate change have been prioritised in the development of the screening criteria for the Taxonomy Regulation.
Why focus on full alignment now?
Without disregarding the inevitable urgency of aligning with the screening criteria for the climate change objectives, we emphasise the importance of the remaining four objectives. A full alignment that is. Rather start aligning today as the impact they will have on your business are substantial.
While there might be more reasons for your business locally, we stick to a handful of reason why:
1 - Become a frontrunner
Even though there are currently no precise criteria and thresholds for the four environmental objectives, the Taxonomy Regulation already specifies for each objective how substantial contribution is defined (Articles 12-15), indicating what activities will be considered as eligible for screening. The Platform on sustainable finance is currently developing technical screening criteria for the objectives which will be published in a report in summer this year. This report will form the basis for the delegated act to be adopted by end of 2021.
As a starting point, businesses can assess now whether they have related activities and how they will be affected. In this way, they will be ahead of their peers and possibly more attractive to investors looking to develop a greener portfolio, a trend that becomes visible already now before disclosure obligations are in place.
This particularly concerns businesses with a potentially high impact on one or more of the objectives, as technical screening criteria are likely to be put forward for these activities first. Nevertheless, other businesses can be frontrunners in assessing their potential contribution to the objectives even before the activity is covered under the Taxonomy, as more and more sectors and activities will be included over the course of the next years.
Smaller companies are also encouraged to assess and disclose their alignment with the Taxonomy due to potential upcoming market or supply chain pressures despite no legal obligation under the EU regulation. They could be called upon by investors or customers to provide data regarding their Taxonomy-alignment.
Furthermore, the scope of the reporting directive is under revision, and might include smaller companies in the near future.
2 - Increased complexity
Whereas the criteria for the climate change mitigation objective are quite straightforward, it is expected that the criteria for the remaining four environmental objectives are going to be much more complex. The screening criteria for climate change mitigation have a single indicator, namely CO2 equivalents. The technical criteria for the four objectives are bound to be based on many more indicators, as they will depend on many more factors and can’t be broken down to one single indicator.
For example, Ramboll analysed the impacts of different economic activities for the four other environmental objectives for the European Commission and based the assessment for pollution prevention and control on as much as twenty-two indicators.
It is still to be seen how the final criteria for the remaining four environmental objectives will be structured, but it is safe to expect a more extensive set of indicators than for the climate change mitigation objective. This will result in a more complicated and time-consuming alignment process.
3 - Pressing timeline
The Taxonomy regulation for the four environmental objectives concerning water, circular economy, pollution and ecosystems & biodiversity is to be adopted by the EU Commission by the end of 2021 and should be applied by companies as of the 1st of January, 2023. This might seem further down the road, but to provide a high-quality assessment and disclosure of these objectives by then it is recommended to start alignment as soon as possible.
Expecting extended complexity of the screening criteria for these objectives, a good preparation and understanding of the objectives, in light of the specific activities of your business, will be an advantage once the criteria are fully established.
hese preparations could include for example following discussions and publications of relevant reports published by parties such as the EU platform on sustainable finance. Furthermore, it is possible to scrutinise the current activities in light of the information that is already made available for each objective of the Taxonomy.
The timeline between adoption of the criteria by the EU Commission and reporting obligations is tight, merely a year, and we even see slight delays in the adaptation process of the climate delegated act now. Although planned to be ready by the end of 2020, the delegated act for the climate objectives is still not adopted as of now, indicating a delay in the process.
This likely also impacts the timeline of establishing the remaining four objectives, which are planned to be adopted by the end of this year. It can be therefore beneficial if not crucial for institutes and companies to consider alignment with the objectives already now.
4 - Overlapping assessments
Even though there are six different environmental objectives, there will be some overlap between them. Take for example the objectives of climate change mitigation and pollution prevention and control. These objectives will overlap on, for example, economic activities involving the reduction of emissions from fossil fuel combustion, as CO2 emissions as well as other air pollutant emissions decrease.
Similar overlaps exist between the water and ecosystem objective. Due to the various expected overlaps, it is recommended to gain an overview of those relevant for your business. This will avoid doing any double-work and create a more efficient alignment process and give insights already now on where a contribution is done to multiple objectives at the same time.
5 - New EU legislation
Besides the Taxonomy Regulation, other legislation and regulation is being developed concerning the four environmental objectives. Take for example the legislation around the Circular Economy Action Plan. The Commission is developing a legislative framework to ensure that products become fit for a climate-neutral, resource-efficient and circular economy, that avoids waste completely wherever possible. At its core is a review and widening of the Ecodesign Directive and the establishment of product sustainability principles that will guide broader policy and legislative developments in the future.
Furthermore, the Commission has also been developing an EU Biodiversity Strategy, including the strengthening of the EU legal framework for nature restoration. The Commission will propose legally binding EU nature restoration targets in 2021 to restore degraded ecosystems. Besides nature restoration, the strategy will also focus on biodiversity issues related to soil ecosystems, agriculture, forests, marine and freshwater ecosystems, urban areas and pollution.
These various legislative frameworks and strategies will be closely aligned with the EU Taxonomy. This implies that aligning with the remaining four environmental objectives will also provide insights and preparation for the forthcoming EU regulations.
The five points explained above underline why companies and institutions should think about all environmental objectives of the taxonomy regulation already now, and not solely focus on the climate objectives. The pressing timeline of alignment and disclosure is apparent, and investors are already increasingly looking for sustainable activities now.
By this, companies can be ahead of peers and legislation by already understanding the requirements for Taxonomy alignment and thoroughly investigating the potential and opportunities it offers. And as we all know, being ahead on your to-dos is so much better than being behind.
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