The EU Taxonomy has been in force since this year and obliges large listed companies with more than 500 employees to disclose the extent to which their activities meet the taxonomy's sustainability criteria. The framework is being gradually expanded and is expected to become mandatory for large companies falling within the scope of the new CSRD in the foreseeable future. Here you can find out who is affected and how, what is in store for you with the new set of rules and how you can prepare for the EU taxonomy.
What exactly is sustainable? A complex question, the answer to which is essential in order to establish a sustainable economy and meet the EU Commission's goals of making Europe the first climate-neutral continent by 2050. With the taxonomy, the EU Commission has now created an assessment basis to enable transparent decisions towards sustainability. Companies will now be required to disclose their economic activities in a transparent and comparable manner, thus contributing to a rapid transformation of the economy.
Content of the EU Taxonomy
The EU Taxonomy (EU) 2020/852 assesses the sustainability of economic activities based on objective criteria. These criteria were defined in a consultation process by technical experts. In the process, six environmental goals were agreed upon:
- Climate protection,
- Adaptation to climate change,
- Sustainable use and protection of water and marine resources,
- Transition to a circular economy,
- Pollution prevention and control, and
- Protection and restoration of biodiversity and ecosystems.
For an economic activity to be considered sustainable, it must make a significant contribution to these climate/environmental goals while not significantly harming any other goals. In addition, minimum social standards must be met.
The specific criteria were set out in the so-called Delegated Acts to the EU taxonomy. The Delegated Acts turn the taxonomy into a flexible piece of legislation that can change and will become continuously more restrictive based on the objective criteria defined in the Delegated Acts. This is the only way to achieve the climate targets and allow the economy to continuously adapt to these targets.
The first two Delegated Acts (climate change mitigation and adaptation) have already been published. The delegated act can be found here:
Commission Delegated Regulation
The four other Delegated Acts will follow soon and will enter into force in 2023.
Incidentally, not all economic activities are covered by the Taxonomy Regulation and the Delegated Acts. This is because economic activities are prioritized that can contribute the most to the respective environmental goals. The first Delegated Act focuses on climate goals (climate change adaptation and mitigation) and therefore includes activities that are most important for reducing greenhouse gas emissions and improving climate resilience.
However, this does not mean that the EU taxonomy is irrelevant for companies that do not operate in the covered sectors. Such companies can use the taxonomy to ensure the sustainability of procured products and benefit from the easier financing of taxonomy-compliant investments.
Tip: The EU Commission has made the so-called "EU Taxonomy Compass" available on the Internet. The tool is intended to make it easier for users to access the contents of the taxonomy.
Which companies have to report according to the EU taxonomy criteria?
Currently, large listed companies with more than 500 employees are affected by the EU taxonomy. They have to report on whether and to what extent their economic activities are covered by the EU taxonomy and whether they meet the sustainability criteria. The so-called Non-Financial Reporting Directive (Directive 2013/43/EU) defines which companies exactly are subject to the reporting obligation. It is currently being revised and will become the Corporate Sustainability Reporting Directive (CSRD). We have summarized the proposal for the new CSRD for you here.
When the CSRD comes into force, the sustainability reporting obligation will gradually be extended to all large companies (listed and unlisted) and later to all listed companies regardless of their size, including SMEs. However, companies of any size, including small companies, can use the EU taxonomy to explain to investors and stakeholders in general whether they are conducting or planning sustainable activities aligned with the taxonomy. Disclosure is only mandatory for large companies that fall within the scope of the CSRD.
Banks are already covered by the reporting obligation today and must publicly report on their investment activities. Indirectly, this also affects all companies that rely on banks for their financing. Finally, banks will increasingly demand a variety of data from their customers in order to meet their own reporting obligations.
The taxonomy in practical application
On the one hand, the introduction of the taxonomy is aimed at financial market participants. By providing a uniform definition of sustainability, the taxonomy gives them the certainty that they are really investing in sustainable economic activities (even if one can certainly argue about the definition of gas and nuclear power as sustainable - but we do not want to discuss that further here). This effectively prevents providers of financial products in Europe from "greenwashing", i.e. marketing financial products as sustainable that are not so according to the common understanding of sustainability.
On the other hand, companies in the real economy are affected by the taxonomy, initially those that are already subject to non-financial reporting requirements. These companies will face additional disclosure requirements in 2022 for the 2021 reporting year. They will be required to disclose taxonomy compliance in relation to certain operating figures such as sales and, where applicable, investment costs. This will allow investors to better compare sustainability efforts.
The further consequences of the taxonomy are still difficult to assess in some cases and will be influenced by political factors and market forces in the process. The following implications should be kept in mind:
As already addressed, the impact mechanism of the taxonomy is primarily aimed at entrepreneurial financing conditions: If a company credibly demonstrates that a certain part of its sales or investments is taxonomy-compliant, this should be perceived by financial actors aiming at certain sustainability goals and lead to more investments in the respective company. In this way, sustainable companies can benefit from more favorable financing options and diversification of their financing sources.
In general, it is also possible that companies that operate in line with the taxonomy benefit from a better reputation and that a competitive advantage is gained from this.
EU Green Bonds and Climate Bonds - Relevance for the Taxonomy
Furthermore, companies in the real economy that are planning investments that make a substantial contribution to an environmental goal, for example, should be able to use taxonomy-compliant financial products for financing purposes in the future. The EU is developing the EU Green Bond standard for this purpose. Climate Bonds certification is already available and, according to the EU, will meet the requirements of the EU Green Bonds Standard. All important information on Climate Bonds certification can be found here.
Possible taxonomy application using the example of a cement manufacturer
Find out how the taxonomy specifically affects companies in this illuminating case study prepared by the German Federal Ministry of Economics and Climate Protection:
A cement manufacturer with more than 500 employees is required to state how its economic activities relate to the taxonomy. The company exclusively produces cement in its five cement plants, with each plant producing the same amount and each contributing 20% to the company's sales. Two of the five plants emit less than 0.489 tons of CO2 on average in the production of one ton of cement, which is below the threshold value for the environmental goal "climate protection" stated in the TEG report (as of 2020). The company must now demonstrate that these two cement plants do not significantly conflict with any of the five other environmental targets (DNSH principle). While one plant does not significantly harm any of the five other environmental goals, the other plant is located in an area with a precarious water situation, where water shortages regularly occur in summer. Thus, cement production at this plant is detrimental to the third environmental objective, the sustainable use of water resources. The cement company also complies with all minimum protection measures (e.g. OECD Guidelines for Multinational Enterprises) for its employees. Accordingly, production at one of the five plants and thus 20% of the company's sales would be taxonomy-compliant.
Furthermore, one of the cement plants of the same company is located near a river mouth where flooding can occur. The company would like to use 1.5 million euros to improve flood protection and in particular the plant's drainage system. In doing so, it is contributing to the second environmental objective "Adaptation to climate change". The installation of the improved drainage system will not significantly violate any of the five other environmental goals. The company is issuing bonds worth 1.5 million euros for this purpose and can report its investment in full as taxonomy-compliant.
How can companies prepare for the
All companies, whether they are affected by the reporting obligation now or later, will benefit from creating the right data basis for the EU taxonomy assessment. In order to have the right data and information available, a good understanding of the EU taxonomy is needed. All EU information on this topic can be found here.
Companies that do not currently produce sustainability reports are encouraged to consider reporting. It is anticipated that the CSRD Regulation will require all large companies to report from 2023, regardless of whether they are listed on a stock exchange and without the current threshold of 500 employees. The CSRD Commission also proposes to extend the scope of reporting requirements to listed small and medium-sized companies, with the exception of listed micro-entities but with simplified standards. All important information on the CSRD proposal can be found here.
What DQS can do for you
As an AA1000-licensed certification body, DQS offers external verification for your sustainability reports (GRI, Global Compact, ISO 26000, ...). The external report verification certifies transparency and credibility in your reporting and gives all stakeholders the assurance that your report is an accurate and complete reflection of your sustainability performance. Further information can be found here.
Bond issuers benefit from using standards and labels to identify sustainable bonds. This gives investors unprecedented insight into the sustainability of an investment. DQS is accredited worldwide for the verification of Climate Bonds. Here you can find all important information about the standard.