The EU taxonomy: A quick guide for business

The EU taxonomy is out and there is more coming. But how many actually understand how this sustainability classification system works and what the implications for business will be? In the spirit of the season, we bring you this quick guide to answer your key questions.

What is the EU taxonomy and who is it designed for?

The EU taxonomy is a classification system that seeks to translate the EU’s climate and environmental objectives into criteria for environmentally sustainable (green) economic activities. It’s designed to provide European investors, businesses and policymakers with a common definition of what is and what is not environmentally sustainable. The EU taxonomy is designed to increase transparency, investment security, standardisation, climate-friendly practices as well as scale up European sustainable investment and carry out the European Green Deal.

How is it supposed to work in practice?

The EU taxonomy establishes a list of environmentally sustainable activities by defining technical screening criteria (TSC) for each of its six environmental objectives: climate change mitigation, climate change adaptation, the sustainable use and protection of water and marine resources, the transition to a circular economy, pollution prevention and control, and the protection and restoration of biodiversity. Economic activities are recognised as environmentally sustainable if they:

1. Make a substantial contribution to at least one of the objectives

2. Do not significantly harm any of the other objectives

3. Meet the minimum social safeguard standards of the OECD Guidelines on Multinational Enterprises and the UN Guiding Principles on Business and Human Rights

In practice, it is the delegated acts that will help establish and maintain clear criteria for economic activities by defining what it means to make a substantial contribution and to do no significant harm within their scope. The first delegated act, covering the first two climate objectives, sets the criteria for economic activities in sectors most relevant for reducing greenhouse gas emissions and improving climate resilience. The delegated acts are living documents that will be added to over time and stakeholders can notify what activities they want included in the EU taxonomy via the assigned EU Platform for Sustainable Finance. The Platform will review the economic activities and screening criteria regularly and ensure they’re aligned with the latest scientific data available.

How will it impact business?

The EU taxonomy sits within the broader sustainable finance framework. Large financial and non-financial businesses that offer financial products on the European market and those who fall under the scope of the EU’s law on corporate sustainability reporting (listed companies with over 500 employees) will have to disclose their share of EU taxonomy related activities starting 1 January 2022. The disclosed information will be available to investors who want to make environmentally sustainable investments. To make it easier for businesses to use the EU taxonomy the European Commission has created a tool called the EU Taxonomy Compass which also seeks to help businesses integrate the criteria into their own databases.

The first act is out – what happens now?

The EU Council cleared the first delegated act which contains the technical screening criteria for climate change adaptation and mitigation in early December. As the act passed through the final stages of the political negotiations it will soon become EU law, entering into force on 1 January 2022. Work now focuses on developing additional criteria for the remaining four objectives and expanding activities to complement the climate delegated act. In parallel, the most politically sensitive part of the EU taxonomy is yet to come as nuclear energy and natural gas activities will be handled in another complementary delegated act, expected before the end of the year.

Why should business care?

More and more companies are beginning to realise that they can’t opt out of sustainability and that it can even be good for business. The EU taxonomy will increase clarity on what is environmentally sustainable, and what is not, so that investment can be channelled towards what is green, rather than greenwashing.

Aligning with the EU taxonomy can provide business with a sustainability compass for economic activities, comparative information and data on climate risk management, and access to finance and ESG-hungry capital markets.

Legal requirements will get tougher with time. The work on refining and developing additional criteria for different sectors and economic activities (including social aspects) is already underway and so is the new EU directive for corporate sustainability reporting. It is highly likely that the European Commission will extend the current mandatory reporting to smaller businesses and parts of their environmentally sustainable economic activities as well. And, like with the rules on data protection – the GDPR – this will shape international classification systems as well.

Finally, business should care because the EU taxonomy is a tool for helping us all make progress on the UN Sustainable Development Goals and reach climate neutrality by 2050.