Why was the EU Taxonomy created?

By passing the Green Deal in 2019, the European Union (EU) set the course for more sustainable investments, for example in areas like renewable energy, biodiversity or circular economy. The goal is to reach a climate-neutral economy in the EU by 2050, with a reduction of 55% already implemented in 2030. To achieve these climate goals, the Green Deal includes an investment plan of 1 trillion euros over the next 10 years. Despite this huge investment, the EU depends also on the support of the private sector to achieve the Paris climate agreement.

The EU Taxonomy regulation and the Sustainable Finance Disclosure Regulation (SFDR) are implemented to ensure equal competition and legal certainty for all companies operating within the EU. Both regulations follow the objective of the Green Deal and have the following key goals:

  1. Reorientation of capital flows with a focus on sustainable investments
  2. Establishing sustainability as a component of risk management
  3. Promoting/encouraging long-term investment and economic activity

What is the EU Taxonomy?

The Taxonomy is a classification system for organizations to identify which of their economic activities, or the economic activities they invest in, can be deemed ‘environmentally sustainable’. The Taxonomy defines environmentally sustainable activities as economic activities that make a substantial contribution to at least one of the EU’s environmental objectives, while, at the same time, not significantly harming any of these objectives and meeting minimum social safeguards. All financial market participants, all large companies and listed SMEs businesses will need to report against the Taxonomy. (Subject to the outcome of the EU political negotiations on the Corporate Sustainability Reporting Directive.)

  1. The economic activity contributes to one of the six environmental objectives
  2. The economic activity does ‘no significant harm’ (DNSH) to any of the six environmental objectives
  3. The economic activity meets ‘minimum safeguards’ such as the UN Guiding Principles on Business and Human Rights to not have a negative social impact
  4. The economic activity complies with the technical screening criteria developed by

Step 1: Making a Substantial Contribution 

The first step to complying with the EU Taxonomy is to make a substantial contribution to at least one of the six environmental objectives. An activity must meet certain TSCs in order to assert that it makes a substantial contribution to an environmental objective. These TSCs are tailored to each activity and objective pairing to ensure that the thresholds and conditions being met are relevant and appropriate.

Step 2: Doing No Significant Harm (DNSH)

If an activity makes a substantial contribution to one of the six environmental objectives, that same activity must at the same time do no significant harm to the remaining environmental objectives. The DNSH principle ensures that the economic activity being screened does not interfere with achieving other environmental objectives. Relevant and respective Technical Screening Criteria (TSC) are defined for each activity-objective pairing to determine whether or not an activity passes the DNSH criteria.

Step 3: Complying with Minimum Social Safeguards

The final step to determining your Taxonomy alignment requires companies to show that they adhere to minimum social safeguards (MSS) as a whole. As per Article 18 of the EU Taxonomy, means that you must either present, if available, or implement procedures that abide by the OECD Guidelines on Multinational Enterprises, the UN Guiding Principles on Business and Human Rights, and the ILO Core Labour Conventions.

Step 4: Calculating your financial KPIs

Once you have completed your alignment screening, the KPIs can be calculated. For each financial KPI (turnover, CapEx, and OpEx), you will need to report the percentage of total turnover, CapEx, and OpEx that is associated with EU Taxonomy-eligible activities and the percentage that is associated with EU Taxonomy-aligned activities.

Step 5: Completing your report and making disclosures

You are now ready to compile this information into the European Commission’s standard reporting template and make your disclosures. The EU standard reporting templates can be found in the Annexes of the Disclosures Delegated Act, and require all the eligibility and alignment details and information produced in the implementation steps outlined above.

What to keep in mind: 

  • Total turnover, CapEx, and OpEx are the denominators needed to determine what percentage of the company’s activities are Taxonomy eligible and what percentage of the company’s activities are Taxonomy aligned.
  • An activity can have more than one environmental objective, but it is important that the activity’s eligibility and alignment should only be counted once.
  • The turnover, CapEx, and OpEx associated with each EU Taxonomy-eligible activity are needed in order to determine the percentage of activities that are Taxonomy eligible and aligned, as well. Once aggregated across eligible and aligned activities, these sums act as the numerators in KPI calculations.