What is the European taxonomy? 

The European taxonomy is a regulatory text adopted by the EU in 2020. It classifies sustainable economic activities according to their environmental impact in order to direct investments towards least polluting ones. 

The taxonomy is one of the EU’s key texts on green finance. The regulation will be applied in various stages until 2024. Read along to know all about the EU taxonomy and how to align your firm’s activities with this regulation. 

 

What is the purpose of the European taxonomy? 

 

The European taxonomy is a classification of sustainable economic activities according to their environmental impact. Its aim is to identify the most sustainable activities to encourage investment towards them.

This regulation was adopted on proposal from the European Commission in 2020. It is in line with the aims of reducing greenhouse gas (GHG) emissions, as expressed by the European Green Deal

As such, the EU is committed to reducing its GHG emissions by 55% by 2030 and achieving carbon neutrality by 2050. 

For an activity to be considered sustainable according to this taxonomy, it must meet one of the following 6 criteria:

  • Adaptation to climate change;
  • Mitigation of global warming;
  • Sustainable use and protection of marine and aquatic resources;
  • Transition to a circular economy;
  • Pollution control;
  • Protection and restoration of ecosystem biodiversity. 

Sustainable activities are the primary focus of the taxonomy. However, it also considers two other types of activities:

  • Transitional activities: these have no viable low-carbon alternatives. Despite their significant carbon impact, they have no available solution to reduce their carbon footprint (e.g. production of recycled aluminium). 
  • Enabling activities: these are not sustainable but allow other activities to substantially contribute to one or more of the environmental objectives (an activity promoting active mobility such as walking or cycling, for instance).

How does the European taxonomy work? 

The taxonomy works like an investment dictionary. For instance, Article 2 is a series of definitions explaining the terminology used in the regulation (e.g. sustainable investment, emitter, greenhouse gases, etc.).

To classify activities, the European Commission used the NACE code. The Statistical Classification of Economic Activities (abbreviated NACE, in French) is a code referencing all current existing economic activities. There are 615. 

The taxonomy uses this classification to determine which activities qualify as green activities, and if so, how to align them with European requirements.

For investment firms, the Sustainable Finance Disclosure Regulation (SFDR) also categorises investment products to determine which are green.

Please note: Within the same firm, some activities may be covered by the taxonomy, whilst some may not be. This is the case for large firms with over 500 employees (see more below).

How should you align your firm’s activities with the taxonomy? 

What is the difference between alignment and eligibility?

Not all economic activities are covered by the taxonomy. You must therefore first determine whether your firm’s activities are eligible

To do so, the EU has set up a taxonomy compass, listing all eligible activities. Amongst the 600+ activities in the NACE code, around 100 of them are eligible for the taxonomy. 

If an activity is aligned with the taxonomy, it may be classified as sustainable. The taxonomy regulation defines technical examination criteria for each economic activity, in order to determine which may be considered “sustainable“.

What are the steps to alignment?

There are 5 steps to aligning your firm’s activity with the taxonomy: 

  • Are your firm’s activities eligible for the taxonomy?

Not all corporate activities are covered by the taxonomy. Before conducting an alignment analysis, you should therefore start with an eligibility analysis, mandatory since 2022.

  • Does your activity substantially contribute to one of the taxonomy’s objectives? 

The taxonomy has 6 environmental objectives (detailed earlier in this article). In order to comply with the taxonomy, your firm must make a substantial contribution to at least one of these objectives.

  • Does your activity jeopardise the other objectives? 

Your substantial contribution to one of the 6 objectives of the taxonomy must not undermine the taxonomy’s other objectives. This is the Do Not Significant Harm (DNSH) principle. For instance, this means that a climate change mitigation policy should not be done at the expense of an ecosystem.

  • Does your activity respect social rights?

For an activity to be aligned with the taxonomy, it must respect fundamental social and labour rights, guaranteed by international law. 

  • Consolidation and publication of data

Once the excluded, eligible, and aligned activities are identified, your firm should publish a Extra-Financial Performance Declaration (DPEF, in French). If criteria 2), 3) and 4) are validated, the activity is considered sustainable for non-financial reporting. 

Please note: An independent third party organisation must verify your firm’s DPEF. 

What are funds’ obligations in terms of the European taxonomy? 

Who does the taxonomy concern?

Only certain large organisations’ economic activities and financial institutions’ investments are eligible for the taxonomy. 

The concerned actors are: 

  • Large firms with over 500 employees. They are already concerned by non-financial reporting and have to publish an Extra-Financial Performance Declaration (DPEF), under the Non-Financial Reporting Directive (NFRD).
  • Member States implementing public measures, standards or labels for green financial products or green bonds.
  • Financial stakeholders, such as financial supervisory institutions (e.g. central banks), public interest institutions (e.g. credit institutions, mutual funds, provident societies, insurance companies).

Almost 12,000 players are currently concerned. Eventually, the regulation’s expansion will make it applicable to over 50,000 institutions and companies.

What indicators are used?

The taxonomy’s indicators are not identical for all players:

  • Non-financial firms have to publish the sustainable share of their turnover, capital expenditure (Capex) and operating expenditure (Opex);
  • Financial institutions are required to publish the share of assets financing and invested in eligible economic activities aligned with the taxonomy.

What is the timetable for the regulation’s implementation? 

The taxonomy’s implementation timetable is as follows: 

  • January 2023:

Texts concerning other environmental objectives than GHG emissions reduction come into effect (pollution, water, circular economy and biodiversity);

Large firms must henceforth declare their activities’ alignment with the European taxonomy.

  • January 2024

Financial institutions must henceforth declare their investments’ alignment with the European taxonomy;

The CSRD (Corporate Sustainability Reporting Directive) comes into effect, progressively extending non-financial reporting obligations (including alignment with the European taxonomy) to 50,000 companies by 2028, as expressed below: 

From the financial year 2024 on (publication in 2025): large firms with over 500 employees already subject to the Non-Financial Reporting Directive (NFRD);

  • From the financial year 2025 on (publication in 2026): large firms not subject to the NFRD;
  • From the financial year 2026 on (publication in 2027, derogation possible until 2028): listed SMEs. 

Please note, this timetable is not fixed. The taxonomy should be updated every three years to incorporate innovations and new practices of financial sector players.

How can carbometrix help you align with the taxonomy?

To assess and prove the sustainability of your eligible activities, the best way to comply to these new texts, is to begin, right now, to precisely compute your carbon emissions, through activity based and full scopes carbon footprint. Carbometrix can help you with this, in an efficient and auditable way. 

Conclusion

The taxonomy helps identify sustainable economic activities, in order to direct the investments of financial institutions and large firms towards them. 

According to its definition, a sustainable activity must substantially contribute to one of the 6 environmental objectives, without harming the others, and whilst respecting fundamental social rights guaranteed by international law. 

In order to determine whether your activities are eligible, how to align them with the taxonomy’s objectives and which indicators to use, you may be assisted in establishing its reporting. Get in touch with us now!