In recent months, a lot has been said and written about the EU Taxonomy, the green classification system of economic activities that aims to drive capital flows to sustainable investments supporting the EU’s policy goals on climate and the environment. Political, corporate, and civil society lobbying reached its peak when the EU published draft rules last December, which deviated substantially from expert recommendations. However, the latest draft delegated act with rules on Taxonomy reporting published by the European Commission on May 7th has received far less attention even though some of the proposed changes affect the practical implementation timelines as well as the scope and ambition of the regulation.
In December 2020, the European Commission published draft technical screening criteria for defining an economic activity as being environmentally sustainable. These criteria deviated from Technical Expert Group (TEG) recommendations in their final report from March 2020. TEG members and civil society questioned the scientific basis for additional activities included in the list of activities that could be classified as environmentally sustainable; This followed pressure from eastern and southern EU member states who threatened to veto the bill and from corporate lobbying. Members of the Platform for Sustainable Finance, the official body recognized in EU law to support the Commission with further developing the Taxonomy, even threatened to give up their seats in the Platform as a result. After further lobbying, the EU postponed decisions on the most divisive topics and published its final delegated acts in late April with a four-month delay.
In stark contrast to these events, there has been relative silence on the latest delegated acts published by the Commission, which are currently in the consultation phase. Two changes, in particular, deviate substantially from previous recommendations by European Supervisory Authorities and the TEG. These changes will likely lessen the global relevance and use of the Taxonomy as a first of its kind impact measurement framework.
- The change: Postponing implementation: Under the draft act, the reporting requirements that would have taken effect in January 2022 have been reduced to only reporting the percentage of eligible activities, i.e., revenues derived from or CapEx invested in activities that are included in the Taxonomy, but without checking if they meet the technical criteria defined by the Taxonomy. Reporting on the Taxonomy alignment will now only be required as of 2023.
The impact: Company reporting of their alignment with the Taxonomy is being postponed by a year: While this delay will allow the market more time to prepare, the usefulness of the reporting requirements for 2022 is questionable. For some sectors, reporting only eligibility figures without alignment figures will give a distorted picture of companies’ sustainable contribution. For instance, a cement manufacturer might have 80-90% revenues associated with eligible activities. However, their alignment might be closer to 0% because of the stringent nature of the technical criteria. Compare this to a solar power generator with similar eligibility levels but that would be likely 80-90% aligned. In 2022, asset managers would have to report on a proportion of eligible activities within their holdings. It is difficult to understand the purpose beyond preparing the sector for implementation. Investment in the cement manufacturer and solar power generator would have the same effect on the eligible percentage, but with different implications.
- The change: Limiting the scope of alignment calculations to the reported data of large EU corporations: Only large EU corporates that fall under the Non-Financial Reporting Directive (NFRD) will have to report their Taxonomy alignment. There is no such obligation for non-EU companies (as the EU cannot regulate non-EU companies), and smaller companies in Europe are out of scope at least until 2025. What is striking is that the rules say that alignment data on non-NFRD companies” shall be excluded” from the calculations of a financial undertaking and that the data can only be reported data. In other words, alignment data can only be based on reported data by EU large caps. There seems to be no room for estimates or coefficients for companies not required to report on their alignment by the regulation, even though previous recommendations by supervisory bodies and experts did allow for these. Even companies that voluntarily report their Taxonomy alignment must be excluded—at least until 2025 when the Commission will review applications of the regulation.
The impact: The change dilutes the EU’s leadership in setting standards around the environmental impacts of companies and investment products.. The Taxonomy Regulation, as well as the Sustainable Finance Disclosure Regulation (SFDR) affects non-EU financial market participants offering products in Europe as they are also subject to the regulations and because EU investors are likely to pressure non-EU corporates to report data that the investor requires to comply with EU regulations. However, this new draft act, which we understand as proposing to exclude all private companies, EU small caps and all non-EU corporates from alignment calculations, removes the incentive for those companies to adopt the EU’s framework. Another effect could be that EU large caps could be favored in terms of green finance, as these corporates would boost the financial institutions ”green asset ratio” or Taxonomy alignment, whereas non-NFRD companies would not. For instance, in terms of Taxonomy alignment, investing in a European large cap with a 10% alignment would be more favorable than investing in a US-based company with a 100% alignment. Finally, while the Taxonomy alignment of green funds was already expected to be low for years to come with the framework still under development and the number of investment opportunities with high alignment being limited, these numbers will now be negligible for funds with global investments.
These delegated acts apply to corporates and financial undertakings and relate to article 8 of the Taxonomy Regulation. It is still unclear whether these proposed rules would also apply to financial products; however, we assume this to be the case so as not to create conflicting regulations for financial institutions. The consultation phase runs until June 2nd. In late June or July, we will likely know whether they will be adopted as final or whether further changes will be made. A delay in implementation of the Taxonomy seems likely, given previous delays. And while the second change highlighted above lowers implementation costs for corporates and financial undertakings significantly, it is this proposal that may face pushback from organizations who had already started embracing the EU Taxonomy as a leading impact framework.
Morningstar and Sustainalytics are staying abreast of all the regulatory developments related to the EU Action Plan. We will respond to the consultation and will make our response available for those who are interested. Please visit our resource centers for more information, newsletters, as well as information about products and solutions we offer to support Taxonomy and SFDR.
Special thanks to Tim Walton, Data Director at Morningstar, for his insights and support in writing this blog.
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 An activity is eligible under the Taxonomy if it is included in the list of activities covered by the Taxonomy and has technical screening criteria developed that determine under what conditions the activity substantially contributes to one or more of the Taxonomy’s objectives (climate change mitigation, adaptation, ecosystems, pollution, water and marine life, circular economy) and does no harm to any of these objectives.
 An economic activity is aligned when it meets all the Taxonomy criteria on ‘substantial contribution’, ‘do no significant harm’ and ‘minimum safeguards. In other words, an eligible activity is aligned when it meets all the criteria.