What is the sustainability taxonomy and why is it a key element for the EU future?

La Tamise à Hampton Court - Alfred Sisley

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In March 2020 the European Commission's Technical Expert Group on Sustainable Finance (TEG) published three documents entitled: EU Taxonomy Technical Report, EU Taxonomy Technical Annex and EU Taxonomy Excel Tool.

As we saw in the entry "The EU's plan for a clean and sustainable economy", these taxonomy documents are part of the Action Plan for a greener and cleaner economy and, specifically, its first objective of establishing a common language for sustainable finance.

The TEG defines the EU taxonomy as a tool to help investors, companies, issuers and project developers make the transition to a low-carbon, more resilient and resource-efficient economy.

The taxonomy identifies six objectives for achieving the transition to a more sustainable economy: 1) climate change mitigation, 2) climate change adaptation, 3) sustainable use and protection of water and marine resources, 4) transition to a circular economy, waste prevention and recycling, 5) pollution prevention and control, and 6) protection of healthy ecosystems.

For the time being, the development of the taxonomy referring to the first two objectives has been published and completing the rest of the objectives is expected to be published between 2021 and 2022. This publication in parts is understandable because of the enormous work involved in developing each of these objectives.

The EU taxonomy classifies business activities according to NACE criteria and also facilitates equivalencies with other international activity classification systems.

The EU taxonomy revolves on three main axes: (i) in the first, it identifies the activities that are positive to sustainability, the activities that can help sustainable development and the activities that do not comply with the taxonomy, (ii) in the second, it establishes the concept of "do no significant harm" (DNSH), as a requirement of not causing harm to other objectives in order to comply with one or several of them, and (iii) in the third, it establishes the minimum guarantees to be complied according to international guidelines such as the OECD Guidelines on Multinational Enterprises and the UN Guiding Principles on Business and Human Rights.

For a business activity to be considered compliant with the EU taxonomy, it must comply with all three axes. Furthermore, the taxonomy distinguishes between activities that help the development of sustainability (substantial contribution) and those enabling activities with regard to the first ones (enabling activities). Thus, the taxonomy is favorable to these two types of activities and contrary to the activities that are not aligned with their criteria. In other words, activities which are excluded from the EU taxonomy and which can therefore not be in line with its criteria.

As a company may carry out several different NACE activities, in order to carry out the alignment analysis with the EU taxonomy, it is necessary to identify each of the company’s activities and the bulk they have in the overall turnover. In this way, the activities and their substantial contribution turnover are 100% eligible for the taxonomy. In contrast, enabling activities and those that do not contribute per se to sustainability require compliance with the DNSH and minimum guarantees of international standards to be eligible (at a certain percentage or 100%).

When there are groups of companies or investment companies with participation in a portfolio, the analysis of alignment with the taxonomy of the parent or holding company is carried out by calculating the weight of each of the investees in the parent or holding company.

The technical annex includes eight mitigation activities that can substantially contribute to the mitigation of climate change: forestry, agriculture, manufacturing, electricity and other supplies such as gas and steam, water and sewage and waste, transport and storage, information and communications, and construction and real estate.

The Technical Annex also covers nine adaptation activities that can substantially contribute to climate change adaptation: forestry, agriculture, manufacturing, electricity and other supplies such as gas and steam, water and sewerage and waste, information and communications, construction and real estate, financial and insurance activities, and professional and scientific and technical activities.

Thanks to the EU taxonomy, there will be a framework on which the various operators can identify and focus to the development of activities and measures for sustainable development.

With the EU taxonomy, investors will be provided with a useful tool to calculate the degree of compliance of business activities with the sustainability objectives, in order to decide whether to invest in the company or not.

Regarding the Member States and EU legislative powers, compliance with EU taxonomy may be the criteria for contracting or not with public administrations, receiving or not receiving tax benefits and deductions, using certain denominations or green labels, being able to issue or not green bonds, etc.

Consequently, the EU taxonomy is bound to be a key tool for the development of policies and regulations, as well as a regular tool for private operators in the EU market.