Eu taxonomy: here’s how things stand on the road to a sustainable economy

In 2022, parts of it will finally come into force: the taxonomy, the EU’s set of rules that defines whether companies are operating ecologically. It is part of a comprehensive change to a more sustainable economy. Social issues are also gradually progressing.

Eu taxonomy: here's how things stand on the road to a sustainable economy

The EU taxonomy regulation comes into force on 1. January 2022 in parts in force. © royalty-free photo, Pixabay

Years of tweaking have gone into it, as of 1. The EU Taxonomy Regulation will come into force on January 1, 2022, but initially only part of it. It sets out precise criteria for what constitutes "environmentally sustainable business practices" for most industries. It is an important building block of the European Green Deal, with which the community of nations aims to become climate neutral by 2050. But what exactly does this mean, on the long road to sustainable finance, and how does the taxonomy embed itself in other upcoming reforms?

First, on the taxonomy itself. It is aimed at companies and financial market players such as banks and insurance companies and defines very precise criteria for different sectors. Jochen Krimphoff calls this 1,000-page work the "Brockhaus of sustainable business". Krimphoff is Deputy Director for Sustainable Finance at WWF France and is a member of the Platform on Sustainable Finance. The panel of more than 100 experts from the real economy, the financial sector, academia, civil society and public authorities is drawing up proposals for the taxonomy for the EU Commission. With the taxonomy, everyone can look up what needs to be done to operate ecologically, as in an encyclopedia for their industry, says Krimphoff.

A compass for taxonomy

The commission has made the rules easy to digest in a taxonomy compass. In principle, an economic activity, such as investing in a new production facility, must serve one of six environmental goals and must not contradict any of them. These are:

  1. Climate protection
  2. Adaptation to climate change
  3. Sustainable use and protection of water and marine resources
  4. Transition to a circular economy
  5. Prevention and reduction of environmental pollution
  6. Protection and restoration of biodiversity and ecosystems

Example: According to the taxonomy, anyone who produces gray cement clinker may emit a maximum of 0.722 metric tons of CO2 or equivalent gases per ton in the interest of climate protection. The value is calculated using the top 10 percent of the most efficient plants in the EU. All ratios in the taxonomy will be tightened in the future in line with the state of the art. To minimize the risks of water pollution at the same time, the company must compulsorily prepare an EU environmental impact assessment for its production.

However, so far only the first two environmental targets of the taxonomy have been conclusively defined for 15 industries, and the details are still being fine-tuned until December. For this reason, only these two environmental goals, i.e. climate protection and adaptation to climate change, come into force on 1. January 2022 in force. Two thorny issues are still completely open, however: The question of whether nuclear power will be included in the taxonomy as a low-carbon, "green technology," as well as the inclusion of natural gas. The Commission announced back in July that it would address these issues in a separate piece of legislation if necessary. So the entry into force of the taxonomy should not fail because of that. The EU Commissioner for Financial Services, Financial Stability and Capital Markets Union, Mairead McGuinness, has already announced in the Financial Times that the Commission will not present a proposal to resolve the dispute until 2022, in consideration of upcoming government formations in some countries.

Concrete proposals have already been made for environmental goals 3 to 6. The Platform on Sustainable Finance presented them in August, and after a consultation period they are to be finalized by the end of the year. "I suspect, however, that this step alone will drag on into next year. Then Parliament and the Council still have to deal with the regulations and approve them," says Alexander Bassen, Professor of Business Administration at the University of Hamburg, one of the leading experts on corporate sustainability information and a member of the German Council for Sustainable Development (RNE). Krimphoff also expects it to take longer: "It’s safe to assume that the Commission will present a delegated act for environmental targets three to six in the next six months."

How the taxonomy is embedded in the other reforms

The impact of the taxonomy can only be understood in the context of the EU’s overall Sustainable Finance Package, and that includes comprehensive reporting requirements for companies and the financial sector. Since March 2021, financial service providers have no longer been able to simply claim that a product is sustainable – if they do, they have to explain what criteria they are using to do so.

In general, the financial sector will have to publish data for the first time next year on how many of its assets it holds in sectors for which environmental criteria are defined in the taxonomy – in other words, all those in which sustainable investments can be made in the sense of an ecological transformation of the economy. Sectors where this is not possible because they can be replaced by other technologies are not part of the taxonomy anyway. Classic example: steel is in it, you can’t replace it, but you can produce it more ecologically. Coal-fired power generation is out, there are alternatives.

The situation is similar in the real economy: "If the final text for goals one and two is adopted as planned on 8. December becomes legally binding, then all large companies in Europe will have to say as early as next spring how they are aligning themselves with this new benchmark," says Krimphoff. Businesses must then declare for 2021 how many of their activities take place in the areas covered by this taxonomy. One year later, they will then have to state whether or not their activities are also environmentally sustainable according to the taxonomy – based on sales, their investments and their operating expenses. "That is, it really goes into the financial area purely. That’s what makes this set of rules so interesting. It bridges the gap between the environment and very concrete numbers," Krimphoff says.

How can be reported to increasing requirements

This reporting requirement will be greatly expanded in the future. Since 2017, large companies throughout the EU have already been required to submit a sustainability report – for example, in accordance with the German Sustainability Code (DNK), which around one third of all companies in Germany subject to reporting requirements use to meet the legal requirement. However, according to the EU’s Corporate Sustainability Reporting Directive (CSRD) presented in April, from 2024 even smaller capital market-oriented companies will have to present corresponding key figures, in much greater detail than in the previous directive of 2017 and audited by independent experts, as is also customary for financial statements. "There will be a lot to come for companies. In Germany, around 600 companies have been affected by mandatory sustainability reporting so far; with the CSRD, this figure will rise to around 15.Be 000. Many still have no one to look after the issue. That’s why there will also be an enormous need for qualifications and personnel," says Bassen.

Information on what this will change for the German Sustainability Code will be provided in good time. However, one thing is already certain: the DNK will provide companies with an opportunity to report on the essential contents of the taxonomy from the beginning of 2022 onwards. And the new CSRD requirements will also be reflected by the DNK team and, as soon as they are concretized, incorporated in an appropriate manner. "An external expert opinion is currently being prepared that compares the 20 criteria of the Sustainability Code with the requirements of the taxonomy and the previously known contents of the CSRD. The first preliminary results look very positive: The GSC is suitable for meeting increasing requirements, for all companies and especially for small and medium-sized enterprises. The added value of the DNK is reflected in its user-friendly structure and the wide range of support offered when creating your own DNK declaration. In this way, the GSC also offers SMEs and smaller companies without their own sustainability departments the opportunity to integrate social and environmental aspects into the company’s core business," say Isabelle Krahe and Florian Harrlandt, who are jointly responsible for the GSC at the RNE office.

What about social standards

The taxonomy already includes minimum standards for labor and human rights. If a company violates this with an investment, it may not call it sustainable in the sense of the taxonomy – no matter how ecological the project is. But this is just the beginning. In July, a working group of the Platform on Sustainable Finance presented a proposal on how to formulate a social taxonomy. At the same time, such indicators are also to be integrated into the reporting obligation for companies that will apply from 2024, the CSRD. The standards for this are currently being developed by EFRAG, the European Financial Reporting Advisory Group, an association of the financial and real economy that supports the EU Commission in the development of reporting standards.

"Many of the criteria of the social taxonomy will be taken up in the CSRD, and EFRAG is currently developing the concrete metrics for this, which companies will probably have to submit in their reporting for the 2023 reporting year," says Bassen, who is a member of EFRAG’s Project Task Force. The question will then be whether there is still a need for a social taxonomy, or whether the issue is not already sufficiently addressed with it. In any case, the challenge is enormous: In order to implement the 17 Global Sustainability Goals of the United Nations, the SDGs, in developing countries, 2.5 to 3 trillion dollars in investments are required. Annually, by 2030.

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