To help the European Union (EU) reach its bold goal of being the first climate neutral continent by 2050, it created a European Green Deal in December 2019. The series of proposals across climate, energy, transport, and taxation aims to reduce emissions by 55% by 2030. To help get there, the EU Commission’s Technical Working Group created the EU Taxonomy for Sustainable Activities (the EU Taxonomy, for short), a mandatory reporting requirement currently covering 11,000 companies.
What is the EU Taxonomy?
The EU Taxonomy provides a minimum standard across sustainability disclosure requirements, effectively creating a green investment rule book specifying which investments can be considered sustainable. It includes detailed criteria for each economic activity to gain a green label. For example, a car manufacturer earning a green label would have to show investments toward EVs or make manufacturing centers net-zero. This helps identify green investments, promote transparency, and prevent greenwashing within financial and non-financial sectors.
Sustainable finance is critical in helping the EU achieve its Green Deal goals of creating a climate neutral continent by 2050 and EU-wide emissions reduction goals laid out by the Paris Agreement. To maximize transparency, standardize reporting criteria across sectors, and ensure investments align with the EU’s Green Deal, the EU Taxonomy will function as a living document. It will be re-reviewed every three years to include new technical aspects. The European Environmental Agency (EEA)—a permanent member of the EU’s Technical Working Group—will provice input and considerations to help ensure that criteria set within the EU Taxonomy can live up to environmental goals.
Who is impacted by the EU Taxonomy?
The EU Taxonomy’s standardized classification system means businesses have clarity on conforming to the EU’s non-financial sustainability reporting criteria for scope 1, 2, and 3 emissions. Under the EU’s Corporate Social Reporting Directive (CSRD) and its predecessor, the Non-financial Reporting Directive (NFRD), the EU Taxonomy will streamline sustainability reporting criteria. Currently, the EU Taxonomy impacts 11,000 companies within the EU under the NFRD. Starting in January 2023, the EU Taxonomy will also be a mandatory tool for the CSRD, impacting roughly 50,000 companies within the EU and international companies operating in the EU.
While the NFRD covers companies and banks with over 500 employees, the CSRD casts a much wider net, covering all large public and private companies that meet at least two of the three criteria:
- 250+ employees
- €20 million or more in total assets
- €40 million or more in turnover
Eligibility and alignment
Activities must first be considered eligible within the EU Taxonomy before determining if the specific economic activities or investments are aligned. Ultimately, alignment determines whether or not assets and investments are considered sustainable or green. For an activity to be taxonomy-eligible, it must contribute to one of the six environmental objectives:
- Climate change mitigation
- Climate change adaptation
- The sustainable use and protection of water and marine resources
- The transition to a circular economy
- Pollution prevention and control
- The protection and restoration of biodiversity and ecosystems
To be considered taxonomy-aligned and meet environmental sustainability requirements, it must:
- Contribute to one or more of the six environmental objectives, and comply with the related technical criteria.
- Do no significant harm to any other environmental objective not directly related to the activity.
- Meet minimum social safeguards around labor rights and human rights.
These criteria prevent greenwashing and promote a platform on sustainable finance and investment that considers core Environmental Social Governance (ESG) aims while ensuring one environmental objective does no significant damage to other areas of environmental concern. For example, a hydropower project may help address emissions and clean power objectives while simultaneously limiting water flow for downstream communities and causing irrevocable harm to ecosystems and fisheries.
Relationship with other regulations
The EU Taxonomy regulation provides a uniform reporting guide across various EU policy agendas, like the CSRD and the Sustainable Finance Reporting Directive (SFRD).
The CSRD will become a requirement for many small and medium enterprises (SMEs), all large companies, all companies on listed markets, and international companies with subsidiaries operating within the EU from 2023. The CSRD’s broad scope of compliance will impact an estimated 49,000 companies, collectively representing over 75% of all European business revenue. Companies that fall under the umbrella of the CSRD will have to use the EU Taxonomy as a guide to their disclosure reporting.
For the CSRD, companies will have to comply every year. But, a review of the EU Taxonomy will occur every three years to reflect new technical criteria. The first three-year review was completed in 2022, and the next one is set for 2025. By then, there will likely be additional technical criteria across every sector in the EU Taxonomy. The malleability and future adaptability of the EU Taxonomy mean it can continue to meet environmental sustainability standards for decades.
While the EU Taxonomy sets a minimum sustainability standard, the EU’s SFRD has required asset managers and others managing financial flows to provide transparency around sustainability while imposing mandatory ESG disclosures since 2021. The SFRD applies primarily to financial institutions operating within the EU and covers sustainability risk to product-level disclosures, which must conform with EU Taxonomy criteria. The SFRD calls for the classification of financial products and advice into one of three categories: mainstream products, products that promote ESG, or products with sustainable investment aims. Product-oriented disclosures can impact pre-contract disclosures from client information to websites.
What are the EU Taxonomy’s environmental goals?
The EU Taxonomy is a classification system for companies to identify which economic activities and investments are considered environmentally sustainable. To conform, activities must address at least one of the EU’s six environmental goals without harming others and meet social safeguards and labor rights—all in line with ESG aims.
The European Commission created the EU Taxonomy Compass, an online interactive tool to make it easier for businesses to access and promote transparency under the EU Taxonomy. Users can see economic activities related to specific environmental objectives, which activities are considered taxonomy-relevant, and GHG reductions underway. The EU Taxonomy Compass will be updated to reflect future criteria and technical screening criteria related to the EU Taxonomy.
Phasing in the EU Taxonomy by sector
The EU Taxonomy first covered financial firms related to pensions and asset management, insurance, and corporate and investment banking. From 2021-2022, it expanded to non-financial sectors. It covered forestry, manufacturing, environmental protection, water supply and management, transport, energy, construction and real estate, IT, education, scientific and technical activities, human health and social work, and arts and entertainment. Agriculture is noticeably missing. That’s because, since 1962, agriculture in Europe has been regulated by the Common Agriculture Policy (CAP). CAP is set to have a new legal framework completed in 2023, and from there, it’s likely agriculture will be phased into the EU Taxonomy.
Rules for specific sectors continue to roll in. Some sectors, like nuclear, lobbied for delays in the roll-out; due to the EU Taxonomy’s criteria to “do no significant harm” and the reality of nuclear accidents, storage, and containment. Rules for nuclear and natural gas were delayed until the European Parliament agreed to include criteria in 2022. Similarly, EU Taxonomy rules for steel plants, EVs, and building renovation requirements also came out in 2022.
What’s the future of the EU Taxonomy?
The EU Taxonomy is a living document. Over time it will continue to be amended, altered, and include new sectors. During the next few years, the EU Taxonomy could expand to include other sectors, like agriculture. Starting in January 2023, all six environmental objectives will have mandatory reporting requirements. From January 2024, financial institutions must disclose their Key Performance Indicators (KPIs). In June 2024, there will be a review to extend the EU Taxonomy to include SMEs, along with related reporting requirements.
By creating a uniform standard sustainability criteria, the EU Taxonomy will likely be utilized in upcoming policies, like the EU Green Bond Standard, a proposed piece of legislation that would set voluntary standards for environmental bonds as a part of the EU’s Green Deal. While the EU’s Ecolabel—a “voluntary label for environmental excellence” for products—has existed since 1992, there is the potential that the EU Taxonomy could play a role in establishing new standards for designation in the future.
Since the EU Taxonomy is a core reporting criterion for non-financial disclosures, like the CSRD, the EU Taxonomy will apply to many non-European-based companies. International companies with subsidiaries operating in the EU that meet CSRD thresholds in taxonomy-related sectors will have to use the EU Taxonomy in their CSRD annual reports. From financial year 2023, the CSRD will require both EU and non-EU companies operating in the EU to report on their non-financial climate and sustainability disclosures. As these requirements impact U.S.-based and global companies, other nations may establish similar uniform sustainability reporting requirements for businesses. With the variety of sustainable reporting standards, it’s never been more important for companies to work toward climate change collaboration and aim higher across their sustainability and emissions targets.