Breaking Down The Basics: EU Taxonomy

What is the EU Taxonomy?

In July 2020, the European Union (EU) began development on the EU Taxonomy, the first-of-its-kind sustainable business classification system that aims to standardize for the investment community what qualifies as an investment in a sustainable business.¹ The EU Taxonomy is a key component of the Sustainable Financial Disclosure Regulation (SFDR), which aims to govern sustainability labeling for financial products and services marketed in the EU. The EU Taxonomy will serve as a common language and reliable benchmark for measuring the sustainability of investments. Additionally, to be labeled as an “Article 9” investment product, the most stringent categorization under SFDR, an investment manager must demonstrate a product’s alignment with the EU Taxonomy.²

Who Does the EU Taxonomy Apply to?

Following the introduction of the EU Taxonomy, several other supplementary regulations were released to provide further guidance around reporting requirements, specifically in relation to the technical screening criteria.

1. Climate Delegated Act of 2021⁷a) On June 4, 2021, the European Parliament established the “technical screening criteria for determining the conditions under which an economic activity qualifies as contributing substantially to climate change mitigation or climate change adaptation and for determining whether that economic activity causes no significant harm to any of the other environmental objectives.”

   b) In June 2023, the European Parliament included additional activities to the Climate Mitigation and Climate Adaptation objectives, including activities focused on manufacturing and transportation sectors.

2. Environmental Delegated Act of 2022⁸a) Formally discloses the remaining eligible activities that can make a substantial contribution to the remaining environmental objectives.
3. Complementary Climate Delegated Act of 2022⁹a) The latest addition to the regulation came into effect in 2023 and includes clauses around the inclusion of nuclear and fossil gas activities within eligible activities.

Taxonomy Eligibility vs. Taxonomy Alignment

To be eligible for consideration for EU Taxonomy alignment, a company has to derive revenue from one of 195 listed business activities that potentially contribute to either climate mitigation or climate adaptation. In the coming months and years, this list of activities will expand to include activities relevant to water, circular economy, pollution prevention, and biodiversity.

Deriving revenue from one of these 195 activities does not make a company aligned with the EU Taxonomy, it only makes it eligible for alignment. To be considered aligned with the EU Taxonomy, a company has to adhere to several criteria that enable a common measurement for sustainability contributions that the economic activity must meet or not negatively impact. These include:

1. Substantial Contribution: Activities must make a significant contribution to the environmental objective and adhere to the Technical Screening Criteria (TSC). These criteria specify what operational benchmarks the sustainable investment has to meet to qualify as sustainable. For example, a company that generates geothermal power, a lower- but not zero-emission power source, cannot exceed a certain carbon emissions threshold per gigawatt hour.
2. Do No Significant Harm (DNSH): Ensures the business activity does not significantly contribute towards harming any one of the other key environmental objectives of the taxonomy. For example, if a company that builds and operates rail infrastructure does not follow particular waste recycling practices, its business would be deemed to cause significant harm to the goal of promoting a circular economy and would therefore be unaligned with the taxonomy.
3. Comply with the Minimum Safeguards: Ensures the company complies with the following international standards:

   a) OECD Guidelines for Multinational Enterprises

   b) UN Guiding Principles on Business and Human Rights, including the International Labour Organization’s (“ILO”) declaration on Fundamental Rights and Principles at Work, the eight ILO core conventions, and the International Bill of Human Rights.

The taxonomy regulations specify the exact requirements for each business activity across the three areas listed previously. Each business activity has a different set of requirements.

EU Taxonomy Environmental Objectives

When finalized, the EU Taxonomy will have lists of eligible activities and alignment requirements across six environmental objectives. Since its inception, only the criteria for two objectives, Climate Change Adaptation and Climate Change Mitigation, had been completed. In June 2023, the technical screening criteria for the remaining environmental objectives were released.¹⁰

1. Climate Change Mitigation (Effective January 2022)
2. Climate Change Adaptation (Effective January 2022)
3. Sustainable Use and Protection of Water Resources (Expected Reporting January 2025
4. Transition to a Circular Economy (Expected Reporting January 2025)
5. Pollution Prevention and Control (Expected Reporting January 2025)
6. Protection and Restoration of Biodiversity and Ecosystems (Expected Reporting January 2025)

Are Companies Reporting Alignment to the EU Taxonomy?

While the regulations lack some clarity around this topic, it is expected that issuing companies will begin to report their alignment to the EU Taxonomy in their annual filings. Some companies have already begun reporting for their year 2021 and 2022 annual filings. Companies reporting against the Taxonomy are required to include a description of their Taxonomy-aligned activities with the percentage of alignment: turnover, CAPEX, and OPEX percentages.

To showcase an example of how some companies are reporting today, below is an excerpt of Schneider Electric’s (OTCPK:SBGSF, OTCPK:SBGSY), a French multinational energy company, self-reported alignment from its 2022 Sustainability Report.

Schneider Electric – Sample Sustainability Report

What Challenges Does the EU Taxonomy Present for Investors?

1. Mapping of NACE Codes and Unsatisfactory Classificationa) In 1970, Europe launched its first statistical classification of economic activities, known as NACE Codes. These NACE Codes were geared towards identifying a company’s primary business line based on its economic activity. Currently

   SDGs, Targets, and Indicators

   1. Which SDGs are addressed or connected to the issues highlighted in the article?

   • SDG 7: Affordable and Clean Energy
   • SDG 9: Industry, Innovation, and Infrastructure
   • SDG 12: Responsible Consumption and Production
   • SDG 13: Climate Action
   • SDG 14: Life Below Water
   • SDG 15: Life on Land

   2. What specific targets under those SDGs can be identified based on the article’s content?

   • Target 7.2: Increase substantially the share of renewable energy in the global energy mix.
   • Target 9.4: Upgrade infrastructure and retrofit industries to make them sustainable, with increased resource-use efficiency and greater adoption of clean and environmentally sound technologies and industrial processes.
   • Target 12.6: Encourage companies, especially large and transnational companies, to adopt sustainable practices and to integrate sustainability information into their reporting cycle.
   • Target 13.2: Integrate climate change measures into national policies, strategies, and planning.
   • Target 14.2: By 2020, sustainably manage and protect marine and coastal ecosystems to avoid significant adverse impacts.
   • Target 15.1: By 2020, ensure the conservation, restoration, and sustainable use of terrestrial and inland freshwater ecosystems and their services.

   3. Are there any indicators mentioned or implied in the article that can be used to measure progress towards the identified targets?

   • Indicator: Share of renewable energy in the global energy mix
   • Indicator: Adoption of clean and environmentally sound technologies and industrial processes
   • Indicator: Integration of sustainability information into company reporting
   • Indicator: Integration of climate change measures into national policies, strategies, and planning
   • Indicator: Conservation, restoration, and sustainable use of marine and coastal ecosystems
   • Indicator: Conservation, restoration, and sustainable use of terrestrial and inland freshwater ecosystems

   SDGs, Targets, and Indicators Table

   SDGs	Targets	Indicators
   SDG 7: Affordable and Clean Energy	Target 7.2: Increase substantially the share of renewable energy in the global energy mix.	Indicator: Share of renewable energy in the global energy mix
   SDG 9: Industry, Innovation, and Infrastructure	Target 9.4: Upgrade infrastructure and retrofit industries to make them sustainable, with increased resource-use efficiency and greater adoption of clean and environmentally sound technologies and industrial processes.	Indicator: Adoption of clean and environmentally sound technologies and industrial processes
   SDG 12: Responsible Consumption and Production	Target 12.6: Encourage companies, especially large and transnational companies, to adopt sustainable practices and to integrate sustainability information into their reporting cycle.	Indicator: Integration of sustainability information into company reporting
   SDG 13: Climate Action	Target 13.2: Integrate climate change measures into national policies, strategies, and planning.	Indicator: Integration of climate change measures into national policies, strategies, and planning
   SDG 14: Life Below Water	Target 14.2: By 2020, sustainably manage and protect marine and coastal ecosystems to avoid significant adverse impacts.	Indicator: Conservation, restoration, and sustainable use of marine and coastal ecosystems
   SDG 15: Life on Land	Target 15.1: By 2020, ensure the conservation, restoration, and sustainable use of terrestrial and inland freshwater ecosystems and their services.	Indicator: Conservation, restoration, and sustainable use of terrestrial and inland freshwater ecosystems

   Behold! This splendid article springs forth from the wellspring of knowledge, shaped by a wondrous proprietary AI technology that delved into a vast ocean of data, illuminating the path towards the Sustainable Development Goals. Remember that all rights are reserved by SDG Investors LLC, empowering us to champion progress together.

   Source: seekingalpha.com

    

   

   Join us, as fellow seekers of change, on a transformative journey at https://sdgtalks.ai/welcome, where you can become a member and actively contribute to shaping a brighter future.