By Laura Canevari and Robin Hamaker-Taylor
The European Commission is continuing to progress the implementation of their Action Plan for Financing Sustainable Growth. New reports have been published, regulations have been established, and more are on the way. Much of this recent activity has implications for financial institutions. This is the first of a two-part article series that aims to round up these developments.
This article narrows focus to the developments relating to the EU Sustainable Finance Taxonomy and impending regulation. The second part, to be published in May 2020, will cover new EU regulations on sustainability‐related disclosures in the financial services sector, the European Bond Standard, the ecolabel for financial products, and the European Green Deal.
Current status of the EU TEG and Sustainable Finance Taxonomy (‘EU Taxonomy’)
A final report on the EU Taxonomy was published in March 2020. Titled ‘Taxonomy: Final report of the Technical Expert Group on Sustainable Finance’, the report was developed by the EU’s Technical Expert Group (TEG) on Sustainable Finance, to share its final recommendations on the design of the EU Taxonomy. The final report takes into consideration feedback on the set of recommendation on the EU Taxonomy, set out by the TEG in a June 2019 technical report.
The March 2020 final report includes guidance on how companies and financial institutions can make disclosures using it, and its technical annex shares technical screening criteria for economic activities that can substantially contribute to climate change mitigation or adaptation. In addition, the TEG has prepared Excel-based tools to help with the implementation of the Taxonomy. The final TEG report and related outputs are available here.
Box 1 provides an overview of the EU Taxonomy.
Status of the EU Taxonomy Regulation and requirements
The Taxonomy Regulation (TR) was established in a political agreement of EU co-legislators in December 2019. The TR creates a legal basis for the EU Taxonomy and sets out the framework and environmental objectives for the Taxonomy. It will be supplemented by delegated acts* which contain detailed technical screening criteria for determining when an economic activity can be considered sustainable, and hence can be considered Taxonomy-aligned, according to the TEG final taxonomy report, Chapter 1.2.
As set out in the TEG final report, Chapter 3, the technical screening criteria will be issued as part of the explicit legal requirements from the European Commission by the end of 2020. Delegated acts containing technical screening criteria will be developed in two phases:
- Adaptation and mitigation environmental objectives- Technical screening criteria for activities which substantially contribute to climate change mitigation or adaptation:
- adopted by the end of 2020, and
- enter into application by the end of 2021.
- Other four environmental objectives – Technical screening criteria which cover economic activities substantially contributing to the other EU’s four environmental objectives (water, a circular economy, pollution prevention and control, and protection of ecosystems):
- adopted by end 2021, and
- enter into application by end of 2022.
* Delegated acts are legally binding acts that enable the Commission to supplement or amend non‑essential parts of EU legislative acts, for example, in order to define detailed measures. The Commission adopts the delegated act and if Parliament and Council have no objections, it enters into force, according to the European Commission.
The Taxonomy Regulation requires the European Commission to review all technical screening criteria regularly.
What does the Taxonomy Regulation stipulate, for who, and when?
The Taxonomy Regulation (TR) sets out legal obligations for financial market participants**, large companies, the EU and Member States. These entities will be required to do the following:
- Financial market participants will be required to complete their first set of disclosures against the Taxonomy, covering activities that substantially contribute to climate change mitigation and/or adaptation. This is required by the 31st December, 2021.
- Large companies will be required to disclose in the course of 2022.
An expanded set of disclosures covering activities that substantially contribute to all six environmental objectives will be required by the end of 2022.
In addition, the TR will introduce a new disclosure requirement for companies already disclosing under the Non-Financial Reporting Directive (NFRD). This is applicable to companies with more than 500 employees, including listed companies, banks and insurers. All companies subject to NFRD will include a description of how, and to what extent, their activities are associated with EUTaxonomy-aligned activities.
** Financial market participants are those firms offering financial products in the EU, including occupational pension providers.
The EU Taxonomy and climate adaptation
The EU Taxonomy sets out criteria specifically for adaption related activities. These are differentiated we “adapted activities” and “activities enabling adaptation”. The TEG has proposed three key guiding principles in order to identify economic activities that substantially contribute to climate adaptation:
- The economic activity reduces all material physical climate risks to the extent possible and on a best effort basis.
- The economic activity does not adversely affect adaptation efforts by others (it supports system adaptation).
- The economic activity has adaptation-related outcomes that can be defined and measured using adequate indicators.
The TEG have made available a list of 70 activities across eight sectors which are believed to make a substantial contribution to climate adaptation (see a summary in Table 1).
Table 1: Activities which make a substantial contribution to climate change adaptation , by sector, as shared in the final TEG report on the EU Taxonomy
The TEG’s final recommendations hold that the criteria for adaption related activities should ensure that an economic activity and its adaptation measures do not lead to increased climate risks for others, hamper adaptation elsewhere, and do not increase the risks of an adverse climate impact on other people, nature and assets. The criteria also ensure that adaptation measures consider the viability of “green” or “nature-based” solutions over “grey” solutions to address adaptation.
The report notes that the technical screening criteria to determine whether an economic activity makes a substantial contribution to climate change adaptation can be applied to any type of economic activity, but must necessarily comply also with the criteria for avoidance of significant harm to the other environmental objectives.
The full list of eligible activities is available here.
Next steps for the EU Taxonomy and how this relates to other taxonomy efforts
On 15 April 2020 the European Council adopted by written procedure its position at first reading with respect to the Taxonomy regulation.
The European Parliament will have to vote on the text pursuant to the “early second reading agreement” procedure. The Commission will only establish the actual taxonomy by defining technical screening criteria, in the form of delegated acts, as described above.
The taxonomy for climate change mitigation and climate change adaptation should be established by the end of 2020, in order to ensure its full application by end of 2021. For the four other objectives, the taxonomy should be established by the end of 2021 for an application by the end of 2022.
Further development of the EU Taxonomy will take place via a new Platform on Sustainable Finance, which is expected to be operating by autumn 2020. The first company reports and investor disclosures using the EU Taxonomy are due at the start of 2022.
Efforts to build green or sustainability taxonomies are proliferating across the globe. Within emerging markets, they are not all going in the same direction, as a recent IFC Sustainability Webinar Series highlighted. Harmonising some of these taxonomies on the climate mitigation side will be easier than doing so on climate adaptation side. Taxonomies for adaptation related activities will have to happen in a context where not all of its elements can be applied or transferred across all geographies. For this reason, harmonisation of adaptation taxonomies globally is most likely going to be guided by principles with common interpretation across places. The IFC is building a green finance review protocol, for example, so that taxonomies from different countries can be compared. The protocol is due out in the second half of 2020.
Box 1: EU Taxonomy at a Glance (Source: Final report of the Technical Expert Group on Sustainable Finance, 2020)