1. Introduction
The European Union (EU) Taxonomy Regulation sets a classification system that aims to promote sustainable investments. The latter provides a standardised definition for environmentally sustainable economic activities.
The Regulation is important an element within EU's growing toolbox for scaling up sustainable investment and implementing the European green deal.
It will provide (once it is complete) companies, investors and policymakers with appropriate definitions for which economic activities can be considered environmentally sustainable.
The aimed result is to create certainty for investors and protect them from greenwashing, to assist companies in increasing their environmental consideration, and to help the shift towards a sustainable bio-economy.
2. Framework Structure
2.1 Sustainable Objective
The Taxonomy defines six environmental objectives:
Climate change mitigation
Climate change adaptation
Sustainable use and protection of water and marine resources
Transition to a circular economy
Pollution prevention and control
Protection and restoration of biodiversity and ecosystems.
It also sets out criteria for economic activities to be considered environmentally sustainable within each objective.
Within each objective, economic activities which can meet the objective are identified, and identify a set of technical screening criteria that the activity must meet to be considered environmentally sustainable.
2.2 Technical Screening Criteria
The technical screening criteria are structured in the following way:
The activity must meet a set of criteria to prove that it 'substantially contributes' towards the sustainable objective(s) it aims to meet.
Examples of activities include renewable energy generation, agricultural machinery which helps minimise fertiliser use, or building construction using circular economy methods.
The activity must meet a set of additional criteria to prove that it 'does not significantly harm' (DNSH) any of the remaining environmentally sustainable objectives.
If an economic activity meets the substantial contribution requirement but fails to meet the DNSH principle, it would not be considered environmentally sustainable.
A renewable energy company may make a substantial contribution to climate change mitigation but could have negative impacts on biodiversity if it is built in a sensitive area. It would not be considered sustainable without proving that it has eliminated such negative impacts.
Finally, to ensure no significant harm is caused to the socially sustainable objectives, through demonstrating good governance practices.
This requires companies to elaborate on the presence of governance practices within the company, including transparency, accountability, and respect for human rights, among other topics such as regulatory and tax compliance.
3. The EU Taxonomy and the SFDR
The Taxonomy is closely linked to the Sustainable Finance Disclosure Regulation (SFDR), which requires financial market participants and advisers to disclose information on how sustainability risks are integrated into their investment decisions.
Under the SFDR, funds that aim to meet environmental objectives can choose the EU Taxonomy framework to prove the 'sustainable' nature of the investments made by the fund. The SFDR also requires funds to disclose the percentage of investments that are aligned with the Taxonomy's objectives.
If a fund markets itself as being environmentally sustainable, it must disclose how it meets the Taxonomy's criteria, and provide information on the level of environmental or social impact of its investments.
The EU Taxonomy and the SFDR aim to create transparency and consistency in sustainable finance, making it easier for investors to identify investments that align with their values and contribute to a more sustainable future. The Taxonomy also assists businesses (portfolio companies) in understanding what criteria that they need to meet to be considered environmentally sustainable and promote investment in sustainable economic activities.