The European taxonomy: operation and objectives

The European taxonomy: operation and objectives

The European taxonomy is a classification of so-called sustainable activities. A central tool of the Green Deal for Europe, it is designed to create a common language for all players in the economy to support and finance the European Union's ecological transition. How does it work? Who is it aimed at? What is the timetable for its implementation?

Matthieu Duault

Matthieu Duault

Climate Copywriter

Update :
6/3/2024
Publication:
12/10/2023

As part of the European Green Deal, the European Parliament has introduced a series of regulations for financial and non-financial companies aimed at redirecting private investment towards so-called sustainable economic activities.

The European Green Taxonomy is part of this list of regulations aiming to make the European Union carbon neutral by 2050, and to reduce GHG emissions by 55% by 2030 compared to 1990 levels.

In concrete terms, green taxonomy is a method of classifying economic activities using a scientific method. Its ultimate aim is to identify environmentally sustainable investments.

It is accompanied by other regulations, including the NFRD, which will be replaced on January 1, 2024 by the CSRD, for extra-financial reporting by companies, and the SFDR, aimed at financial players to bring greater transparency to investment mechanisms.

The taxonomy regulation, for its part, is transverse in the sense that it is aimed at all players and aims to develop a common language and harmonize information on the sustainability of the activities of companies in the European Union.

The objectives of green taxonomy

The deployment of the taxonomy has several objectives. As mentioned above, it is part of the European Union's objective of achieving climate neutrality by 2050.

To achieve this, the EU intends to rely on private investment in addition to the European funds mobilized for this ecological transition.

This is where green taxonomy comes in. Its aim is to create a framework conducive to green investment, using a common framework to identify activities that contribute to the development of a sustainable economy.

The first objective is therefore to harmonize all the criteria and information used to define a sustainable activity, so that companies and investors have a clear and shared vision of what sustainable means.

The second, and more important, objective is to use this nomenclature to redirect financial flows towards these sustainable activities, and thus finance the ecological transition of the European economy.

The final objective is obviously to prevent greenwashing. By concretely defining what constitutes a sustainable activity, the European Parliament is setting a strict framework for what can and cannot be considered sustainable, thereby preventing any drift or abuse on the part of companies wishing to forge a better reputation with investors, institutions and/or the general public at a lower cost.

How does the European taxonomy work?

The European Green Taxonomy is a nomenclature designed to determine whether a company's economic activity is "green". To this end, the European Union has defined 6 environmental objectives that these activities must meet.

Not all activities are included in the taxonomy. Some activities have no impact, or even a negative impact, on the environmental objectives of the TVE, and are therefore not intended to be included in this standard. Others are still being examined and will be included in the taxonomy as and when they become available.

Since 2022, an eligibility analysis has been mandatory for companies subject to non-financial reporting, i.e. 50,000 of them as soon as the European CSRD directive comes into force.

This involves comparing the activities included in the taxonomy with the company's activity, and accounting for the operating expenses (OpeX) and investments (CapEx) dedicated to developing this activity as part of the organization's overall expenses.

What are the environmental objectives of the European taxonomy?

Source : EU taxonomy navigator - European Commission

For an activity to be considered sustainable within the meaning of the European taxonomy, it must make a substantial contribution to at least one of these 6 environmental objectives:

  • climate change mitigation
  • adapting to climate change
  • sustainable use and protection of aquatic and maritime resources,
  • the transition to a circular economy
  • pollution prevention and control
  • protecting and restoring biodiversity and ecosystems.

These objectives cover a wide range of subjects, such as the energy transition, the reduction of greenhouse gas emissions, the protection of living organisms, waste treatment...

For an activity to be eligible, it must also meet 2 other conditions.

  • According to the Do No Significant Harm (DNSH) principle, it must not undermine any of the taxonomy's objectives.
  • Finally, it must comply with minimum standards for the protection of social and human rights (human rights, ILO conventions, etc.).

The 3 levels of activity

This classification is accompanied by a further categorization of activities according to their level of involvement in achieving these environmental objectives. There are 3 levels:

  • Companies that make a concrete and significant contribution to the objectives of the taxonomy and thus to the environmental transition (wind farms, recycling companies, etc.).
  • Enabling activities that enable other activities to contribute to the taxonomy's environmental objectives (electric vehicle charging stations, etc.).
  • Transitional activities for which there are currently no low-carbon alternatives, but which are nonetheless part of a trajectory to reduce environmental impact. This has recently become the case, subject to certain conditions, for activities linked to gas and nuclear power generation.

Who is subject to European green taxonomy?

As we said in the introduction to this article, the scope of the taxonomy regulation is vast, in the sense that it applies to all players in the economy: non-financial companies, financial companies and, finally, governments and institutions.

Non-financial companies

All companies subject to extra-financial reporting under the CSRD (and previously the NFRD) will be obliged to follow a 3-stage process to determine whether or not their activities are sustainable within the meaning of the European taxonomy.

  • Eligibility analysis: companies will have to carry out an eligibility analysis to determine whether their activities qualify as sustainable according to the list established by the taxonomy.

  • Alignment analysis: as a second step, they must carry out an alignment analysis to ensure that their eligible activities meet the 3 requirements of the taxonomy (contribution to one of the environmental objectives, DNSH, respect for social and human rights).

  • Contribution analysis: finally, using financial indicators (KPIs), companies will have to determine what proportion of their sales is accounted for by aligned activities, and what operating expenses (OpEX) and capital expenditure (CapEX) are dedicated to these activities.

These analyses and data will be integrated into the extra-financial reporting that the company is required to publish each year as part of the CSRD. They will give investors and stakeholders a precise idea of the proportion of the company's overall activity accounted for by sustainable activities.

Financial companies

Since 2021, European financial players have been subject to the SFDR regulation (investment funds, asset managers, investment advisory firms, etc.). The aim of this European regulation is to increase the transparency of financial investments. It obliges financial market players and financial advisors to publish information on the sustainability of the investment products they manage or invest in. 

These regulations also oblige them to apply the principle of double-materiality to financial products, by providing an analysis of the potential impact of climate and social change on the future profitability of products. 

Within this framework, financial products are classified into 3 categories according to their level of sustainability:

  • article 6 funds: no sustainability objective
  • article 8 funds: funds with a sustainability objective. They integrate ESG criteria into their investment strategy, without binding rules, or invest in activities not yet classified in the taxonomy but with a sustainability vocation.
  • article 9 funds: sustainable funds. They make a substantial contribution to the environmental objectives of the taxonomy. 

The European taxonomy, aimed at redirecting private investment towards sustainable activities, reinforces this process. For an investment to be considered sustainable (Article 9 funds), it must therefore finance 100% of what the taxonomy defines as sustainable activities. 

For greater transparency, financial players are therefore also required to indicate how much of their asset portfolio is made up of sustainable investments, and how these investments contribute to the environmental objectives defined by this nomenclature.

European Union member states

The European Union and its member states should use the taxonomy to establish public measures, standards and labels for green financial products and green bonds. 

Once again, the aim is to harmonize the definition of what is sustainable in order to redirect investments and avoid greenwashing.

This harmonization work has already begun with the European Green Bond Standard (EuGBS) currently under discussion within European institutions. The aim of this standard is to regulate the term "green bond". Bond issuers will have to comply with a list of requirements and align themselves with the objectives set by the European taxonomy in order to be able to market their bonds as "green bonds".

What is the timetable for implementing the European taxonomy?

The European taxonomy has been implemented progressively, in line with the various objectives that make up the reference system.

The arrangements for implementing the first two climate change objectives have been applicable since January 1, 2022.

They contain an initial list of activities considered eligible, as well as the technical examination criteria (TEC) for carrying out the alignment analysis, which is mandatory for companies subject to the NFRD and then the CSRD.

The implementation procedures for the other 4 objectives of the taxonomy came into force on January 1, 2023.

As of 2022, companies with over 500 employees subject to the NFRD had to carry out and publish their eligibility analysis and their KPIs for the 2021 financial year, concerning the first two objectives of the taxonomy. In 2023, they published their alignment analysis for these two objectives.

From 2025 onwards, they will have to include analyses of eligibility and alignment with all the taxonomy's objectives, for the 2024 financial year and beyond.

Initially applicable to companies subject to the NFRD, this reporting obligation will be extended to all companies newly subject to the CSRD as it is implemented.

Timetable for implementing the European taxonomy

To sum up: 

2022: mandatory publication of eligibility analyses and KPIs for the 2021 financial year for European companies with more than 500 employees in relation to the first two objectives of the taxonomy.

2023: obligation to publish eligibility and alignment analyses and KPIs for fiscal 2022 for the first two taxonomy objectives.

2024: obligation to publish eligibility, alignment and KPI analyses for fiscal 2023 for the first two taxonomy objectives. 

2025: obligation to publish eligibility and alignment analyses and KPIs for fiscal 2024 for all taxonomy objectives.

2026: obligation to publish eligibility and alignment analyses and KPIs for fiscal 2025 for large companies meeting at least two of the following criteria:

  • 40M sales
  • 20M balance sheet
  • 250 employees or more

2027: obligation to publish eligibility, alignment and KPI analyses for the 2026 financial year for listed SMEs

2028: obligation to publish eligibility and alignment analyses and KPIs for the 2027 financial year for non-EU companies generating more than €150 million in net sales in the European Union via a subsidiary or branch located within the EU.

 

Since January 1, 2023, financial companies have also been required to publish information on the portion of their asset portfolio aligned with the taxonomy.

This is also the date on which the taxonomy began to be used as a benchmark for analyzing the various financial products and their classification as article 6, 8 or 9, which is why many financial products were reclassified from article 9 to article 8 at the end of 2022.

What does the future hold for European taxonomy?

The taxonomy is destined to evolve and expand in line with technological developments and the integration of new activities. Mapping all the activities of an economy is a Dantesque task which will take several years, but will eventually provide an effective classification tool, common to all member countries of the European Union.

The classification system is also often debated. This was notably the case when nuclear power and gas were included in the benchmark, with some countries having a fundamentally different view of the level of contribution of these energy sources to achieving climate objectives.

The European Commission is also planning regular changes to the TECs (Technical Examination Criteria) used to measure an activity's contribution to the objectives of the taxonomy. Technological advances and economic developments will inevitably have an impact on classification methods.

Towards a brown taxonomy?

The European Platform on Sustainable Finance, which advises the European Commission and has worked on the 4 non-climate objectives of the taxonomy, has raised the idea of an extended taxonomy with greater granularity in the current classification.

In particular, it proposes the creation of a neutral taxonomy and a brown taxonomy.

These two taxonomies can be used to identify activities that have no impact on the environment or, on the contrary, are considered to have a negative impact on TVE's environmental objectives.

The brown taxonomy would provide investors with information on whether certain activities are harmful to the environment or too vulnerable to climate change. The aim is to redirect capital flows towards neutral or green activities.

Finally, the possibility was also raised of creating a social taxonomy in the future, classifying activities according to objectives linked to respect for human rights, poverty reduction, or improving education and health.

Conclusion

A central element of the Green Deal for Europe, green taxonomy is a formidable tool at the service of sustainable finance.

It will enable the European Union's economic and institutional players to mobilize their capital to develop sustainable activities and thus contribute to achieving the carbon neutrality objectives set by the European Union.

Its implementation and extension, via the CSRD, to more than 50,000 European companies, will enable us to quickly see its effects, and if necessary to enrich and adjust it over the years.

Sources : 

  • "2nd year of application of the Taxonomy regulation: AMF assessment and focus on 2 FAQs from the European Commission", Revue Fiduciaire, 16/05/2023
  • "European green taxonomy: what is it?", ecoact, 20/04/2023
  • "Green bonds: European Union defines standards to avoid greenwashing", Toute l'Europe, 01/03/2023
  • "The European platform for sustainable finance", Novethic Essentiel, 02/15/2023
  • "Sustainable finance: understanding the Taxonomy and the SFDR regulation to express your preferences"AMF, 06/10/2022
  • "Carbon neutrality: the European taxonomy in six questions", Vie-publique.fr, 06/07/2022
  • "Deciphering the European taxonomy [episode 1]", Groupe BPCE, 02/25/2022
  • "Green taxonomy: instructions for use", European Commission, 13/01/2022
  • "Carbon neutrality: Europe's new green taxonomy"gouvernement.fr, 10/01/2022
  • "European green taxonomy", Banque de France, 11/10/2021
  • "Green Deal: how the EU intends to mobilize 1,000 billion euros over 10 years", Toute l'Europe, 24/01/2020
  • "European Taxonomy: financing sustainable growth", Mazars
  • "European green bond standard, European Commission
  • "EU taxonomy navigator, European Commission

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