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The EU Taxonomy is a classification system for economic activities that are considered green. The tool is used by investors to assess the sustainability of potential investments, whether they meet the EU’s environmental standards and can qualify as ‘green investments’. The first Delegated Act under the EU Taxonomy came into force on 1 January 2022, focusing on sectors that can make a substantial contribution to climate objectives.
For companies, the Taxonomy acts as a guide to transparency in disclosures and incentivises green activities. Companies that fall under the scope of the Non-Financial Reporting Directive (NFRD) and the Corporate Sustainability Reporting Directive (CSRD) are required to disclose their alignment with the criteria outlined in the EU Taxonomy. The NFRD in particular requires public-listed companies with more than 500 employees to disclose sustainability-related information annually and is being revised to align with the EU Taxonomy.
Recently, the EU Platform on Sustainable Finance, which advises the European Commission on the development of the EU Taxonomy, presented the Extended Environmental Taxonomy (SG3) also known as the ‘Significant Harm Taxonomy’. The extended proposals are designed to include a wider range of economic activities, specifically those classified as having ‘No Significant Impact’ and having ‘Significant Harm’ to the environment. This is a key difference with the current Taxonomy which only covers two categories: ‘Substantial Contributions’ to at least one of six environmental objectives, and ‘Do No Significant Harm’ to the environment.
The issue with the current classification system is the narrow binary framework that divides economic activities into ‘sustainable’ and ‘unsustainable’, or ‘Taxonomy-aligned’ and non-aligned’, leaving little room for those companies with intermediate performance or companies in transition to access finance opportunities. The proposed extension includes activities that are in urgent need of exit or transition to avoid creating significant harm. Inclusion of these new economic categories would ideally facilitate much-needed transition finance.
Classification of companies into Substantial Contribution, Do No Significant Harm, and the newly proposed categories of Significant Harm and No Significant Impact will provide a wider framework to recognise different levels of environmental contribution and crucially, fund a transition away from significantly harmful activities.
The current Taxonomy is limited to a non-exhaustive list of sectors including transport, water, waste, energy, manufacturing, construction and real estate, forestry, and information and communication. With the expanded categories, previously excluded ‘non-green’ sectors such as the service sector could be included. Specifically, sectors that fall within the NACE codes in macro-sectors J-U are likely to be considered No Significant Impact. Sector coverage has yet to be decided, but if this is anything to go by, at least 35% of the EU economy would be affected. This is an opportunity for many companies to leverage Taxonomy-aligned disclosures for better access to green or transition financing.
The EU Taxonomy is not completely irrelevant to foreign-owned companies operating in the EU. EU investors will want to know if a company is Taxonomy-aligned with the latest extended categories. Companies can use Taxonomy criteria to benchmark their position and evaluate ways to align further with the Taxonomy as a competitive strategy.