30 APRIL 2021 | SUSTAINABLE FINANCE
The Taxonomy seeks market harmonization by creating legal criteria to classify economic activities as environmentally sustainable. While the Taxonomy is a technical document with only a few disclosure obligations for companies, it requires robust preparatory work, including thorough data collection and analysis.
Companies subject to the non-financial reporting obligations in Articles 19a and 29a of Directive 2013/34 on annual and consolidated financial statements and related reports (as transposed into national law) (the Accounting Directive) must report the extent of their alignment with the Taxonomy. However, smaller companies may also benefit from reporting on a voluntary basis.
While the Taxonomy currently focuses on environmental objectives, companies must also respect minimum social and governance requirements within the scope of environmentally sustainable economic activities (ESEAs).
Sustainable development (economic, social, and environmental) is an objective of the internal market reflected in the Treaty on European Union. The Taxonomy, adopted in June 2020, is a significant step towards achieving climate neutrality by 2050, and is part of the EU’s wider effort to promote sustainability that includes the adoption of the SFDR and launch of the European Green Deal in November and December 2019, respectively.
While many market participants/players currently do not disclose environmental, social, and governance (ESG) information related to their activities, others disclose such information using non-uniform criteria. This leads to a lack of comparability for capital providers, who are then disincentivised to allocate funds based on ESG information. Sustainable finance and investments are critical to meeting regional and international environmental goals, including the UN Paris Agreement and the Sustainable Development Goals. With this in mind, the Taxonomy introduces a standard classification to enhance investor confidence in sustainable finance, mitigate the risk of greenwashing*1, reduce transaction costs, and optimize the ability of sustainability-minded companies to raise capital.
THE CAPITAL PROVIDER’S PERSPECTIVE
The Taxonomy supplements the requirements of the SFDR that are applicable to capital providers, i.e. financial market participants and financial advisers. In particular, it specifies certain disclosure obligations concerning periodic reports and pre-contractual disclosures. Another relevant link between the Taxonomy and SFDR pertains to the definition of “sustainable investment” in Article 2(17) of the SFDR, which includes investments in ESEAs as described in Article 3 of the Taxonomy.
As discussed in our previous Client Alert, companies that are ready to provide ESG information to their capital providers at an early stage, as required by the SFDR and the Taxonomy, could gain a competitive advantage in the corporate finance market.
THE COMPANY’S PERSPECTIVE
The Taxonomy also supplements non-financial reporting obligations in Articles 19a and 29a of the Accounting Directive on annual and consolidated financial statements and related reports (as transposed into national law). Specifically, Article 8 of the Taxonomy requires companies to publish a non-financial statement with information on:
These disclosure obligations apply to companies with an average number of employees exceeding 500 in a fiscal year and that have a balance sheet total of EUR 20 million or a net turnover of EUR 40 million. However, smaller companies can make such disclosures voluntarily*2.
The Taxonomy also serves as a key component to the proposed EU Green Bond Standard (EU GBS). Companies seeking to issue green bonds in accordance with the EU GBS will be required to ensure that proceeds from green bond issuances fund projects that are aligned with the Taxonomy.
According to Article 3 of the Taxonomy, ESEAs are those that meet four conditions:
The Taxonomy was adopted in June 2020 and companies’ obligations under Article 8 become applicable on different dates:
Under the Taxonomy, the EU Commission has the mandate to adopt delegated acts, including those related to Article 8(4)*6 and the TSC regarding each of the six environmental objectives, as well as to update concepts like “significant harm” and “substantial contribution” as technology and scientific understanding evolves.
For the environmental objectives other than climate change and climate change adaption, the EU Commission is expected to adopt TSC by December 2021, with application from January 2023*7.
WHAT CAN COMPANIES DO?
As first steps to comply with the Taxonomy’s requirements, companies are encouraged to start by collecting data to assess whether their economic activities:
Based on this assessment, companies may define future targets for maintaining or increasing their contribution to an environmental objective.
Moreover, companies may engage finance, risk management, and sustainability staff to:
*1 Recital 11 of the Taxonomy defines “greenwashing” as “the practice of gaining an unfair competitive advantage by marketing a financial product as environmentally friendly, when in fact basic environmental standards have not been met”. In practice, the concept applies to the marketing of any economic activity as environmentally friendly, where minimum standards have not been respected.
*2 Directive 2013/34 is under review as part of the EU sustainable corporate governance initiative. As a result of this review, non-financial reporting may become required for smaller and non-listed companies.
*3 The Taxonomy currently covers only environmental objectives, but it is expected to be extended to social objectives in the future.
*4 According to recital 40 of the Taxonomy , “where scientific evaluation does not allow for a risk to be determined with sufficient certainty, the precautionary principle should apply in accordance with Article 191 Treaty on the Functioning of the European Union”.
*5 The draft TSC for climate change mitigation and adaptation are available on the EU Commission’s website.
*6 A consultation paper regarding Article 8 of the Taxonomy is available on the European Securities and Markets Authority’s website.
*7 According to recital 44 of the Taxonomy, the TSC should promote appropriate governance frameworks integrating environmental, social, and governance factors as referred to in the United Nations-supported Principles for Responsible Investment at all stages of a project’s life cycle. This statement recognizes the relevance of social and governance aspects within ESEAs.