On 28 March 2019, the EU Parliament voted that the new taxonomy will not be used as a reporting standard for all funds. Instead of forcing all kinds of funds to disclose how their portfolios are positioned with regard to the taxonomy, MEPs decided only funds which claim that they are investing with an ESG or socially responsible investing (SRI) approach will have to report how the fund is positioned by using the taxonomy. The new legislation will make it much harder for asset and fund managers to maintain “greenwashing strategies”. Nevertheless, conventional asset managers who claim to use ESG/SRI criteria in their overall approach will not have to publish this kind of reporting and may, therefore, be able to claim they have integrated ESG/SRI criteria even if they use them only in a very limited way.
The goal of the Sustainable Investments Taxonomy is to determine whether an economic activity is environmentally sustainable.
The EU Taxonomy Technical Report published in June 2019 gives practical guidance for policymakers, industry and investors on how best to support and invest in economic activities that contribute to achieving a climate-neutral economy. To qualify as green, an investment needs to contribute to at least one of the following six objectives while not significantly harming any other:
- Climate Change Mitigation – i.e. the activity contributes to greenhouse gas stabilisation consistent with the goals of the Paris Agreement, through certain prescribed means including, for example, the generation of renewable energy;
- Climate Change Adaptation – i.e. the activity includes adaptation solutions that substantially reduce the adverse impact (or risk) of the current and expected future climate on (i) other people, nature or assets; or (ii) the economic activity itself, in each case without increasing the risk of an adverse impact on other people, nature and assets;
- Sustainable Use and Protection of Water and Marine Resources – i.e. the activity substantially contributes to achieving the good status of water bodies or marine resources, or to preventing their deterioration when they are already in good status, through certain prescribed means (including, for example, through wastewater management);
- Transition to a Circular Economy – i.e. the economic activity contributes substantially to waste prevention, re-use and recycling, through certain prescribed means (including, for example, by improving the recyclability of certain products);
- Pollution Prevention and Control – i.e. the activity contributes substantially to pollution prevention and control through certain prescribed means (including, for example, by preventing or, where that is not practicable, reducing pollutant emissions into air, water or land (other than greenhouse gasses)); and
- Protection and Restoration – i.e. the activity contributes substantially to protecting, conserving or restoring biodiversity and to achieving the good condition of ecosystems, or to protecting ecosystems that are already in good condition, through certain prescribed means (including, for example, sustainable land use and management).
In addition to contributing to one of the six objectives described above, for an activity to qualify as an environmentally sustainable activity under the Taxonomy Regulation, the activity must also comply with the following criteria:
- No Significant Harm – i.e. the activity must not significantly harm any of the environmental objectives above;
- Compliance with Technical Screening Criteria – i.e. the activity must comply with technical screening criteria for each of the six objectives that will be specified by the European Commission; and
- Minimum Social and Governance Safeguards – i.e. the activity must be carried out in compliance with a number of minimum social and governance safeguards as referred to in the Taxonomy Regulation.
Application of the Taxonomy Regulation
The Taxonomy Regulation applies to the following parties:
- “Financial Market Participants” who offer “Financial Products” – financial market participants (as defined in the Disclosure Regulation) will be required to provide, in pre-contractual disclosures and periodic reports, information on how and to what extent the investments that underlie their “financial products” support economic activities that meet the criteria for environmental sustainability under the Taxonomy Regulation. As defined in the Disclosure Regulation, “financial products” include:
- (i) portfolios managed in accordance with mandates given by clients on a discretionary client-by-client basis where such portfolios include one or more financial instruments;
- (ii) alternative investment funds;
- (iii) insurance‐based investment products meeting certain criteria;
- (iv) pension products;
- (v) pension schemes;
- (vi) UCITS; and
- (vii) pan‐European Personal Pension Products.
For those financial products that do not invest in environmentally friendly activities, a disclaimer will need to be included by the financial market participant stating that the relevant investments “…do not take into account the EU criteria for environmentally sustainable investments.”;
- Financial and Non-financial Companies Falling under the Non-Financial Reporting Directive – firms in scope of the Non-Financial Reporting Directive will need to disclose information on how and to what extent the undertaking’s activities are associated with environmentally sustainable economic activities. The European Commission will publish the detailed reporting requirements by 1 June 2021; and
- Individual Member States and the EU – individual Member States and the EU must apply the criteria specified in the Taxonomy Regulation for determining environmentally sustainable economic activities for the purposes of any legislative / measures setting out the requirements of financial market participants or issuers in respect of financial products or corporate bonds to label such products as “environmentally sustainable”.
2021 Key performance indicators
Last year, financial regulators in the EU have proposed new key performance indicators, or KPIs, to measure the alignment of banks, insurers and asset managers with the EU ‘green’ taxonomy:
- For banks, the EBA has proposed a ‘green asset ratio’ (GAR), which would measure the value of climate-friendly loans, advances and debt securities as a proportion of a lender’s overall assets. The EBA mooted three additional indicators relating to advisory fees, trading books and off-balance sheet exposures associated with taxonomy-compliant activities.
- Insurance: Under EIOPA’s proposals, insurers will need to report the ratio of non-life gross premiums and investments corresponding to activities identified as environmentally sustainable in the EU taxonomy.
- Asset Managers: ESMA has recommended that asset managers report the total ratio of investments – both stocks and bonds – that are aligned to the taxonomy. According to the regulator, green bonds issued under existing standards should also be admissible as taxonomy-compliant investments until the completion of an overarching EU Green Bond Standard.
The announcement of the adoption of the Taxonomy Regulation on 15 April 2020 means that the Council has adopted its position at first reading. The Taxonomy Regulation now needs to be adopted by the European Parliament at second reading, before it is published in the EU Official Journal. It will enter into force 20 days following publication in the EU Official Journal, although the measures relating to the climate mitigation and adaptation objectives will apply from 31 December 2021, while requirements relating to the other environmental objectives are due to apply from 31 December 2022.
The Disclosure regulation is a parallel piece of legislation that will refer to the Taxonomy. The first reporting requirements for investment firms under those rules will start to apply in December 2021, with additional criteria included annually thereafter.
The EU Taxonomy: implications for corporates
Current consultation on the appropriate set of rules for undertakings under the NFRD to include in their non-financial statements, consolidated non-financial statements or other relevant separate reports, when allowed, information on how and to what extent their operations are associated with economic activities that qualify as environmentally sustainable under the EU Taxonomy.
This requirement will apply from 1 January 2022 for the two climate-related objectives of the Taxonomy and from 1 January 2023 for the other four environmental objectives.
The criteria under the climate mitigation and adaptation pillars cover the economic activities of roughly 40% of listed companies, in sectors which are responsible for almost 80% of direct greenhouse gas emissions in Europe. This includes sectors such as energy, forestry, manufacturing, transport and buildings.
The Taxonomy Regulation already specifies that, in particular, non-financial undertakings under the NFRD are legally obliged to disclose:
- The proportion of their turnover derived from products or services associated with environmentally sustainable economic activities.
- The proportion of their total investments (CapEx) and expenditures (OpEx) related to assets or processes associated with environmentally sustainable economic activities.