EU Taxonomy: Explaining New Requirements Due January 2024
Answering Frequently Asked Questions about New EU Taxonomy Regulatory Requirements
The EU Taxonomy regulatory requirements were implemented in January 2022, but until recently only two out of the six environmental objectives have been established. Moreover, financial market participants are presently only obligated to disclose a limited number of Key Performance Indicators (KPIs) in their reports. However, starting from January 2024, investors and companies will face additional reporting obligations under the EU Taxonomy framework.
What is the EU Taxonomy?
The EU Taxonomy is a standardized classification system that establishes a framework for identifying economically sustainable activities with regards to the environment within the EU. It plays a crucial role in the EU’s Sustainable Finance Action Plan, aiming to promote sustainable investments and facilitate the transition to a low-carbon, resource-efficient economy.
As part of a broader sustainable finance agenda announcement, on 13 June 2023 the European Commission made a number of important announcements related to the EU Taxonomy. The key changes were to:
- Expand the list of criteria related to the two climate-focused taxonomy objections (climate change mitigation, climate change adaptation¹), and
- Introduce criteria for the remaining four environmental objectives (sustainable use and protection of water and marine resources, transition to a circular economy, prevention and control of pollution, and protection and restoration of biodiversity and ecosystems).
Once formally adopted, the new Delegated Acts will be sent to the European Parliament and Council for review. Once complete, we expect these to apply from January 2024.² The EC has not ruled out adding more activities to the EU Taxonomy in the future.
What are the existing reporting requirements for investors?
Investors offering environmentally-focused Article 8 or 9 products within the EU must comply with the following requirements for two out of the six defined objectives (Climate Change Mitigation and Climate Change Adaptation):
- Product level: Financial products must clearly indicate their alignment with the EU Taxonomy. Compliance is mandatory in the following ways:
- Pre-contractual disclosures: Since January 2022, these disclosures must specify the minimum commitment of the financial product in terms of EU Taxonomy alignment.
- Periodic disclosures: In 2023, financial market participants are expected to provide detailed information on the actual EU Taxonomy alignment of their products, even if their pre-contractual disclosures indicated 0% alignment. This clarification was confirmed in the latest hearing with the European Securities and Markets Authority (ESMA) on June 6th.
Financial market participants (FMPs) falling under the scope of the Non-Financial Reporting Directive (NFRD), which includes large EU-based companies, are required to disclose their eligibility and alignment with the EU Taxonomy at the entity level. This means that these companies must provide information regarding their overall alignment with the Taxonomy and the extent to which the activities of their investee companies are classified as environmentally sustainable.
What are the upcoming requirements for investors by January 2024?
Investors offering Article 8 or 9 products within the EU will be required to consider all six environmental objectives defined by the EU Taxonomy. These objectives include Climate Change Mitigation, Climate Change Adaptation, Water, Circular Economy, Pollution, and Biodiversity. Therefore, within a period of six months, investors need to have EU Taxonomy data available for the additional four environmental objectives.
FMPs falling under the scope of the NFRD will have to publish a specific set of EU Taxonomy-related KPIs. This includes disclosing the percentage of turnover and CAPEX aligned with each environmental objective for Asset Managers, or the “Green Asset Ratio” (percentage of the loan book financing taxonomy-aligned economic activities) for credit institutions.
Why should investors disclose alignment beyond reporting requirements?
- Gold standard for sustainability: The EU Taxonomy stands as the gold standard for sustainability classification globally. It establishes a comprehensive list of environmentally sustainable economic activities and is set to expand to include social activities in the near future. By aligning your financial product with the EU Taxonomy, you benefit from being part of the most robust framework, avoiding further methodological scrutiny and contributing to greening the economy.
- Increase your revenues: Consider that, the 2022 Edelman Trust Barometer revealed that 64% of global retail investors consider their values and beliefs when making investment decisions, and that Article 8 and 9 funds witnessed inflows of €15.8bn in Q4 2022 and €29bn in Q1 2023. Leverage the EU taxonomy to demonstrate the sustainability of your investments, which can support the inclusion of these investments in Article 8 and 9 products.
- Green MiFiD regulation: The EU Taxonomy alignment is one of the three key indicators in the assessment of sustainability preferences required under the MiFiD II regulation (together with SFDR PAIs and % of Sustainable investment). End clients are now expected to specify the minimum EU Taxonomy threshold for the products they wish to invest in. Consequently, the higher the EU Taxonomy alignment of your product, the greater the number of clients it will attract.
- Contribution to Sustainable Investment % under Article 2(17) SFDR: Taxonomy aligned activities can be included in financial products’ sustainable investment percentage, improving the overall profile of investment funds. This can help FMPs demonstrate that their product has a sustainable investment objective (Article 9) or promotes environmental or social characteristics (Article 8).
Over the next six months, EU Taxonomy requirements will become more stringent, requiring investors to report on four additional environmental objectives. Simultaneously, a new set of KPIs will be implemented for Financial Market Participants. To meet these evolving demands, investors must ensure they possess the necessary data, methodologies, and tools to effectively comply with these requirements.
For additional information and to learn how Clarity AI can help you report, request a demo with one of our team members.
¹ New activities have been added for sectors including Transport, Manufacturing, Disaster risk management, Water supply, Information and communication, and Professional, scientific and technical activities.
² January 1, 2024: Non-financial undertakings will be required to report taxonomy eligibility for the four non-climate environmental objectives and the new criteria for the two climate-focused objectives. Financial undertakings will need to report eligibility.
January 1, 2025: Non-financial undertakings will be required to report taxonomy alignment for the four non-climate environmental objectives and the new criteria for the two climate-focused objectives.
January 1, 2026: Financial undertakings will be required to report taxonomy alignment for the four non-climate environmental objectives and the new criteria for the two climate-focused objectives.