An Introduction to the EU Taxonomy

Key Takeaways

The EU taxonomy is a classification system of “environmentally sustainable economic activities”
It has been created to help investors make green investments
Six environmental objectives have been identified
The taxonomy specifies how each activity can contribute to each objective
To be taxonomy aligned, an activity must contribute to at least one objective, Do No Significant Harm (DNSH) to any of the others, and meet minimum social safeguards
From 2022, companies will need to report on the percentage of their overall turnover, CapEx and OpEx in FY'22 that is taxonomy eligible

A little background

Of the many developments in ESG legislation in recent years, the introduction of the EU taxonomy is arguably one of the most pivotal. But what is it exactly? What makes it so important, and who is it likely to affect? To answer all your burning questions, we’ve put together this introductory guide.

As we already know, the EU has set itself some ambitious goals when it comes to its climate policy, including a 55% reduction in greenhouse gas emissions by 2030 and to become an entirely climate-neutral continent by 2050.

To help achieve these goals, the European Commission released a sustainable finance plan in 2018, with the aim of bringing together economic and environmental policies and encouraging green investment.

But for this to be a success, they first needed to establish clearer definitions of what ‘green’ consisted of. And so the EU taxonomy, first published in June 2020, was established.

So…what is the EU taxonomy?

In biology, taxonomy is the science of naming, describing, and classifying all living things. The European Commission has taken this approach and applied it to sustainable business.

The EU taxonomy is a classification system of environmentally sustainable economic activities. Put simply, it’s a dictionary-style tool detailing specific business activities that are considered sustainable by the EU.

What makes the taxonomy unique

The taxonomy fills two important needs: it provides us with a common language for talking about sustainability and uses objective, quantifiable criteria for assessing businesses.

Previously, differing sustainable finance legislations and organisations (such as Ecolabel and the Green Bond Standard) each had their own terminologies. One of the aims of the EU taxonomy is to bring everyone together with unified definitions, measurements and objectives.

It has identified six environmental objectives:

Climate change mitigation
Climate change adaptation
Protection of water and marine resources
Transition to a circular economy
Pollution control
The protection of ecosystems

While previous guidelines left room for interpretation, the taxonomy takes a more rigorous approach, looking at individual business activities in granular detail while using a science-backed approach.

A tool for both investors and corporates

The taxonomy is designed primarily to be used as a tool for sustainable investment. By putting everyone on a level playing field, it will help investors understand more clearly where companies stand in relation to one another.

It will also play a vital role in guiding business decision-making. Due to its objective framework, the taxonomy will make it harder for companies to hide behind their marketing.

Who is affected by the EU taxonomy?

Taxonomy rules apply to all large European companies that fall under the NFRD (Non-Financial Reporting Directive); i.e. public interest entities with more than 500 employees.

Financial market participants offering products in the EU that promote environmental objectives are also required to report.