One More Step Towards Sustainable Finance in the European Union

One More Step Towards Sustainable Finance in the European Union

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On 9 December 2021, the European Commission’s (“Commission”) EU Taxonomy Climate Change Delegated Act (“DA”) was published in the Official Journal of the EU after being approved by the European Council. It will enter into force on 1 January 2022. The DA provides the first set of technical screening criteria (“TSC”) to establish whether an economic activity contributes substantially to climate change mitigation and adaptation in the context of scaling up sustainable investments. 

The next day, on 10 December, the Commission’s EU Taxonomy Article 8 Delegated Act (“Article 8 Delegated Act”) was also published in the Official Journal of the EU. It is also set to enter into force on 1 January 2022. This second instrument specifies the content and the presentation of the information that financial and non-financial companies are required to disclose by virtue of Article 8 of the EU Taxonomy Regulation. The Article 8 Delegated Act is discussed at the end of this alert.

The legal basis for the DA: the EU Taxonomy Regulation 

The EU Taxonomy Regulation marked a milestone for sustainable finance in the EU. It is one of the key European instruments to channel private sector money towards the Green Deal and achieve the bloc’s climate goals.

The regulation provides a classification system to categorize economic activities based on six objectives: 

  • Climate change mitigation;
  • Climate change adaptation;
  • The sustainable use and protection of water and marine resources;
  • The transition to a circular economy;
  • Pollution prevention and control;
  • The protection and restoration of biodiversity and ecosystems.

The EU Taxonomy Regulation aims to help investors and companies make informed decisions on “environmentally sustainable” economic activities. However, the regulation does not prevent investments in activities not eligible under the EU Taxonomy. The main objective of the green investment rules is to provide a long-term incentive to direct financial flows towards environmentally sustainable activities.

The EU Taxonomy Regulation’s classification system also provides four cumulative criteria to identify whether a given economic activity should be considered “environmentally sustainable”. An economic activity qualifies as “environmentally sustainable” when: 

  • It contributes substantially to one or more of the environmental objectives set out in the regulation.
  • It does not significantly harm any of the environmental objectives.
  • It is carried out in compliance with the minimum safeguards set out in the Regulation.
  • It complies with technical screening criteria set up by the Commission in accordance with the Regulation.

To that effect, the EU Taxonomy Regulation empowered the Commission to adopt a delegated act in order to establish the TSC for each environmental objective. In other words, the Commission was tasked to elaborate in detail what it means for an activity to substantially contribute to an environmental objective.

While the EU Taxonomy Regulation had required the Commission to adopt the DA by 31 December 2020, it was only on 21 April 2021, after consulting numerous stakeholders, that the Commission published its draft of the DA establishing the TSC for the objectives of climate change mitigation and climate change adaptation. The DA was then adopted on 4 June 2021. On 9 December 2021, following the European Council’s approval, the DA was published in the Official Journal of the European Union. 

Setting out the Technical Screening Criteria

The new DA sets out the TSC for determining the conditions under which an economic activity qualifies as contributing substantially to climate change adaptation (i.e., under Article 11 of the EU Taxonomy Regulation, contributing to the reduction of the risks of the adverse impact of the current and expected climate change; preventing an increase or shifting of negative effects to climate change) and climate change mitigation (i.e., under Article 10 of the EU Taxonomy Regulation, contributing to the stabilization of greenhouse gas concentrations by reducing emissions or enhancing removals). The DA also provides generic criteria to determine whether an economic activity causes no significant harm to any of the six environmental objectives laid down in the EU Taxonomy Regulation. 

Annex I of the DA lists a wide range of economic activities - such as the ones pertaining to forestry, manufacture, energy, water supply, transport and others - and provides the TSC required for each activity to qualify as environmentally sustainable by contributing to the objective of climate change mitigation. 

Annex II targets the same activities as the activities listed in Annex I, with the addition of some financial and insurance activities, education, human health and social work activities as well as arts, entertainment and recreation. It enunciates the TSC required so that these economic activities can be considered as environmentally sustainable for the purpose of contributing to the objective of climate change adaptation.

In both cases, the TSC provide for technical thresholds, qualitative performance requirements, production or process requirements, project duration, and of course a precise description of the economic activities which by their nature contribute to climate change mitigation/adaptation. 

In total, the DA covers 88 economic activities which can be considered as environmentally sustainable provided that they meet the TSC laid down therein. 

The DA will apply from 1 January 2022. It will allow the EU Taxonomy Regulation to be concretely applied for the relevant two objectives.  

What does it mean in practice?

In practice, businesses and financial market participants will be able to start using the TSC to determine and report whether their activities are eligible and aligned with the EU taxonomy requirements. They will therefore be able to meet upcoming disclosure requirements under the EU Taxonomy Regulation.

On that basis, investors will have the opportunity to decide whether their investments are channeled to environmentally sustainable economic activities, which may be at the detriment of the companies whose activities do not qualify as environmentally sustainable or which did not check if such activities qualified.

The DA also gives the market a clear environmental performance benchmark and establishes a common language for investors, businesses, and other stakeholders.

One of the main challenges was the unavailability of data for businesses to implement the EU Taxonomy. The DA should give guidance as to what data needs to be captured.

Economic activities not included in the DA

One of the controversial points raised after the adoption of the DA was indisputably the non-inclusion of nuclear energy related activities in the taxonomy. This seems to be still subject to political discussion between EU countries. The DA indicates in its Recital 27 that the assessment for nuclear energy is still ongoing. Nuclear energy may be included in the Taxonomy at a later stage through a separate act. 

The DA also provides that the TSC for agriculture should be delayed in view of the negotiations regarding the reform of the EU Common Agricultural Policy (Recital 14). An agreement on that reform was eventually adopted on 2 December 2021, leaving no time to include any TSC on agriculture in the DA.

The Commission has indicated that a complementary Delegated Act on natural gas could be adopted later this year. It should cover natural gas and related technologies as a transitional activity in as far as they fall within the limits of the EU Taxonomy Regulation.

Next Steps for TSC

Regarding the TSC for the four remaining environmental objectives (water, circular economy, pollution and prevention control, biodiversity and ecosystems), the EU Platform for Sustainable Finance, advising the Commission on taxonomy, has published a draft report with preliminary recommendations subject to public consultation. 

The Commission is required to adopt the relevant separate delegated act for the four remaining environmental objectives by 31 December 2021, a deadline which likely will not be met, with a view to ensuring its application from 1 January 2023.

The Article 8 Delegated Act

Under Article 8 of the EU Taxonomy Regulation, any company subject to an obligation to publish non-financial information under the Non-Financial Reporting Directive (“NFRD”) must include in its non-financial statement or consolidated non-financial statement information on how and to what extent its activities are associated with economic activities that qualify as environmentally sustainable. 

The Article 8 Delegated Act fleshes out in detail the information that companies are required to report on the proportion of the environmentally sustainable activities they carry out in their business. It also provides a methodology to be used (e.g. KPIs to be used for sustainable Capex and Opex of non-financial companies). 

In practice, the new DA will allow companies to meet their upcoming disclosure requirements with respect to Article 8 of the EU Taxonomy Regulation.

The companies must report only on certain elements (regarding taxonomy-eligibility) as of 1 January 2022. The other reporting provisions (regarding taxonomy-alignment) will start applying from 1 January 2023 for non-financial companies and from 1 January 2024 for financial companies. 

On that basis, investors should then be able to make more informed investment decisions regarding the companies they are investing in. This is in line with the EU’s goal to increase the flow of investment money towards environmentally sustainable activities across the region.

Possible impact of the Commission’s CSRD proposal on disclosure obligations

It must be mentioned that the Commission has also proposed to extend the scope of the NFRD, and therefore the categories of companies that are subject to the disclosure obligations under Article 8 of the EU Taxonomy Regulation, by submitting in April 2021 a proposal for a Corporate Sustainability Reporting Directive (“CSRD”). If adopted, the CSRD would apply to all listed companies (except listed micro-enterprises) and all large companies (listed or not) exceeding two out of three of the following criteria: (i) a balance sheet total of €20 million; (ii) net turnover of €40 million; and 250 employees on average number the financial year. Currently the NFRD only applies to large public-interest entities (i.e. companies with securities listed on the EU markets, banks and insurance companies) with an average number of employees in excess of 500. 

It is expected that the CSRD will be agreed on in 2022, for a potential application from 2024 with companies reporting on the 2023 financial year.

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