Europe

EU Taxonomy Eligibility an Ongoing Challenge in 2022

Major corporates and financial institutions to report as and when Delegated Acts go live. 

Financial and non-financial entities must identify and disclose the eligibility of their activities in line with the EU’s Green Taxonomy on a rolling basis throughout 2022, after the regulation came into force at the beginning of the year.

According to the FAQs document published by the European Commission last month, under the taxonomy’s Article 8 Delegated Act (DA), eligibility disclosures should currently only concern activities falling under the climate change adaptation and mitigation DA (Climate DA).

However, as more DAs are finalised over the course of the year, entities will need to assess and disclose the eligibility of their economic activities across a “wider range of environmental factors”, such as biodiversity and pollution prevention, on an ongoing basis, according to Jannis Bille, ESG and Climate Change Associate at law firm Herbert Smith Freehills.

Article 8 applies to all large financial and non-financial companies under the Non-Financial Reporting Directive (NFRD), which will soon be replaced by the Corporate Sustainability Reporting Directive (CSRD).

The EU is currently considering a complementary DA for gas and nuclear energy generation. If this DA is agreed upon and finalised, Article 8 will also require eligibility and alignment reporting on sustainable gas and nuclear activities, too.

Article 8 DA disclosures will give asset owners more visibility on the degree to which investee companies and financial service providers are prioritising sustainability in their business models, processes and products. This will in turn influence future investment decisions and who they appoint to manage their assets.

“The more information is made available, the better the flow of capital towards relevant sustainable targets,” Bille said.

From eligibility to alignment

From January 2023, non-financial companies will be required to further disclose the degree of alignment of their economic activities with all live taxonomy DAs. Financial companies have until 2024 until they must also report on both.

In 2025, financial companies may include estimates on taxonomy alignment for ‘do no significant harm’ assessments of non-NFRD investments, subject to a 2024 review period, the FAQs document noted.

The Commission added that eligibility reporting “should serve to help undertakings prepare for their alignment disclosures”.

To further help entities prepare, Bille told ESG Investor it is likely the EC will publish more specific guidance for reporting the alignment of eligible economic activities to the taxonomy later this year.

“Companies and financial firms first need to understand which of their activities are eligible under the taxonomy’s DAs before they can measure and report the extent to which they are aligned with the specific criteria,” Bille said. “Once more DAs are implemented, the FAQs document can be better tailored to answer any emerging questions non-financial and financial entities may have.”

A recent report by US investment bank Jefferies noted that there is “limited [taxonomy] eligibility across many of the main European indices”, with average eligibility below 50%, leaving the bank “somewhat circumspect on current [eligibility] reporting laying the groundwork for the resulting alignment regime”.

Connecting the threads

With the Taxonomy Regulation now live, through the Climate and Article 8 DAs, investors and companies should be better able to connect its reporting requirements to other EU legislation.

Effective from 2023, CSRD will increase the scope of non-financial and financial companies expected to comply with Article 8 rules, “allowing comparability on a much wider scale”, says Bille.

Under CSRD, qualifying companies must provide a non-financial statement on a series of ESG-related factors. It applies to all large and listed corporates with at least 250 employees and/or a net turnover of more than €40 million.

Further, CSRD means asset managers reporting under the Sustainable Finance Disclosure Regulation (SFDR) will have access to relevant environmental data on investee firms.

SFDR Level 1 went live in March 2021, requiring asset managers to sort their EU-domiciled funds into progressively greener categories. Level 2, which has been delayed again until January 2023, introduces regulatory technical standards through which investors have to justify their fund categorisations.

“Asset managers’ reporting is dependent on strong and reliable data from companies on their sustainable activities. By companies disclosing taxonomy eligibility and alignment through Article 8, asset managers will also be to utilise that information in their own [SFDR] reporting,” Bille noted.

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