Commentary

EU Taxonomy Takes First Steps Beyond Climate

Benjamin Howard-Cooper, Head of Sustainable Finance at Briink, explains what investors need to know about ‘taxo4’ and related updates to the European Taxonomy.

On 7 April, the European Commission released the highly anticipated (and severely overdue) update to the European Taxonomy for Sustainable Activities. The regulatory update included the introduction of a new Environmental Delegated Act, as well as amendments to existing parts of the regulation.

As part of a larger package of regulatory updates, the Commission published updates to the current Climate Delegated Act, including the introduction of new activities associated with both climate change mitigation and adaptation objectives. There were also minor changes made to some of the existing technical screening criteria for economic activities under the Climate Delegated Act, as well as updates to the Disclosures Delegated Act.

Phased approach

It is important to keep in mind that both the Environmental Delegated Act and the amendments to the existing delegated acts are still in draft form and open to feedback until 3 May 2023. As was the case when the first part of the Taxonomy was introduced, the regulation will be implemented in a series of phases. Based on the draft delegated acts, companies and financial market participants (FMPs) will have to disclose their Taxonomy-eligibility under the new activities in 2025 based on the reference period of fiscal year 2024.

Moving forward, companies will have to report on their alignment to the new activities starting in 2025, while FMPs will need to disclose in 2026. In light of these significant new developments, it is critical to fundamentally understand the direction of the draft regulation and compare it against the recommendations published by the Platform on Sustainable Finance (PSF) in March 2022.

The core feature of the new Environmental Delegated Act is the introduction of four new environmental objectives (colloquially referred to as the Taxo4) including, sustainable use and protection of water and marine resources, transition to a circular economy, pollution prevention and control, and lastly protection and restoration of biodiversity and ecosystems. The annexes to the Environmental Delegated Acts elaborate on 35 new eligible economic activities associated with the four environmental objectives, and updated annexes to the Climate Delegated Act create 13 new activities associated with the climate objectives.

A common source of frustration with the regulation has been the relatively limited scope of the Taxonomy, with only specific parts of the economy captured under the existing list of economic activities. While this update certainly expands the usability of the framework given its more robust coverage of sectors, it falls well short of expectations. Last year the PSF, the EU Commission advisory body responsible for supporting the development of the Taxonomy regulation, recommended over 70 new activities to come online as part of this regulatory update. Those hoping that the PSF recommendations would be taken in whole by the commission will certainly be disappointment.

Surprising omission

While the proposed regulation has cut activities from every environmental objective compared against the PSF guidance, the most extreme deviation was under the protection and restoration of biodiversity and ecosystem objective, where the Annex IV of the Environmental Delegated Act only lists two economic activities. While the PSF recommendation included activities aligned to the agriculture and food sectors, the draft regulation has disregarded those suggestions and opted for a much more limited set of activities.

This is a surprising decision, considering agricultural activities account for a large share of the European economy and the sector has a material impact on the environment. Without the inclusion of these activities in the Taxonomy, the regulation does not provide tools to support the agricultural sector’s transition into sustainable practices, at this point.

It’s not just agriculture which got axed. The updated regulation has scrapped proposed activities related to textiles, fashion and leather, which were proposed to fall under the pollution prevention and control objectives. Similar to agricultural activities, the fashion and textile industry accounts for a large share of the European economy and has a high impact on sustainability objectives, as they are heavy polluters. Further, the EU Taxonomy is a gold standard in identifying truly sustainable activities, and given the fashion sector’s notoriety for greenwashing, the regulation could have been highly supportive in developing standard tools to address dubious claims.

Although the Environmental Delegated Act certainly did not fully deliver against expectations, there are several new activities introduced under the transition to circular economy objective that are sector agnostic and capture large swaths of the economy: for example, the manufacture of electrical and electronic equipment. This is a different approach than in the Climate Delegated Act where a vast majority of the activities are sector specific. The table below shows some of these newly introduced catch-all activities that could apply to companies across sectors.

ObjectiveActivity
Transition to circular economyManufacture of electrical and electronic equipment
Transition to circular economyProvision of IT/OT data-driven solutions and software
Transition to circular economyRepair, refurbishment and remanufacturing
Transition to circular economySale of spare part
Transition to circular economyProduct-as-a-service and other circular use- and result-oriented service models
Climate change adaptationSoftware enabling climate risk management
Climate change adaptationConsultancy for climate risk management

Additions to climate delegated act

As mentioned above, the draft updated Climate Delegated Act introduces new activities that are linked to climate change mitigation and adaptation objectives. One of the most prominent (and controversial) new additions is the aviation sector. While there is much scrutiny applied to the inclusion, it is important to remember that inclusion in the Taxonomy does not define whether a sector is sustainable or not, but rather indicates what parts of the economy the Commission is targeting for sustainable investments to provide capital for transitioning.

Considering that aviation is one of the largest contributors to carbon emissions, developing a common lexicon to describe and encourage sustainable investments is critical. Less controversially, there are substantial new catch-all activities (see above) associated with climate change adaptation. These new activities cover firms who enable adaptation to climate change at their client sites.

To close out, the European Commission’s recent publication of the Environmental Delegated Act and amendments to the Climate Delegated Act represent a noteworthy step towards enhancing sustainable finance regulation. However, the exclusion of certain activities, such as those related to agriculture and food, could hinder the transition and create market frustrations.

On the other hand, the catch-all activities included in the transition to a circular economy and climate change adaptation objectives are positive moves and allow a much larger chunk of the economy to leverage the framework to describe their own activities and investments. It is now up to companies, FMPs and other stakeholders to provide feedback on the draft Delegated Acts until 3 May 2023 to contribute to further developments over the coming years.

This article was co-authored by Tazegul Taganova, Sustainable Finance Analyst at Briink.

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