Sustainability - new EU Taxonomy classification system for green investments

The EU is moving forward with the Taxonomy Regulation creating a uniform and harmonised classification system that aims at facilitating and encouraging green investments and avoiding “greenwashing”. Once fully implemented, the Taxonomy will lead to disclosure requirements for financial market participants and is likely to impact corporate ESG reporting.

The European Council and the European Parliament have reached an agreement on the wording of the EU Commission’s proposal for a Taxonomy Regulation on the establishment of a classification framework to facilitate sustainable investments within the EU markets in line with EU policies.

With the Taxonomy Regulation, a joint EU vocabulary on environmental sustainability will start to materialize. We advise corporates to start preparing for the new classification system, recognizing that transparency and factual non-financial reporting[1] on sustainability and ESG issues will generally be required and necessary to maintain the ability to attract capital, whether by way of third party financing or equity.

What is the Taxonomy Regulation?

The Taxonomy Regulation aims to establish an EU-wide classification system (but not a label as such) in order to provide a common framework for identifying and determining to what degree certain economic activities can be classified as “environmentally sustainable”.

The Taxonomy Regulation sets out a list of six environmental objectives to be considered when determining whether an economic activity is environmentally sustainable[2]:

• Climate change mitigation,
• Climate change adaptation,
• Sustainable use and protection of water and marine resources,
• Transition to a circular economy, waste prevention and recycling,
• Pollution prevention and control and
• Protection of healthy ecosystems.

An important cornerstone of the Taxonomy Regulation is the “do no significant harm”-principle[3]. This means that while contributing to one environmental objective, the activity must not significantly harm any of the other five environmental objectives[4]. The purpose is to avoid that investments are considered “environmentally sustainable” although the economic activities benefiting from those investments cause harm to the environment to an extent outweighing their contribution to an environmental objective.

Furthermore, economic activities only qualifies as “environmentally sustainable” under the Taxonomy Regulation when carried out in compliance with fundamental principles of i.a. human rights.[5] The fundamental principles – which are incorporated in the Charter of Fundamental Rights of the European Union[6] – include the prohibition of slavery and forced labour and the principle of non-discrimination.

A technical expert group on sustainable finance (the “TEG”) appointed by the European Commission has prepared a report on environmentally sustainable activities from a technical perspective – intended to help with the technical classification procedure.

The TEG published its preliminary report in July 2019 which contains (i) technical screening criteria for activities that can make a substantial contribution to climate change mitigation; (ii) methodology and examples for making an evaluation; and (iii) guidance on the use of the Taxonomy Regulation.

Based on available greenhouse gas emissions data, the TEG report identified 6 macro-sectors, which currently are considered key for climate change mitigation and on which the TEG particularly focused in their report:

• Agriculture, forestry and fishing
• Manufacturing
• Electricity, gas, steam and air conditioning supply
• Water, sewerage, waste and the related remediation
• Transportation and storage
• Information and Communication Technologies
• Buildings

The TEG further identified priority activities within each sector. By way of example, within the manufacturing sector, manufacturing of low carbon technologies would be considered a climate change mitigating activity; within the agriculture, forestry and fishing sector, reforestation would be considered a climate change mitigating activity.

To whom does the Taxonomy Regulation apply?

The Taxonomy Regulation applies to (i) Financial Market Participants (defined below) making available financial products as well as (ii) certain companies and groups which are also obliged to publish a non-financial statement in accordance with Articles 19a or 29a of Directive 2013/34/EU[7].

“Financial Market Participants” are defined as (i) insurance undertakings which make available insurance‐based investment products; (ii) managers of alternative investment funds; (iii)  investment firms which provide portfolio management; (iv) institutions for occupational retirement provision; (v) management companies of undertakings for collective investment in transferable securities; (vi) managers of qualifying venture capital funds; or (vii) certain qualifying social entrepreneurship funds.

Disclosure under the Taxonomy Regulation

Together with the new Disclosure Regulation, the Taxonomy Regulation sets out certain disclosure obligations applicable to Financial Market Participants, who market their investments as “environmentally sustainable”, including a requirement to disclose information on (i) the percentage of holdings pertaining to companies carrying out environmentally sustainable economic activities and (ii) the share of the investment funding environmentally sustainable economic activities as a percentage of all economic activities.

For further information regarding new disclosure obligations on financial market participants, please refer to our recent newsletter (in Danish): https://gorrissenfederspiel.com/viden/nyheder/offentliggoerelse-af-esg-oplysninger-i-den-finansielle-sektor

Adoption by the EU Commission

The Taxonomy system will not be effective until the Commission has adopted delegated legislation, which is expected to be developed in two steps[8]:

1. The delegated act on the climate-related objectives (i.e. “climate change mitigation” and “climate change adaptation”) is expected to be adopted by the EU Commission by 31 December 2020.
2. The remaining four environmental objectives are expected to be adopted by the EU Commission by 31 December 2021[9].

For any questions regarding the EU Taxonomy Regulation or ESG related matters, please reach out to your regular Gorrissen Federspiel contact or any of the below.