The EU Taxonomy Regulation, which classifies what activities companies can claim as sustainable, is the underappreciated foundation of the EU’s entire disclosure ecosystem. While other parts of this ecosystem, like the Corporate Sustainability Reporting Directive (CSRD) and the Sustainable Finance Disclosure Regulation (SFDR), are drawing a lot of headlines and frantic corporate and investor attention, the EU Taxonomy mostly lingers in the background, with most companies giving it only cursory attention.
The results of our second EU Taxonomy assessment across the EU are a case in point. 2022 marked the second year companies and financial institutions were expected to disclose which economic activities are classified as potentially sustainable, so-called “Taxonomy-eligible” activities. Non-financial companies, also for the first time, had to disclose what percentage of their eligible activities were conducted sustainably, the so-called “Taxonomy-aligned” activities.
Room for improvement
For both, the results are mixed. The EU Taxonomy focuses on Turnover, capital expenses (CapEx), and operational expenses (OpEx). For all three categories, the average Taxonomy-eligibility percentages companies reported barely budged since 2021, even though eligible activities have expanded with the introduction of the Complementary Climate Delegated Act. Eligibility scores also fluctuated considerably from country to country. The average reported Taxonomy-aligned percentages for 2022 were low and concentrated in just a few sectors, indicating that companies still have a long way to go on alignment.
Another sign that many companies underestimate the importance of the EU Taxonomy is the flaws in the execution of the Taxonomy’s mandatory requirements. Inconsistencies we encountered include unsubstantiated Taxonomy alignment, the absence of mandatory disclosure tables in reporting, and not taking full stock of Taxonomy-eligible activities. Taxonomy results also vary significantly from country to country, indicating a lack of unified interpretation of the EU Taxonomy.
Deep ties with CSRD and SFDR
However, neglecting the EU Taxonomy comes with serious risks. Companies should not forget their EU Taxonomy classification needs to be firmly in place before they can adequately satisfy the reporting requirements under CSRD and/or SFDR. Disclosing how company activities align with the EU Taxonomy is a mandatory part of both. This cannot be a back-of-the-envelope exercise: starting in 2025, the CSRD requires that EU Taxonomy classified activities are third-party assured, replacing the current voluntary assurance process.
In essence, this means that CSRD disclosures will only pass external assurance if Taxonomy eligibility and alignment information are present and credible, and activities will only be deemed sustainable if all screening criteria for EU Taxonomy alignment are met. This includes the thousands of non-EU companies that also must report in line with CSRD. Companies failing to do so risk monetary fines on top of increased liability and reputational damage.
Other parts of the disclosure ecosystem, like the Corporate Sustainability Due Diligence Directive (CSDDD), which largely focuses on supply chains, will likely also lean on the Taxonomy classification to assess if corporate supply chains are sufficiently sustainable and measure future improvements.
Neglecting the EU Taxonomy is risky
Last but not least, Taxonomy-eligible activities are about to explode in scope. The current eligible activities, as listed in the Climate Delegated Acts, focus on the potential contribution to climate change mitigation and adaptation. From 2024 onwards, the Environmental Delegated Act will add eligible activities with the potential to positively contribute to circular economy, pollution prevention and control, biodiversity and ecosystem preservation, and the protection of water and marine resources.
Companies must realize that the EU Taxonomy is the foundation of the EU disclosure ecosystem, underpinning the policy objective of re-orienting capital flows in line with sustainability imperatives. With the start of CSRD reporting just a year away, they should lose no time implementing a comprehensive system for mapping Taxonomy-eligible activities and transparently screening to what extent these activities are Taxonomy-aligned. Maximizing Taxonomy alignment also helps companies strengthen their sustainability profile.
Our key recommendations for company action on EU Taxonomy are:
- Prepare for mandatory third-party assurance of your company’s EU Taxonomy results (which will be part of CSRD reporting starting in 2025) by creating a structured company process for assessing eligibility and alignment.
- Assess proactively how the Environmental Delegated Act will impact your EU Taxonomy eligibility, alignment requirements, and opportunities. The Act will add eligible activities relating to circular economy, pollution prevention and control, biodiversity, and water and marine resources.
- Set a strategic ambition and benchmark current EU Taxonomy results against other peers in your industry. After mapping all relevant existing and new eligible activities, companies should set clear goals for levels of alignment in their strategic interest.
- Watch for regulatory updates and push EU regulators for more clarity. More standardization and guidance on eligibility assessment and interpreting the Taxonomy’s Technical Screening Criteria for alignment are urgently needed.