EU Taxonomy Regulation & Disclosure Requirements Guide

What is EU Taxonomy regulation and disclosure requirements? The European Union (EU) has over the years set up the climate and energy target for 2030 and an agenda to make the 27 EU member nations climate neutral by 2050. To achieve these environmental targets and objectives, it became important to direct investments towards sustainable projects and provide a comprehensive definition of the term sustainable.

A political agreement was reached between the European Parliament and the European Council in December 2019. The agreement centered on what the contents of the proposed Regulation on the Establishment of a Framework to Facilitate Sustainable Investment will be. T

This article provides an overview on this regulation and all you need to know. Read to find out more.

What is EU Taxonomy Regulation?

The EU Taxonomy is an EU-wide system of classification that lays out a list of environmentally sustainable economic activities. It intends to let businesses, investors, companies, financial institutions, and issuers know and identify the degree to which economic activity can be environmentally sustainable and enable them to make informed decisions.

The taxonomy was initially focused on sustainability in terms of climate. It is also intended to establish rules and other environmentally sustainable objectives and expand into social objectives later on.

The EU Taxonomy is presumed to give investors security, help companies structure transition, protect investors against green washing, diminish market fragmentation, and ultimately help to shift investments to where they are most needed. 

The EU Taxonomy Regulation was published in the European Union’s Official Journal on June 22, 2020. It was adopted on 18th of June 2020 and enforced on 12 July 2020. It is however, planned to be adopted by the end of 2021, and its practical application will begin from 1 January 2022.

What does the EU Taxonomy regulation says?

This Taxonomy is one of the EU’s sustainable finance and climate program strongholds, and a part of the sustainable finance legislation that involves the Low Carbon Benchmarks Regulation and the Disclosure Regulation. 

The EU Taxonomy applies to 

• Financial market participants (primarily buy-side firms and institutional investors) offer financial products and market them as environmentally sustainable.
• Member states and European Union institutions. They use it to set the rules about corporate bonds and financial products that are projected as environmentally sustainable 
• Organizations that are covered by the Non-Financial Reporting Directive. 

The EU Taxonomy Regulation defines a financial product by referring to the definitions in the Regulation (EU) 2019/2088 of the European Parliament and the European Council of the 27th of November 2019 on the sustainability-related disclosures in the sector of financial services:

• A portfolio that is managed in accordance with Article 4(1) of Directive 2014/65/EU (MiFID II)
• Alternative Investment Fund (AIF)
• An insurance-based Investment product
• A pension product 
• A pension scheme 
• A UCITS fund
• A Pan-European Personal Pension Product 

The Taxonomy Regulation majorly affects asset managers who make financial products that have environmental sustainability as their objective or promotes environmental characteristics available.

The Regulation also says that the financial market participants that do not take the criteria for environmentally sustainable investments into account should provide a statement about that.  

EU Taxonomy Regulation 4 Tests

According to the Taxonomy Regulation, four tests must be satisfied by an economic activity before being environmentally sustainable. The activity must 

• Contribute substantially to one of the following specified environmental objectives 
• Climate change mitigation
• Climate change adaptation
• Sustainable usage and protection of marine and water resources
• Circular economy transition
• Pollution prevention and control
• Restoration and protection of biodiversity and ecosystems 
• It does not do any significant harm to any of the six environmental objectives above. If an economic activity causes more harm than benefits to one of these objectives, it should not qualify as an environmentally sustainable activity. 
• It should be executed in compliance with the minimum social and governance safeguards. When working in compliance with these minimum safeguards, undertakings should stick to the “do no significant harm” principle referenced in the Disclosure Regulation.
• Compliance with the technical screening criteria that will be developed in due course using delegated legislation. The European Commission is also required to establish a platform on sustainable finance that consists of experts that will advise on technical screening criteria.

The Taxonomy Regulation alters the Disclosure Regulation to include a requirement from FMPs to communicate information on how, and to what extent the investments that sustain their financial product support activities that economic activities that meet the test requirements, or a statement from products that do not invest in activities that comply with the taxonomy.

It also requires the European Supervisory Authorities to develop technical, regulatory standards that specify the details of the presentation and the information content relating to the “do no significant harm” principle.

EU Taxonomy Article 8

According to Article 8 of the Taxonomy Regulation, organizations (both financial and non-financial) that are Non-Financial Reporting Directive (NFRD) are covered to provide information on how and to what extent their activities are associated with environmentally sustainable economic activities.

The Taxonomy Regulation requires the European Commission to adopt a delegated act by 1 June 2021 that specifies the content, methodology, and presentation of the information to be revealed under Article 8.

Non-financial undertakings are also required by Article 8 to reveal the part of their turnover, capital, and operating expenditure derived from products or services, assets, or processes associated with environmentally sustainable activities. 

The climate change mitigation and adaptation rules should apply from 1st of January 2021 while the rule for the sustainable usage and protection of marine and water resources, circular economy transition, pollution prevention and control, restoration and protection of biodiversity and ecosystems should apply to form the 1st of January 2023.

Conclusion

The major aim of the Taxonomy Regulation is to inspire the flow of investment from the financial sector to undertakings that are engaged more sustainable activities that help the EU achieve objectives. The taxonomy will initially apply to certain stakeholders, but it is expected to expand. The Taxonomy requires a party to provide a toolkit for assessing if a business or financial product is environmentally sustainable.