A further step towards sustainable finance in the European Union – Environment
On December 9, 2021, the Delegated Act of the European Commission (âCommissionâ) on the EU Taxonomy on Climate Change (âADâ) was published in the Official Journal of the EU after having been approved by the European Council. It will enter into force on January 1, 2022. The DA provides the first set of Technical Selection Criteria (âSTCâ) to establish whether an economic activity substantially contributes to climate change mitigation and adaptation in the context of the intensification of sustainable investments.
The next day, December 10, the delegated act of the European Commission relating to Article 8 of the taxonomy (“Article 8 of the delegated act”) was also published in the Official Journal of the EU. It is also expected to enter into force on January 1, 2022. This second instrument specifies the content and presentation of the information that financial and non-financial companies are required to publish under Article 8 of the EU taxonomic regulation. Article 8 of the delegated act is discussed at the end of this alert.
The legal basis of DA: the EU taxonomy regulation
the EU taxonomy regulation marked a milestone for sustainable finance in the EU. It is one of the main European instruments for channeling money from the private sector towards the Green Deal and achieving the bloc’s climate objectives.
The regulation provides for a classification system to categorize economic activities according to six objectives:
- Mitigation of climate change;
- Adaptation to climate change;
- Sustainable use and protection of aquatic and marine resources;
- The transition to a circular economy;
- Pollution prevention and control;
- The protection and restoration of biodiversity and ecosystems.
The EU taxonomic regulation aims to help investors and businesses make informed decisions about âenvironmentally sustainableâ economic activities. However, the regulation does not prevent investments in activities not eligible under EU taxonomy. The main objective of green investment rules is to provide a long-term incentive to direct financial flows towards environmentally friendly activities.
The classification system of the EU Taxonomy Regulation also provides four cumulative criteria for determining whether a given economic activity is to be considered âenvironmentally sustainableâ. An economic activity is qualified as âenvironmentally sustainableâ when:
- It makes a substantial contribution to one or more of the environmental objectives set out in the regulation.
- It does not significantly harm environmental objectives.
- It is carried out in compliance with the minimum guarantees set out in the regulation.
- It complies with the technical selection criteria established by the Commission in accordance with the Regulation.
To this end, the EU Taxonomy Regulation empowered the Commission to adopt a delegated act to establish the TSA for each environmental objective. In other words, the Commission has been tasked with elaborating in detail what it means for an activity to contribute substantially to an environmental objective.
While the EU taxonomic regulation required the Commission to adopt the DA by December 31, 2020, it was not until April 21, 2021, after consultation with many stakeholders, that the Commission published its draft DA establishing the CST for climate change mitigation objectives. and adaptation to climate change. The DA was then adopted on June 4, 2021. On December 9, 2021, following the approval of the European Council, the DA was published in the Official Journal of the European Union.
Establish technical selection criteria
The new DA defines the TSC to determine the conditions under which an economic activity is considered to contribute substantially to adaptation to climate change (that is to say, under Article 11 of the EU Taxonomy Regulation, contributing to the reduction of the risks of negative impact of current and expected climate change; prevent an increase or displacement of negative effects on climate change) and climate change mitigation (that is to say, under Article 10 of the EU Taxonomy Regulation, contributing to the stabilization of greenhouse gas concentrations by reducing emissions or increasing removals). The DA also provides generic criteria for determining whether an economic activity causes no significant damage to one of the six environmental objectives defined in the EU taxonomy regulation.
Annex I of the DA lists a wide range of economic activities – such as those related to forestry, manufacturing, energy, water supply, transportation and others – and provides the required TSA for that each activity be qualified as environmentally sustainable by contributing to the objective of climate change mitigation.
Annex II targets the same activities as the activities listed in Annex I, with the addition of certain financial and insurance activities, education, human health and social work activities as well as the arts, entertainment and recreation. It sets out the TSA required for these economic activities to be considered environmentally sustainable in order to contribute to the objective of adaptation to climate change.
In both cases, the TSAs provide for technical thresholds, qualitative performance requirements, production or process requirements, the duration of the project, and of course a precise description of the economic activities which by their nature contribute to the mitigation / adaptation to climate change.
In total, the DA covers 88 economic activities that can be considered environmentally sustainable provided they meet the TSAs set therein.
The DA will apply from January 1, 2022. It will allow the EU taxonomy regulation to be applied in practice for the two objectives concerned.
What does this mean in practice?
In practice, companies and financial market participants will be able to start using the TSC to determine and report whether their activities are eligible and comply with EU taxonomic requirements. They will therefore be able to meet the next disclosure requirements under the EU Taxonomy Regulation.
On this basis, investors will be able to decide whether their investments are geared towards environmentally sustainable economic activities, which may be to the detriment of companies whose activities are not qualified as environmentally sustainable or which have not verified whether these activities meet the conditions.
The DA also gives the market a clear environmental performance benchmark and establishes a common language for investors, businesses and other stakeholders.
One of the main challenges was the unavailability of data allowing companies to implement the EU taxonomy. The DA must give indications on the data to be entered.
Economic activities not included in the DA
One of the controversial points raised after the adoption of the Development Agenda was undoubtedly the non-inclusion of nuclear energy activities in the taxonomy. This still seems to be the subject of political discussions among EU countries. The DA indicates in its recital 27 that the assessment for nuclear energy is still ongoing. Nuclear energy can be included in the taxonomy at a later stage through a separate law.
The DA also foresees that the TSA for agriculture should be delayed due to the negotiations on the reform of the common agricultural policy of the EU (recital 14). An agreement on this reform was finally adopted on December 2, 2021, leaving no time to include any CST on agriculture in the Development Agenda.
The Commission has indicated that an additional delegated act on natural gas could be adopted later this year. It should cover natural gas and related technologies as a transitional activity as they fall within the limits of the EU taxonomic regulation.
Next steps for TSC
Regarding the TSC for the four remaining environmental objectives (water, circular economy, pollution and prevention control, biodiversity and ecosystems), the EU platform for sustainable finance, advising the Commission on taxonomy, published a draft report with preliminary recommendations for public consultation. .
The Commission is required to adopt the relevant separate delegated act for the remaining four environmental objectives by 31 December 2021, a deadline which is unlikely to be met, with a view to ensuring its application from 1 January 2023.
Article 8 of the delegated act
Under Article 8 of the EU Taxonomy Regulation, any company subject to the obligation to publish non-financial information under the Non-Financial Reporting Directive (âNFRDâ) must include in its declaration non-financial or its consolidated non-financial statement of information on how and to what extent its activities are associated with economic activities classified as environmentally sustainable.
Article 8 of the delegated act details the information that companies are required to report on the proportion of environmentally friendly activities that they carry out in their company. It also provides a methodology to be used (eg KPIs to be used for sustainable capital and operating expenses of non-financial corporations).
In practice, the new DA will allow companies to meet their upcoming disclosure obligations with regard to Article 8 of the EU Taxonomy Regulation.
Companies need to report only certain items (regarding taxonomy eligibility) from January 1, 2022. The other reporting provisions (regarding taxonomy alignment) will start to apply from January 1, 2023 for non-financial corporations and from January 1, 2024 for financial corporations. .
Based on this, investors should then be able to make more informed investment decisions about the companies in which they invest. This is in line with the EU’s goal of increasing the flow of investment money into environmentally sustainable activities in the region.
Possible impact of the Commission’s CSRD proposal on disclosure obligations
It should be mentioned that the Commission has also proposed to extend the scope of the NFRD, and therefore the categories of companies which are subject to the disclosure obligations under Article 8 of the Taxonomy Regulation of the EU, by submitting in April 2021 a proposal for a directive on sustainable development reports (âCSRDâ). If adopted, the CSRD would apply to all listed companies (excluding listed micro-enterprises) and to all large enterprises (listed or not) exceeding two of the following three criteria: (i) a balance sheet total of 20 millions of euros ; (ii) net sales of 40 million euros; and 250 employees on average number the year. Currently, the NFRD only applies to large public interest entities (that is to say companies listed on EU markets, banks and insurance companies) employing on average more than 500 people.
The CSRD is expected to be agreed in 2022, for potential application from 2024 with companies reporting on fiscal year 2023.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.