EU Taxonomy

The European Union Taxonomy, sets out overarching conditions and specific performance criteria for certain economic activities. It provides a comprehensive means by which the sustainability credentials of particular business activities can be assessed. This enables investors to determine to what extent an investment can be considered “sustainable”. At present, limited reporting requirements apply, while relevant new and existing portfolio business must be examined against the criteria.

By improving clarity and transparency regarding which economic activities contribute the most to meeting the EU’s environmental objectives, the aim is to push further investment into supporting the green economy. The EU Taxonomy could therefore play a key role in driving efforts to achieve Europe’s target of becoming carbon neutral by 2050.

Though an important step towards green standards and combating greenwashing, the Taxonomy does place renewed responsibility on financial sector participants in terms of their reporting requirements, bringing with it the need to disclose the “green” credentials of their lending and investment business. It aims to reveal the extent to which these institutions finance Taxonomy-aligned activities. The results of the EU Taxonomy, which are translated into the main KPI “Green Asset Ratio” for financial institutions, must be published as part of the non-financial reporting. The KPIs for non-financial undertakings are based on the share of their Taxonomy-aligned turnover or expenditures (capital and operational).

Non-financial reporting in the European Union is subject to change

The topic of non-financial reporting has been on the EU’s agenda for several years. In the EU, the foundations were laid with the Non-Financial Reporting Directive (NFRD), which applies in all EU member states and imposes disclosure regulations on certain large companies around how, and to what extent, their business activities contribute to sustainable objectives. The NFRD has been transposed into separate legislation in each member country. In Germany, this is the CSR-Richtlinien-Umsetzungsgesetz.

Since 2017, certain large German companies have been required to comply with the regulations on non-financial reporting, imposing reporting requirements for listed companies with 500 or more employees, with a view to disclosing the ecological and social impact of their activities. By virtue of its requirements, investors – and indeed the public – can receive information around companies’ environmental and social positions, as well as employee wellbeing, human rights, corruption and bribery issues.

The existing non-financial reporting requirements are currently under review by the EU. The new Corporate Sustainability Reporting Directive (CSRD) will incorporate the quantifiable results of the Taxonomy and lead to increased comparability.

It is important to notice, however, that companies which are required to publish a non-financial report are also obliged to report on the EU Taxonomy. This becomes especially relevant with the new CSRD regulation, significantly expanding the number of companies now subject to reporting requirements.

So far, the non-financial reporting requirements in the EU apply to around 11,700 companies, but the EU Commission has proposed to extend the requirement to apply across almost 50,000 companies. Furthermore, the minimum employee number of 500 is set to be lowered to 250, while listed small and medium-sized enterprises (SMEs) will also need to publish similar information. The European Commission wants to develop voluntary standards for non-listed SMEs, though the exact date this will come into force is not yet known.

It is important for companies to remember that, although these reporting requirements do not begin until 2022 and 2023, they always relate to the previous year. This means that companies will need to start collecting the relevant data from 2021 and from 2022. The CSRD also states that companies must submit any non-financial reports to external audit.

So far, the non-financial reporting requirements in the EU apply to around 11,700 companies, but the EU Commission has proposed to extend the requirement to apply across almost 50,000 companies. Furthermore, the minimum employee number of 500 is set to be lowered to 250, while listed small and medium-sized enterprises (SMEs) will also need to publish similar information. The European Commission wants to develop voluntary standards for non-listed SMEs, though the exact date this will come into force is not yet known.

Even though the CSRD has not yet come into effect, SMEs may already be, or likely will be, affected by the existing regulation. The NFRD stipulates that companies must report on the sustainable credentials of their counterparties, so companies complying with the regulation must provide data on behalf of their suppliers, for instance. As such, numerous companies are already passing on certain data requests, asking their suppliers or counterparties to develop and report on their own sustainability strategies, for example, in order to comply.

As the new reporting requirements are rolled out and broaden in scope, it will therefore likely trigger a significant increase in the number of medium-sized companies that will need to provide at least some relevant data to buyers of their products and services. It should therefore be a priority for companies subject to these reporting standards to enter into dialogue with their suppliers about the new data requirements and make appropriate preparations in a timely manner.