knowledge 27 February 2020 |

Sustainable Finance:  Taxonomy Regulation - Final Text Agreed

It is envisaged that the new taxonomy will create a common and unambiguous understanding across markets and amongst market participants as to what constitutes environmentally sustainable activities.  This should facilitate cross-border investment by minimising the risk of market fragmentation caused by having different classification systems in different jurisdictions.  The EU also hopes that it will result in cash flows being reoriented toward more sustainable investments by increasing transparency and, due to the stringent criteria introduced by the Taxonomy Regulation, reducing “green washing”.

What does the Regulation do?

Simply summarised, the Regulation establishes a framework for determining whether an economic activity is environmentally sustainable.

Who and what does the Taxonomy Regulation apply to?

The Regulation applies to:

• “financial market participants” making available “financial products” (as defined in the related Disclosures Regulation, as to which see our briefing here.  This covers a broad range of investment funds, product manufacturers and managers, including insurance undertakings, pension funds, AIFMs and UCITS management companies);
• undertakings which are subject to the obligation to publish a non-financial statement or a consolidated non-financial statement pursuant the Non-Financial Reporting Directive (Directive 2013/34/EU); and
• measures adopted by Member States or by the EU setting out any requirements on financial market participants or issuers in respect of financial products or corporate bonds that are made available as environmentally sustainable.

What criteria are established by the Taxonomy Regulation?

An economic activity will be considered environmentally sustainable where that activity:

• provides a substantial contribution to one of the six environmental objectives set out below;
• causes no significant harm to any of the other environmental objectives;
• complies with specific technical screening criteria; and
• complies with minimum social and governance safeguards.

The six environmental objectives set out in the Taxonomy Regulation are:

• Climate change mitigation
• Climate change adaption
• Sustainable use and protection of water and marine resources
• Transition to a circular economy
• Pollution prevention and control
• Protection and restoration of biodiversity and ecosystems.

The Regulation recognises three types of environmentally friendly sustainable economic activities:

• Direct contribution:  those that contribute substantially to one of the environmental objectives in and of themselves;
• Best alternative:  in the case of the climate change mitigation objective, transition activities for which there are no technologically and economically feasible low-carbon alternatives and which meet specified criteria such that they support the transition to a climate-neutral economy in a manner that is consistent with a pathway to limit the temperature increase to 1.5 degrees Celsius above pre-industrial levels; and
• Enabling activities:  activities that directly enable other activities to make a substantial contribution to one of the environmental objectives and at the same time (i) do not lead to greenhouse gas emissions from long-term assets (which would undermine long-term environmental goals); and (ii) have a substantial positive environmental impact on the basis of asset lifetime. 

In the energy space, power generation activities from solid fossil fuels are explicitly ineligible.  Nuclear energy has not been explicitly excluded or included and so it is speculated that the ultimate decision will be based on an expert technical assessment under the “no significant harm principle”.  Similarly, gas has not been explicitly included or excluded, and this will be subject to a technical assessment before the delegated acts are adopted.

What obligations are imposed by the Taxonomy Regulation?

The Taxonomy Regulation obliges Member States, the EU, financial market participants and undertakings subject to the Non-Financial Reporting Directive to use the Regulation in specific cases.  Specifically, it:

• provides that both Member States and the EU use the Regulation when setting out the requirements for marketing financial products or corporate bonds as environmentally sustainable;
• sets out disclosure and transparency obligations for financial market participants offering financial products, which are marketed as environmentally sustainable or as investments with similar characteristics;
• also sets out disclosure and transparency obligations, including prescribed disclosure statements, where relevant financial products do not take into account the criteria set out in the Regulation (ie where the investment relates to financial products that are not classified as environmentally sustainable activities);
• requires any undertaking which is subject to the obligation to publish non-financial information pursuant to the Non-Financial Reporting Directive to outline in its non-financial statement (or, where applicable, a separate report) “…how and to what extent the undertaking’s activities are associated with environmentally sustainable economic activities”.  More specifically, the undertaking must disclose:
  • the proportion of its turnover derived from products or services associated with environmentally sustainable economic activities; and
  • the proportion of its total investments (capital expenditure) and/or expenditures (operating expenditure) related to assets or processes associated with environmentally sustainable economic activities.

When will the Regulation take effect?

The Regulation itself will enter into force 20 days following its publication in the EU’s Official Journal.  However, from a practical perspective, the implementation time-frame is longer as the Regulation is to be implemented through delegated acts which will be developed in two phases.

The first phase will relate to the climate change mitigation and climate change adaption objectives and should be adopted by the Commission by 31 December 2020 and therefore apply from 31 December 2021.

The second phase on the remaining four objectives should be adopted by the Commission by 31 December 2021 and therefore apply from 31 December 2022.