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In depth

Deep dive into the key characteristics of the EU sustainable finance regulation

Taxonomy

Taxonomy

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The EU Taxonomy Regulation (EU Taxonomy – Regulation (EU) 2020/852) is a Regulation introduced by the European Commission establishing criteria to define environmentally sustainable economic activities for investment purposes. Therefore, it is a classification system which establishes the conditions for certain economic activities(1) to be considered “environmentally sustainable” and, therefore, being “Taxonomy-aligned”.

An economic activity included in the EU Taxonomy is defined as “Taxonomy eligible.” However, in order to be considered “Taxonomy-aligned,” a taxonomy-eligible activity should contribute substantially to at least one of the following six environmental objectives:

  1. Climate change mitigation;
  2. Climate change adaptation;
  3. The sustainable use and protection of water and marine resources;
  4. The transition to a circular economy;
  5. Pollution prevention and control;
  6. The protection and restoration of biodiversity and ecosystems.

Besides contributing to at least one of the environmental objectives,  the activity must also successfully pass two other conditions to be defined as “Taxonomy-aligned”:

  • Not significantly harming any other of the environmental objectives (Do No Significant Harm principle, also known as “DNSH”);
  • Complying with a set of defined minimum social safeguards.

The detailed criteria to successfully pass all of the conditions mentioned in the paragraph above are established through Delegated Acts. The Delegated Act (EU) 2021/2139, amended by the Delegated Act (EU) 2023/2485(2), clarifies the conditions for the two climate change-related objectives, while the latest Delegated Act (EU) 2023/2486 adopted in 2023 clarifies the conditions for the remaining 4 environmental objectives.

Further details on these conditions are provided below:

  • The technical screening criteria are scientific-based quantitative and qualitative requirements and thresholds that an eligible economic activity must meet to be considered “significantly contributing to a sustainable objective”. These criteria are economic activity- and environmental objective-specific;
  • The Do No Significant Harm principle defines the criteria that eligible economic activities must respect to ensure that they do not generate any significant negative impact on the other EU Taxonomy objectives;
  • Minimum social safeguards ensure that a company and its economic activity(ies) adhere to the following internationally-recognised standards and guidelines:
    • The OECD Guidelines for Multinational Enterprises;
    • The UN Guiding Principles on Business and Human Rights;
    • The principles and rights set out in the eight fundamental conventions identified in the Declaration of the International Labour Organisation on Fundamental Principles and Rights at Work and the International Bill of Human Rights.

The EU Taxonomy currently covers the following sectors and economic activities.

The technical screening criteria for the first two environmental objectives, namely climate change mitigation and climate change adaptation defined by the Delegated Act 2021/2139 cover economic activities of roughly 40% of listed corporates in sectors responsible for almost 80% of direct greenhouse gas emissions in Europe. Extending the EU Taxonomy criteria to the other four objectives will increase this coverage.

The EU Taxonomy currently does not cover social dimensions. The European Platform on Sustainable Finance – a permanent expert group of the European Commission established to assist with the development of sustainable finance policies – published a report on Social Taxonomy in February 2022. This report includes recommendations for the development of an EU Social Taxonomy. Currently, the works and discussions towards the EU Social Taxonomy have been paused indefinitely to prioritise other EU initiatives.

Notes: 

(1) An economic activity means every activity a company performs that uses resources (e.g., labour) to generate a product (e.g., goods or services).
(2) The Delegated Act (EU) 2023/2485 introduces Technical Screening Criteria for four additional economic activities and addresses certain technical and legal inconsistencies of Delegated Act (EU) 2021/2139.