What are ‘green’ economic activities? EU pioneering the development of a common understanding

In accordance with its commitments under the Paris Agreement on climate change, the EU’s goal is to be carbon neutral by 2050. To achieve this goal the EU Commission has set out a broad range of ambitious policy measures under the so-called European Green Deal, with a focus on transforming the EU into a sustainable and climate neutral economy. At the core of these measures sits the Commission’s strategy on sustainable finance which aims at mobilizing and redirecting private investments towards ‘green’ economic activities.

The Commission has established a framework for a common understanding of ‘green’ economic activities and disclosure obligations for financial market participants and large public-interest companies (ie listed companies, banks, insurance companies and other companies designated by national authorities as public-interest entities) with more than 500 employees with Regulation (EU) 2020/852 ('the Taxonomy Regulation'). 

Most recently, the Commission has adopted two important delegated acts complementing the Taxonomy Regulation: 

• the EU Taxonomy Climate Delegated Act ('the Taxonomy Climate Delegated Act'), which was formally adopted on 4 June 2021; and 
• a draft Delegated Act on Art.8 of the Taxonomy Regulation ('the Draft Delegated Act'), which was published on 6 July 2021 in connection with the Commission’s renewed strategy for financing the transition to a sustainable economy.

In case these delegated acts are not blocked by the Council or the European Parliament for political reasons they will both likely apply from 1 January 2022.

It is therefore worth taking a closer look at the Taxonomy Climate Delegated Act, the Draft Delegated Act, the EU’s role as a pioneer in this field and the Commission’s next steps in developing a comprehensive and detailed taxonomy framework.

Taxonomy Regulation

The Taxonomy Regulation sits at the heart of the EU’s legislative actions aimed at scaling up sustainable investments through increasing transparency and consistency in the classification of ‘environmentally sustainable economic activities’ and limiting the risk of greenwashing (ie unsubstantiated claims that an investment is sustainable). 

To implement this goal, the Taxonomy Regulation:

• introduces criteria for a robust, science-based classification system for environmentally sustainable economic activities ('the EU Taxonomy'); and 
• establishes a regime for companies to disclose information on how and to what extent their activities and products are associated with the EU Taxonomy.

In order to qualify as environmentally sustainable pursuant to the EU Taxonomy, an economic activity must:

• contribute substantially to one or more of the six environmental objectives set out by the Taxonomy Regulation (ie climate change mitigation and adaptation, water, biodiversity, pollution prevention and circular economy);
• not significantly harm any of the environmental objectives;
• be carried out in compliance with certain social safeguards; and
• comply with technical screening criteria (TSC) established by the Commission through delegated acts.

Taxonomy Climate Delegated Act

The Taxonomy Climate Delegated Act is the first of such delegated acts providing for a set of TSC determining which economic activities:

• can make a substantial contribution to climate change mitigation (Annex 1) and climate change adaptation (Annex 2); and 
• do not significantly harm any other environmental objective.

The Taxonomy Climate Delegated Act covers more economic activities than used so far in market-based green financing frameworks from various sectors such as manufacturing, energy, water supply, sewerage, waste management and remediation, transport, information, and communication, as well as construction and real estate. According to the Commission, the Taxonomy Climate Delegated Act covers the economic activities of roughly 40 per cent of EU-domiciled listed companies, in sectors which are responsible for almost 80 per cent of direct greenhouse gas emissions in Europe.

To illustrate, an example of how detailed the Taxonomy Climate Delegated Act classifies economic activities:

The renovation of existing buildings substantially contributes to climate change mitigation if it leads to a reduction of primary energy demand (PED) of at least 30 per cent, and does not significantly harm the environmental objective of sustainable use of water, if the water appliances installed as part of the renovation work only have a specific maximum water flow (six litres/minute for wash basin taps and eight litres/minute for showers).

EU decision-makers and stakeholders generally agree that the EU Taxonomy should be science-based. The TSC contained in the Taxonomy Climate Delegated Act are therefore based on the scientific advice of the Platform of Sustainable Finance, a permanent expert group established by the Commission in 2020. However, it is clear that the process of developing the TSC is also highly political in nature due to the diverging economic interests of EU member states (who eventually have their say in the legislative process).

Draft Delegated Act on Art.8 of the Taxonomy Regulation

The Draft Delegated Act specifies the content, methodology, and presentation of the information to be disclosed by large public-interest companies, asset managers, credit institutions, investment firms and insurance companies concerning the proportion of environmentally sustainable activities in their business, investments or lending activities under Art.8 of the Taxonomy Regulation. Other companies (eg SMEs, non-EU companies) may decide to disclose the relevant information on a voluntary basis. 

The provisions of the Draft Delegated Act allow companies subject to the disclosure obligations under Art.8 of the Taxonomy Regulation to translate the TSC of the Taxonomy Climate Delegated Act into different key performance indicators (KPIs) associated with environmentally sustainable activities. 

For example, companies must disclose turnover from sustainable economic activities as well as taxonomy-aligned capital expenditure and operational expenditure together with:

• information on their accounting policy explaining how the KPIs were determined; 
• an assessment of compliance with the Taxonomy Regulation; and 
• an explanation of the figures of each KPI and the reasons for any changes in those figures in the reporting period. 

Credit institutions will have to disclose their ‘green asset ratio’ and investment firms, inter alia, the proportion of assets associated with EU Taxonomy-eligible and EU Taxonomy-aligned economic activities.

The Annexes to the Draft Delegated Act specify how the different KPIs must be calculated. The information will have to be presented in tabular form by using the specific templates set out in the Annexes to the Draft Delegated Act.

Listed companies and large companies will have to disclose the KPIs set out by the Draft Delegated Act from 1 January 2023; asset managers, credit institutions, investment firms and insurance companies from 1 January 2024.

EU as a pioneer

The Taxonomy Climate Delegated Act constitutes one of the first undertakings of establishing a detailed, science-based taxonomy of sustainable economic activities. Apart from the EU, only very few countries have developed taxonomy frameworks (eg China), while other countries are still developing them (eg the UK). 

We assume that the Taxonomy Climate Delegated Act will be an important reference point for other jurisdictions currently developing taxonomy frameworks. Even though the UK has established its own advisory group for developing the scientific metrics of its taxonomy framework, it can be reasonably expected that the UK will follow the EU Taxonomy in many aspects in order to avoid increasing the regulatory burden for financial companies that offer financial products in both the EU and the UK. China’s central bank has also announced that it is co-operating with the EU, notably by taking part in the International Platform on Sustainable Finance launched by the Commission, with the aim of converging its taxonomy framework with the EU Taxonomy.

What’s next? The Commission’s sustainable finance strategy

The Taxonomy Climate Delegated Act is considered to be a ‘living document’ by the Commission and will thus continue to evolve over time with more economic activities being added to its scope and up-to date scientific evidence and technical innovation being reflected. 

Further, the Commission announced the intention to adopt a complementary delegated act containing TSC for sustainable economic activities not yet covered in the Taxonomy Climate Delegated Act in relation to agriculture and – highly disputed among EU member states – certain energy sectors like natural gas and nuclear energy. 

In the first half of 2022, the Commission aims to adopt another delegated act covering the remaining four environmental objectives (ie water, biodiversity, pollution prevention and circular economy) as well as TSC for further sustainable economic activities in relation to activities already covered by the Taxonomy Climate Delegated Act, such as manufacturing and transportation activities. This will facilitate ‘green’ investments beyond the climate change objectives. 

In its renewed sustainable finance strategy, the Commission also considers options for extending the EU Taxonomy beyond environmentally sustainable economic activities to economic activities with a mere ‘intermediate level of environmental performance’ in order to encourage transition efforts towards a sustainable economy.