EU Taxonomy Regulation

EU TAXONOMYTAXONOMY

What is the EU Taxonomy?

The EU Taxonomy, a classification framework, plays a vital role as a market transparency tool by channeling investments toward activities that are most critical for advancing the transition to net zero emissions and promoting environmental sustainability. This system aims to provide clear guidelines that help investors identify projects and economic activities that contribute meaningfully to climate and environmental goals.

In line with new EU regulations, starting in 2023, large, publicly listed companies across the EU have begun reporting in accordance with the Taxonomy’s requirements for two key climate objectives: climate change mitigation and climate change adaptation. These reports represent an essential step toward greater transparency in how companies align their activities with sustainability goals. In addition to climate-focused metrics, the latest reporting also includes information related to the Taxonomy’s four other environmental objectives, broadening the scope of disclosures to include a more comprehensive picture of environmental impact.

The initial outcomes from these reporting efforts are promising. Evidence suggests that companies, public entities, and financial institutions are increasingly leveraging the Taxonomy as a foundation for shaping their business strategies, guiding their transition planning, and informing investment and lending decisions. This growing integration into financial and operational processes demonstrates the Taxonomy’s expanding influence as a cornerstone in the journey towards a more sustainable and climate-resilient economy.

Scope of EU Taxonomy

The EU Taxonomy is a classification system designed to help investors, companies, and policymakers identify which economic activities are environmentally sustainable. It aims to guide financial flows toward sustainable activities and to combat “greenwashing” by providing clear criteria for what qualifies as “sustainable.” The scope of the EU Taxonomy is broad, and it affects several key stakeholders and sectors:

1. Companies

Listed Companies: Large publicly listed companies within the EU, particularly those subject to the Non-Financial Reporting Directive (NFRD), are required to disclose how their activities align with the Taxonomy.
Large Non-listed Companies: Companies with over 500 employees, even if they are not publicly listed, must also comply if they fall under the NFRD or its successor, the Corporate Sustainability Reporting Directive (CSRD).
Financial Institutions: Banks, asset managers, insurers, and pension funds must disclose the proportion of their portfolios aligned with the Taxonomy criteria. This includes the proportion of sustainable investments they hold and how they meet Taxonomy requirements.

2. Sectors and Economic Activities

The Taxonomy applies to a wide range of sectors, focusing on those that have a significant environmental impact. Key sectors include:

Energy (renewable energy, energy efficiency, and electricity generation)
Manufacturing
Transport
Water supply and waste management
Construction and real estate
Information and communication technology (ICT)
Agriculture and forestry

The Taxonomy defines criteria for economic activities within these sectors that contribute substantially to one or more of the six environmental objectives:

Climate change mitigation
Climate change adaptation
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

3. Investors

Institutional investors and asset managers are required to disclose how they use the Taxonomy in their investment decision-making processes. They must report how their investments align with the Taxonomy’s sustainable activities, thus helping investors make more informed decisions about the sustainability of their portfolios.

4. Public Authorities

EU and national authorities may use the Taxonomy as a basis for sustainable finance policy, public spending, and investment programs. This could influence how public funds are allocated, ensuring that they are directed toward activities classified as environmentally sustainable.

5. Small and Medium Enterprises (SMEs)

While SMEs are not directly subject to mandatory reporting under the Taxonomy, they may be indirectly affected, particularly if they are part of the supply chains of larger companies or if they seek to attract sustainable financing.

6. Sustainable Bond and Green Finance Markets

Issuers of green bonds or sustainable finance products may use the Taxonomy to demonstrate that the proceeds of the bonds or investments will be used for Taxonomy-aligned projects, thus enhancing transparency in green finance markets.

The EU Taxonomy’s scope will continue to expand with the development of additional criteria for other sectors and environmental objectives beyond climate change.

Six Environmental Goals

Related to EU Taxonomy

Climate change mitigation

Climate change adaptation

Sustainable use & protection of water resources

Transition to a circular economy

Pollution prevention & control

Protection & restoration of biodiversity & ecosystem

The EU Taxonomy is built around six environmental objectives, each designed to help guide financial and business activities toward a more sustainable economy. These goals are critical to addressing environmental challenges, promoting transparency in financial markets, and directing investment toward environmentally sustainable projects. Here’s why these six environmental goals are important:

1. Climate Change Mitigation

Purpose: To reduce or prevent greenhouse gas (GHG) emissions, in line with the EU’s commitment to achieving net-zero emissions by 2050 under the European Green Deal and the Paris Agreement.
Why We Have It: Climate change poses a significant threat to ecosystems, human health, and economies globally. By prioritizing activities that actively reduce emissions (e.g., renewable energy, energy efficiency), the EU Taxonomy aims to accelerate the transition to a low-carbon economy and mitigate the impacts of climate change.

2. Climate Change Adaptation

Purpose: To make economies, infrastructures, and ecosystems more resilient to the impacts of climate change, such as extreme weather events, rising sea levels, and changing temperatures.
Why We Have It: Even with efforts to reduce emissions, the effects of climate change are already being felt. This goal encourages investment in activities that help adapt to these changes, ensuring that societies and businesses can continue to function effectively in a warming world. Adaptation is crucial for minimizing economic and social disruptions caused by climate-related risks.

3. Sustainable Use and Protection of Water and Marine Resources

Purpose: To safeguard water quality, ensure sustainable water use, and protect marine ecosystems from pollution, overfishing, and degradation.
Why We Have It: Water scarcity, pollution, and the degradation of marine ecosystems are growing global challenges. Freshwater and marine resources are essential for human life, biodiversity, agriculture, and industry. This goal aims to promote sustainable water management and protect marine environments from over-exploitation and damage.

4. Transition to a Circular Economy

Purpose: To move away from a linear economy (take-make-dispose) toward a circular economy where resources are reused, recycled, and kept in use for as long as possible.
Why We Have It: The linear economic model leads to resource depletion, waste, and pollution. By promoting circular economy principles, the EU Taxonomy encourages businesses to reduce waste, minimize resource extraction, and reuse materials. This helps reduce environmental impact and supports long-term sustainability by making more efficient use of finite resources.

5. Pollution Prevention and Control

Purpose: To minimize pollution of air, water, and soil, and reduce the release of harmful chemicals and waste into the environment.
Why We Have It: Pollution from industrial activities, agriculture, and urbanization significantly harms ecosystems, human health, and biodiversity. By emphasizing pollution prevention, the Taxonomy aims to support activities that reduce or eliminate the release of harmful substances, thereby improving public health and reducing the environmental footprint of economic activities.

6. Protection and Restoration of Biodiversity and Ecosystems

Purpose: To halt the degradation of ecosystems, protect endangered species, and promote the restoration of natural habitats and biodiversity.
Why We Have It: Biodiversity loss and ecosystem degradation threaten food security, climate regulation, and the provision of clean air and water. By focusing on the protection and restoration of natural systems, this goal seeks to reverse biodiversity decline and ensure ecosystems continue to provide essential services. Healthy ecosystems are critical to both the environment and the economy, as they support agriculture, fisheries, and tourism, among other sectors.

Why These Goals Matter Collectively

The six environmental goals of the EU Taxonomy are designed to work in harmony, addressing the most pressing environmental challenges of our time. They reflect the need for a systemic transformation across sectors and regions to ensure long-term sustainability.

Promoting Sustainable Investment: By setting clear criteria for what counts as environmentally sustainable, the EU Taxonomy channels investments into activities that contribute to achieving these objectives. This helps create a sustainable finance market where capital is allocated to projects and companies that support a green transition.
Preventing Greenwashing: The goals ensure that companies cannot falsely label their activities as “green” unless they meet rigorous, evidence-based criteria. This transparency helps investors and consumers make informed decisions.
Aligning with Global Climate and Environmental Targets: The EU Taxonomy aligns with the EU’s broader climate and environmental goals, such as the Paris Agreement, the European Green Deal, and the UN Sustainable Development Goals (SDGs). It supports global efforts to mitigate climate change, protect biodiversity, and promote sustainable development.

In essence, these six goals are about steering the economy towards a sustainable future, balancing economic growth with environmental preservation.

Current Adoption

Companies have increasingly adopted the EU Taxonomy to plan and highlight their investments in sustainable activities. On average, about 20% of their capital investments are now aligned with Taxonomy criteria, with the utilities sector—particularly electricity providers—leading the way at over 60% alignment .

Capital investments into Taxonomy-aligned activities have seen significant growth in 2024 compared to the previous year. In 2023, roughly 600 European companies reported capital investments of €191 billion in Taxonomy-aligned projects. By May 2024, reported investments had already reached €249 billion, indicating robust growth. The combined total for 2023 and early 2024 amounts to €440 billion, and this number is expected to increase as companies expand reporting to include the Taxonomy’s four additional environmental objectives, thus broadening the scope of eligible activities and companies .

Sector-wise data reveals that the utilities sector made the largest aligned investments, followed by consumer discretionary, industrials, energy, and real estate sectors. The number of companies reporting such investments also grew, with 723 companies reporting in 2023 compared to 608 in 2022, highlighting expanding adoption. Notably, Germany led in Taxonomy-aligned investments with €114 billion, followed by France (€63 billion), Spain (€60 billion), and Italy (€48 billion).

Stock market analysis suggests a correlation between Taxonomy alignment and positive market performance, as companies reporting higher alignment figures have consistently outperformed the overall market in recent years.

Banks & Financial Markets

Banks are increasingly incorporating the EU Taxonomy into their lending strategies and processes for evaluating companies’ investment plans. This alignment ensures that financial institutions prioritize projects that support sustainability goals. According to initial data, mortgages and loans connected to activities falling within the scope of the Taxonomy now represent, on average, over 50% of the asset portfolios of large EU banks. This demonstrates the growing role of the Taxonomy in shaping the financial sector’s approach to environmentally aligned investments.

In addition to this shift in banking practices, the EU continues to lead the global green bond market. In 2023, more than half of the worldwide green bond issuance originated from Europe, underscoring the EU’s commitment to funding sustainable projects and maintaining its position at the forefront of green finance initiatives.

Funds

56% of EU funds either promote environmental or social characteristics or have a sustainable investment objective as disclosed according to the Sustainable Finance Disclosure Regulation (SFDR)[5]. The assets aligned with the Taxonomy form a small, but growing part of what these funds invest in.

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CSRD vs EU Taxonomy

The EU Taxonomy and Corporate Sustainability Reporting Directive (CSRD) work together to enhance corporate accountability and transparency, creating a cohesive framework for sustainability in the corporate sector.

1. EU Taxonomy: Defining Sustainability

Classification Tool: The EU Taxonomy defines which economic activities are sustainable, providing a common language for companies, investors, and policymakers.
Key Objectives: It focuses on six environmental goals, like climate mitigation and pollution control, ensuring activities contribute meaningfully.
Driving Investments: By establishing sustainability criteria, the Taxonomy directs investments toward activities supporting the green transition, aiding the EU’s climate ambitions.

2. CSRD: Enhancing Transparency

Mandatory Disclosure: The CSRD mandates companies to report how their activities align with the EU Taxonomy, enhancing data transparency.
Broader Applicability: It extends reporting requirements to more companies, including large and listed SMEs, thus widening the scope of accountability.
Detailed Metrics: Companies must disclose ESG performance, ensuring stakeholders have reliable data to evaluate sustainability efforts.

3. How EU Taxonomy and CSRD Work Together

Alignment and Synergy: The Taxonomy defines sustainability standards, while the CSRD ensures companies disclose performance against those standards, aligning strategy with accountability.
Better Decision-Making: These regulations guide informed decisions by clarifying sustainability definitions and requiring transparent reporting, supporting responsible investments.
Driving Economic Resilience: By combining clear standards with reporting, the EU integrates sustainability into corporate strategy, aiming for carbon neutrality by 2050.

4. Impact on Corporate Strategies

Corporate Transformation: Companies adapt their business models to align with Taxonomy standards, moving towards more sustainable practices.
Level Playing Field: Clear definitions and disclosures provide a uniform assessment basis, reducing greenwashing by requiring verifiable sustainability evidence.

5. Future of Sustainable Finance

Boosting Green Finance: The synergy between Taxonomy and CSRD fosters sustainable finance, strengthening investor confidence in ESG performance.
Sector-Wide Change: Beyond financial performance, these regulations promote innovation, pushing companies across industries like energy and agriculture to create sustainable value.

High-Level Process

For EU Taxonomy

Step 1

Eligibility Assessment

Step 2

Activity Analysis

Step 3

Financial Mapping

1) Eligibility assessment:

Leveraging both finalized and draft legislation detailed in the following section, we comprehensively identify all eligible activities within our business. A consolidated list of reportable activities is then generated, alongside the identification of subject matter experts (SMEs) within each business area to facilitate the subsequent analysis phase.

2) Activity analysis:

We rigorously assess the alignment of our activities with the EU Taxonomy, conducting a detailed review against all Technical Screening Criteria, Do No Significant Harm (DNSH), and Minimum Social Safeguards (MSS) requirements. To streamline and enhance this process, we will be exploring the potential of extending Greenly software to ensure a clear and well-supported audit trail.

3) Financial mapping:

Subsequent to identifying eligible and aligned activities through the previous steps, we leverage existing and modified reports derived from our financial systems to report the financial Key Performance Indicators (KPIs) as stipulated in the EU Taxonomy.

Summary of the Alignment

EU Taxonomy

Environmental Objective	Eligible Activities (%)	Taxonomy-Aligned Activities (%)
Climate change mitigation	23%	8%
Climate change adaptation	5%	15%
Water and marine resources	23%	8%
Circular economy	23%	8%
Pollution prevention and control	5%	15%
Biodiversity and ecosystems	1%	15%

Eligibility vs. Alignment Analysis Across Key Environmental Objectives

The EU Taxonomy provides a structured approach to assessing the sustainability of various economic activities, aiming to ensure alignment with the EU’s climate and environmental objectives. Here is an analysis of specific sectors related to the Taxonomy’s key environmental goals, focusing on the eligibility and alignment rates of different activities:

Climate Change Mitigation

Currently, 23% of economic activities are eligible under the climate change mitigation criteria, yet only 8% are actually aligned. This significant gap between eligibility and alignment underscores the need for increased efforts to comply with the stringent sustainability requirements set by the Taxonomy. It suggests that while many activities theoretically qualify for climate mitigation efforts, meeting the practical, technical, and performance standards remains challenging. This gap presents an opportunity for companies to further refine their practices to better align with sustainability goals.

Climate Change Adaptation

For climate change adaptation, the alignment rate (15%) is notably higher than the eligibility rate (5%). This indicates that there is a concentrated effort on activities that enhance resilience to climate impacts, and companies are prioritizing such measures even if fewer activities are eligible initially. This trend shows that stakeholders are recognizing the strategic value of adaptation initiatives, which can serve to safeguard operations against climate-related disruptions and capitalize on the growing focus on climate resilience.

Water and Marine Resources

Both the eligibility and alignment rates for water and marine resources are at 8%, indicating that while the scope of eligible activities is still somewhat limited, efforts to align with sustainability objectives are consistent. This balanced percentage highlights an opportunity for stakeholders to invest in and improve sustainable water management practices and marine resource protection, contributing to better environmental stewardship in these vital areas.

Circular Economy

The circular economy presents a challenging scenario, with 23% of activities deemed eligible but only 8% achieving alignment. This disparity points to difficulties in effectively transitioning from a traditional linear model to a circular one, where waste is minimized and materials are reused. Achieving alignment in this area will require focused investments, technological advancements, and policy support to overcome the barriers to adopting circular economy practices across industries.

Pollution Prevention and Control

Pollution prevention and control shows a positive trend, with a 15% alignment rate compared to a 5% eligibility rate. This suggests that effective policies and advanced technologies are being successfully implemented to address pollution issues, resulting in substantial alignment beyond what is currently eligible. This progress is a positive indicator of the success of targeted measures to minimize pollutants and underscores the importance of innovation and regulatory compliance in reducing environmental impacts.

Biodiversity and Ecosystems

Despite a low eligibility rate of 1%, the alignment rate for biodiversity and ecosystem protection is 15%, pointing to the impact of targeted niche projects. These initiatives, though relatively few, are proving to be effective in enhancing biodiversity and ecosystem health. This trend emphasizes the potential to scale up these successful efforts, encouraging more stakeholders to adopt practices that benefit natural habitats and contribute to biodiversity restoration.

Conclusion

The comparison between eligibility and alignment across these environmental goals reveals important insights into where progress is being made and where challenges remain. For climate change mitigation and circular economy, the gaps between eligibility and alignment highlight areas that need greater focus, policy support, and investment to overcome barriers. Conversely, the higher alignment rates in climate change adaptation, pollution control, and biodiversity indicate successful strategies that could be leveraged and expanded to drive further positive impact. The EU Taxonomy, by setting clear criteria, continues to provide a critical framework for guiding these improvements and advancing overall environmental sustainability.

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