Think ESG: a view of the EU Taxonomy

This special Think ESG episode of the Better Finance podcast features Brian Tomlinson from Ernst & Young LLP, and Nathan Fabian, Chief Responsible Investment Officer at the Principles for Responsible Investment.

The discussion sheds light on the EU taxonomy:  a system for reporting on sustainable activities. The taxonomy is expected to be a lasting reform, with significant implications for companies with operations in the EU.

The EU has placed sustainable finance and the transition to a sustainable net-zero economy at the core of its growth strategy. Efforts were directed toward development of a taxonomy with standardized environmental performance criteria aligned with the Corporate Sustainability Reporting Directive, and the Sustainable Finance Disclosure Regulation. Communication and disclosure of progress toward alignment of companies’ economic activities with the taxonomy’s sustainability performance criteria was a priority. 

The EU taxonomy creates the concept of “green by law” and provides an objective set of largely science-based criteria by which activities are measured in order to be labeled and marketed as “sustainable.” The taxonomy structure  indicates when an activity makes a substantial contribution to one of six environmental objectives (climate change mitigation, climate change adaptation, water, circular economy, pollution and biodiversity) with no significant harm done to the other five.

A recent EY study examines the first-year results of the  application of the taxonomy and the disclosure practices adopted by EU companies in the first wave of reporting. 

Key takeaways:

• “Green” implies making a contribution to a sustainable environment by measuring activities  against a set of objective benchmarks developed by the EU.
• The taxonomy may operate as a “forcing function”— as companies will do significant work to map activities agains the taxonomy criteria.
  
• Companies initially should not expect high alignment with the taxonomy. The first round of reporting by EU companies showed low alignment numbers but high strategy commitment. Numbers are expected to increase over the next few years.
  
• Many investors will look at data (such as alignment of capex to taxonomy) to understand the seriousness of companies’ transition plans.