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The market for green financial products has experienced tremendous growth in recent years. However, for a long time it was uncertain whether these products were light, dark green or even in fact grey. The extensive Taxonomy Regulation (Regulation (EU) 2020/852) that came into force in July 2020 seeks to increase transparency within this market by providing criteria on the contribution of economic activities to environmental objectives. How this Regulation is structured and what the impact is, is explained in this article.

Criteria for environmental sustainability

How the Taxonomy Regulation elaborates which economic activities may bear the stamp ‘(environmentally) sustainable’ is in the context of a number of criteria.

(i) Objectives

Firstly, the Regulation sets six objectives in the field of climate and environment. An economic activity must make a substantial contribution to at least one of these objectives. A contribution is substantial if a company crosses a threshold set for the activity or performs even better based on technical screening criteria. The following sustainability objectives are used in this context:

1. combating climate change (climate mitigation);
2. adaptation to climate change (climate adaptation);
3. the sustainable use and protection of hydrological and marine resources (water);
4. the transition to a circular economy that includes both waste prevention and recycling (circular economy);
5. the prevention and control of pollution (pollution control), and
6. the protection of healthy ecosystems (biodiversity).

Of the above targets, the first two (climate mitigation and adaptation) will come into force in January 2022. The last four objectives (water, circular economy, pollution control and biodiversity) will come into force on 1 January 2023.

(ii) Do no significant harm

If there is a substantial contribution to one or more objectives, a second criterion applies: do no significant harm. This criterion implies that the economic activity does not cause significant damage to the other objectives. For example, buildings that contribute to climate mitigation and adaptation are not ecologically sustainable if they have a significant impact on biodiversity or are polluting.

(iii) Social minimum standards

Although the above objectives give an interpretation of ecological sustainability and not (yet) so much of a social and governance dimension, the third criterion focuses on social minimum standards. It was initially proposed to take account of the International Labour Organisation’s Declaration on Fundamental Principles and Rights at Work. This includes standard labour rights such as the prevention of forced labour, freedom of association, the right of employees to organise and bargain collectively, equal pay for men and women and the prevention of child labour. Ultimately, the scope was extended to include the OECD Guidelines for Multinational Enterprises, the UN Guiding Principles on Business and Human Rights and the International Bill of Human Rights. As a result, a wide range of social provisions apply to the assessment of the sustainability of economic activities.

(iv) Technical screening criteria

As can be seen above Taxonomy Regulation provides a broad framework for assessing economic activities. Nevertheless, the interpretation of these criteria may differ per economic activity. In order to provide a thorough assessment framework, the Commission has therefore created the technical screening criteria in delegated acts. These criteria do not provide a separate criterion in themselves but specify how the above criteria must be fulfilled per economic activity. These criteria are based inter alia on scientific evidence and existing market practices and may be modified or supplemented over time.

Types of economic activities

In addition to the above criteria, the Taxonomy Ordinance also sets out different types of economic activities that may meet the criteria. The following activities are considered to comply with the regulation:

1. Low carbon activities: activities that have low greenhouse gas emissions such as transport, energy production and reforestation.
2. Enabling activities: activities that lead to greenhouse gas savings from other economic activities. These activities must not create any lock-in that undermines long-term environmental objectives and they must have a positive impact on the environment on the basis of their life cycle. For example, building wind turbines or producing A++ household appliances.
3. Transitional activities: activities that have significantly lower greenhouse gas emissions than the average in the sector or industry, which also have to avoid lock-in of carbon intensive assets or processes. Examples are the renovation of buildings or the production of cement.

Impact

In conjunction with the Sustainable Finance Disclosure Regulation (“SFDR”), financial market participants – such as banks, fund managers, insurers, certain pension providers and investment firms – must disclose the extent to which their financial products contain investments in sustainable economic activities according to the criteria of the Taxonomy Regulation. This information must be widely disclosed in, among other things, fund prospectuses, periodic reports, investor information and annual reports. The Taxonomy Regulation also applies outside the financial sector. Companies that are required to report on non-financial information under the Non-Financial Reporting Directive (‘NFRD’) and the future Corporate Sustainability Reporting Directive (‘CSRD’) will have to assess whether their economic activities are sustainable on the basis of the Regulation. In addition, financial institutions will also be more demanding with respect to transparency regarding the economic activities of the companies they finance. Therefore, the Taxonomy Regulation will also have an impact on the creditworthiness of companies.

In this article you have read that the Taxonomy Regulation provides a comprehensive legal framework with the aim of increasing information about the sustainability of economic activities on the market. This Regulation will have an impact both within and outside the financial sector. Do you have questions about the Taxonomy Regulation and its specific impact on your business? Then please contact Law & More. Our lawyers are specialised in sustainable business law and will be pleased to help you!