Funds that took due account of environmental, social and governance (ESG) factors in their investment strategies generally outperformed their conventional counterparts during the Corona pandemic (FT, 3 April 2020). At the same time there is an omnipresent call to align the economic recovery in Europe with the ‘green transition’ (FT, 18 June 2020). In sharp contrast to this emphasis on the importance for investors to take ESG factors on board when making investment decisions stands the uncertainty about the requirements an investment must meet to be actually sustainable.
On 18 June 2020 the European Parliament decided to remedy the lack of clarity by adopting the Taxonomy Regulation which defines an environmentally sustainable economic activity. More specifically, it sets out the broader framework within which the European Commission will have to come up with the technical criteria an economic activity must adhere to in order to be considered environmentally sustainable. This contribution will give an overview of the key changes brought by the Taxonomy Regulation.
The definition of what makes an economic activity sustainable will lie at the center of an emerging legal framework for sustainable finance. Creating such a legal framework pioneered as a priority in the Action Plan on Building a Capital Markets Union of 2015 and was translated in more concrete policy in the Action Plan: Financing Sustainable Growth of 2018 based on a blueprint designed by the High-Level Expert Group on Sustainable Finance. In particular the latter Action Plan’s goal to reorient capital flows towards sustainable investments justified the adoption of a detailed EU classification system – or taxonomy – to make it clear for investors which activities qualify as ‘green’ or ‘sustainable’.
Leaving it to the market or member states to define ESG was deemed to lead to the use of different and incomparable concepts which could diminish confidence in sustainable finance and hamper the functioning of the internal market. Numerous examples of borderline cases seemed to provoke some controversy about where to draw the line between being sustainable and gaining an unfair competitive advantage by marketing a financial product as for example environmentally friendly, when in fact basic environmental standards have not been met (greenwashing).
This lack of confidence in sustainable finance is especially problematic for the European Union in upholding its commitments under the Paris Agreement to keep global average temperature well below 2°C above pre-industrial levels, and under the UN Sustainable Development Goals which it pledged to use as an overarching policy framework. With the adoption of the EU Green Deal and the proposal for an EU Climate Law, the commitment to become climate neutral by 2050 is likely to become a legally binding obligation. The financial markets’ role in reallocating ownership of capital is thereby an essential enabler in attaining these climate goals. It must ensure that sufficient capital is available to economic activities that fit in or evolve towards a climate neutral Europe in a science-based way.
The definition of an environmentally sustainable economic activity under the Taxonomy Regulation consists of three requirements that will be specified in so-called technical screening criteria developed by the European Commission in delegated acts within the boundaries set by the Regulation. In order to be environmentally sustainable, an economic activity must (i) substantially contribute to one or more of the environmental objectives (ii) without significantly harming any of the environmental objectives while (iii) being carried out in compliance with the minimum safeguards as set out in the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights.
The environmental objectives referred to are climate change mitigation, climate change adaptation, use and protection of water and marine resources, the transition to a circular economy, pollution prevention and control, and the protection and restoration of biodiversity and ecosystems. In other words, the taxonomy as it stands focuses on climate change and other environmental challenges, as opposed to social and governance factors. In principle, it also leaves the qualification of all other activities intact, regardless of how harmful they are. In practice, however, the ‘do no significant harm’-element of the definition could serve as a minimum standard in assessing the particularly unsustainable nature of certain activities.
The Taxonomy Regulation gives a broad interpretation of the first requirement of making a ‘substantial contribution’ by also including economic activities directly enabling other activities to make a substantial contribution to one or more of those objectives (enabling activities). For the objective of climate change mitigation which aims at stabilizing the greenhouse gas concentrations in the atmosphere, it also includes so-called transitional activities which support the transition to a climate neutral economy by being consistent with a predetermined pathway. The latter makes the taxonomy a transition tool that companies can use as a guide to follow a credible, science-based pathway to becoming climate neutral by 2050 even if there are no alternative climate neutral ways to perform an economic activity yet. In general, it can be said that, by including enabling and transitional activities, the taxonomy uses an inclusive definition and does not only focus on the most obvious sustainable economic activities.
The Taxonomy Regulation also amends the so-called ESG Disclosure Regulation applicable to ‘financial market participants’ being collective investment funds, insurance undertakings making insurance‐based investment products available, credit institutions and investment firms providing portfolio management, and manufacturers and providers of certain pension products. When these financial market participants offer a financial product with sustainable investment as its objective, they are inter alia required under the ESG Disclosure Regulation to provide a description of their sustainability objectives and the methodology or index used to measure the objective.
With the amendment of the Taxonomy Regulation, financial market participants will have to inform investors about the alignment of these financial products with the Taxonomy Regulation. Their precontractual disclosures and periodic reports must include a description of how and to what extent the investments underlying the financial product qualify as environmentally sustainable under the Taxonomy Regulation and which environmental objective(s) set out under the Taxonomy Regulation they contribute to.
The same information must be provided for sustainable financial products that do not meet the threshold of ‘sustainable investment’ as set out under the ESG Disclosure Regulation but nevertheless promote environmental characteristics. For this catch all category of financial products that are less ambitious regarding sustainability, the above-mentioned information must be complemented with the following disclaimer:
‘The “do no significant harm” principle applies only to those investments underlying the financial product that take into account the EU criteria for environmentally sustainable economic activities.
The investments underlying the remaining portion of this financial product do not take into account the EU criteria for environmentally sustainable economic activities’
All other financial products must add the following disclaimer to their precontractual disclosures and periodic reports:
‘The investments underlying this financial product do not take into account the EU criteria for environmentally sustainable economic activities.’
The second category of mandatory users are undertakings that are required to publish (consolidated) non-financial statements. These statements will have to contain information on how and to what extent the undertaking’s activities are associated with economic activities that qualify as environmentally sustainable under the Taxonomy Regulation. In doing so they must identify the proportion of their turnover derived from products or services associated with environmentally sustainable activities as well as the proportion of their capital expenditure and the proportion of their operating expenditure related to assets or processes associated with economic activities that qualify as environmentally sustainable.
Lastly, Member States and the EU must use the definition of the Taxonomy Regulation when setting out requirements for financial market participants or issuers in respect of financial products or corporate bonds that are made available as environmentally sustainable.
Next to these three categories of mandatory users, there are already several other voluntary applications. The taxonomy has for example been assigned to guide investment in the European Commission’s €750 billion Covid-19-recovery instrument, Next Generation EU. More generally, the Commission indicates in its policy that public investments in the economic recovery should respect the green oath to “do no harm” and 25% of the EU budget will be spent on climate-related investments.
It took the European legislator over two years to adopt the Taxonomy Regulation since its proposal in May 2018. In the meantime a Technical Expert Group has been developing possible technical screening criteria to support the European Commission in adopting its delegated acts. The Technical Expert Group published a final report and annex with the criteria for some economic activities that can substantially contribute to climate change mitigation or adaptation, including an assessment of significant harm to other environmental objectives as well as guidance for the abovementioned disclosures. The Taxonomy Regulation requires the delegated acts for climate change mitigation and adaptation to be adopted by 31 December 2020 and for the four other environmental objectives to be adopted by 31 December 2021. Each time the application of the delegated acts is foreseen at the latest one year after the adoption. Currently a Platform on Sustainable Finance is being established which will take over the advisory role of the Technical Expert Group and monitor the taxonomy.
By adopting the Taxonomy Regulation, an important step is made in providing clarity to investors what sustainability means in a language that is useable in a financial markets context. The introduction of the general framework is of course only the beginning of a process which tends to become more political when more technical issues need to be resolved, as previous tensions over nuclear energy have shown. The European Commission is also running a public consultation until 15 July 2020 to serve as the basis for a renewed sustainable finance strategy as part of the EU Green Deal which will be adopted in September 2020. The extension of taxonomies defining sustainable economic activities will most likely play a key role in this renewed strategy as well.
Arnaud Van Caenegem
Jan Ronse Institute
 Position Council, 15 April 2020, Regulation on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088, 5639/2/20 REV 2 as endorsed by the European Parliament: Legislative resolution European Parliament, 17 June 2020, on the Council position at first reading with a view to the adoption of a regulation of the European Parliament and of the Council on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088 (05639/2/2020 – C9-0132/2020 – 2018/0178(COD)), P9_TA-PROV(2020)0130 (hereafter: Taxonomy Regulation).
 Communication European Commission, 8 March 2018, Action Plan: Financing Sustainable Growth, COM(2018) 97 final, 4.
 Whether a bond issued for buying fuel-efficient tankers transporting oil from offshore drilling sites could be marketed at green triggered for instance divergent responses in the market (FT, 18 October 2019).
 Communication European Commission, 8 March 2018, Action Plan: Financing Sustainable Growth, COM(2018) 97 final, 2.
 Article 3, d Taxonomy Regulation.
 Article 3 Taxonomy Regulation.
 Article 9 Taxonomy Regulation.
 There is a ‘review clause’ in Article 26, §2, b Taxonomy Regulation which would allow an extension of the taxonomy to social objectives and even gives leeway for the development of a taxonomy of particularly unsustainable economic activities.
 Article 16 Taxonomy Regulation.
 Article 10, §2 Taxonomy Regulation.
 Regulation Council and Parliament nr. 2019/2088, 27 November 2019 on sustainability‐related disclosures in the financial services sector, Pb.L. 9 December 2019, L 371, 1 (hereafter: ESG Disclosure Regulation).
 Article, 2, §1 ESG Disclosure Regulation.
 Article 9 and 11 ESG Disclosure Regulation.
 Article 5 Taxonomy Regulation.
 Article 6 Taxonomy Regulation.
 Article 7 Taxonomy Regulation.
 Article 19a or Article 29a Directive Council and Parliament nr. 2013/34/EU, 26 June 2013 on the annual financial statements, consolidated financial statements and related reports of certain types of undertakings, amending Directive 2006/43/EC of the European Parliament and of the Council and repealing Council Directives 78/660/EEC and 83/349/EEC Directive 2013/34/EU, Pb.L. 29 June 2013, L 182, 19.
 Article 8 Taxonomy Regulation.
 Article 4 Taxonomy Regulation.
 Communication European Commission, 27 May 2020, Europe’s moment: Repair and Prepare for the Next Generation, COM(2020) 456 final, 6.
 Article 10, §6; 11, §6; 12, §5; 13, §5; 14, §5; 15, §5 Taxonomy Regulation
 F. SIMON, “‘Do no harm’: Nuclear squeezed out of EU green finance scheme”, 6 December 2019, EURACTIVE.com; C. BARBIERE, “Paris, Berlin divided over nuclear’s recognition as green energy”, 28 November 2019, EURACTIVE.com.