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The EU taxonomy mandate continues to evolve, but with their sustainable initiatives? Many questions remain. Why is it important for banks? And how can they help with this topic?
What is European taxonomy? According to the European Union, “the EU taxonomy is a classification system, establishing a list of environmentally sustainable economic activities. Simply put, it’s a tool that lists particular commercial activities that the EU regards as sustainable.”
The EU taxonomy meets two crucial needs:
1. It provides a shared language for discussing sustainability.
2. It employs objective, quantifiable standards for evaluating enterprises.
The terminology used by other sustainable finance laws and organizations (such as Ecolabel and the Green Bond Standard) varied in the past. One essential goal that was set at the EU level was to create a climate-neutral European economy by 2050 via the EU Taxonomy Regulation. This regulation, at the very least, created a unification of definitions, measurements, and missions.
The EU taxonomy has identified six primary environmental objectives:
1. Climate change mitigation
2. Climate change adaption
3. Protection of aquatic and marine resources
4. Making the switch to a circular economy
5. Pollution control
6. Protection of the ecosystem
The EU taxonomy adopts a more rigorous approach, using a science-backed initiative. The EU taxonomy is important because it enables companies and investors to make sound, conscious investments for a sustainable future.
Further, it provides a working framework to put everyone on an even playing field that allows investors to better understand how different companies compare to each other. Additionally, it will assist with business decision-making and make it more difficult for businesses to hide behind ad-hoc marketing plans.
All significant European businesses covered by the NFRD (Non-Financial Reporting Directive), i.e., public interest entities with more than 500 employees, are subject to EU taxonomy rules.
Participants who offer goods in the EU that support environmental goals must also disclose their relevant information.
How is European Taxonomy affecting banking clients?
Currently, companies covered by the Non-Financial Reporting Directive (NFRD) started disclosing the percentage of their operations that the Taxonomy Regulation deems to be “environmentally sustainable” since the beginning of 2022.
After January 1, 2023, more businesses will start submitting reports in accordance with the Corporate Sustainability Reporting Directive (CSRD), which replaces the NFRD.
The percentage of a company’s revenue, capital investment, and operating expenses that can be attributed to at least one of the six environmental goals will need to be explained by the company by referencing the pertinent Technical Screening Criteria (TSC).
Companies must also explain how they meet minimal social and governance criteria, as well as how they avoid violating other environmental standards. Banking clients need to embrace the EU taxonomy and how it might alter their frameworks, reporting requirements, and systems.
Banks help with EU taxonomy
By giving businesses the chance to evaluate their performance and advancement in achieving environmental goals, banks are helping clients to succeed with EU taxonomy.
A strong taxonomy alignment should enhance a company’s reputation, and make them more appealing to banks and investors while increasing its access to financing.
How will the taxonomy be applied by lenders and investors?
Asset managers and investment firms must disclose key performance indicators that demonstrate how closely a portfolio adheres to a taxonomy. Additionally, banks will have to declare their Green Assets Ratios (GAR).
The degree to which their investment products fall under articles 8 (investments promoting environmental or social characteristics) and 9 (sustainable investment products) of the Sustainable Finance Disclosure Regulation (SFDR) is required disclosure for financial market participants in the EU. The EU taxonomy should be an effective tool to help with investment decision-making as well.
What are the effects if your company is not based in Europe via EU taxonomy?
The EU taxonomy will have an impact on enterprises beyond the EU that provide products in Europe.
The European Commission released a report last year expanding the taxonomy’s coverage to include economic activities that have a minimal impact on environmental sustainability, those that have a significant negative impact on it, as well as other sustainability goals, like social ones. Other nations, like the UK, Canada, China, and Japan, are now following suit and creating their own taxonomies.
Although it will take time, it’s expected that international green finance norms will begin to converge. This is already beginning to become apparent. A paper outlining an analysis of similarities between various issues was published at COP26, called The Common Ground Taxonomy (CGT). Time will tell the extent of bringing international alignment into place.
Conclusion
By joining the Net-Zero Banking Alliance (NZBA), banks can match financing and investment portfolios with the essential course for attaining carbon neutrality by 2050. Precise metrics and data are needed to attain net zero. The EU taxonomy is a useful framework for achieving these goals.
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