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Feb 01 2024

European Taxonomy Regulation Simplified | Why, What and How of the European Taxonomy Regulation?

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European Taxonomy Regulation Simplified | Why, What and How of the European Taxonomy Regulation?

Attention all financial market participants and large companies operating in the European Union! The game has changed, and you're now playing by a new set of rules. The European Taxonomy Regulation has arrived, and it's not just another piece of bureaucratic red tape. It's a game-changer that can help you attract a flood of green investments, but only if you can navigate the complex maze of taxonomy criteria.

Why the European Taxonomy Regulation?

The EU introduced the Taxonomy Regulation to establish a unified classification system for sustainable economic activities. The regulation aims to provide investors and other stakeholders with a common language to identify environmentally sustainable investments and prevent greenwashing. It's part of the EU's broader sustainable finance agenda to redirect capital flows towards sustainable projects.

What does the Taxonomy Regulation require?

Under the Taxonomy Regulation, financial market participants and large public-interest entities must disclose the proportion of their turnover, capital expenditure, and operating expenditure aligned with the taxonomy. The regulation sets out 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, and protection and restoration of biodiversity and ecosystems.

How to comply with the Taxonomy Regulation?

Companies must assess their economic activities against the technical screening criteria for each environmental objective. They must disclose the proportion of their turnover, capital expenditure, and operating expenditure that is taxonomy-aligned in their non-financial statements or separate reports. Financial market participants must disclose the taxonomy alignment of their financial products in pre-contractual disclosures and periodic reports.

If you haven't started preparing for the Taxonomy Regulation, you're likely to get nudges from your investors to comply. At some point, you'll cave in because a little over half of the large companies and financial market participants in the EU are already assessing their taxonomy alignment. Companies are scrambling to gather data and prepare disclosures. The EU ranked 14 globally in the number of companies reporting under the Taxonomy Regulation in the quarter ended December, according to a report by the Global Reporting Initiative (GRI) earlier in April.

There's much to brag about one of the most comprehensive sustainable finance frameworks in the world, even though the EU is not providing any financial incentives for compliance. Still, companies, per the GRI report, are not happy about the quality of the taxonomy criteria or feel no difference between the Taxonomy Regulation and other sustainable finance regulations.

The EU's sustainable finance story is a tangled web of contradictions and inconsistencies. Just when you thought you had it all figured out, the powers that be are set to shake things up again. Mark your calendars for 20 May, because that's when the Taxonomy Regulation is going under the microscope. But don't hold your breath for any groundbreaking changes. It's likely to be a subdued affair, with just a few minor tweaks here and there. After all, companies aren't exactly clamoring for new taxonomy criteria, except for a few small morsels to keep the regulators at bay.

It's time to get off the Taxonomy Regulation high horse and assess the regulation for what it is. The European Commission—the executive branch of the EU—and global sustainability experts portrayed the Taxonomy Regulation as an almost utopian solution. They oversold it: as an enhanced transparency tool for investors; as a window to new sustainable finance opportunities; and as a channel to launch low-carbon transition plans.

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