In the face of the European Green Deal and its ambitious objectives for climate and energy transformation by 2030, as well as Europe’s goal of achieving climate neutrality by 2050, the EU is taking a closer look at how it can make sustainability considerations an integral part of its financial policy. To do so, the European Union is cooperating with climate change experts and research centers to better understand how it can channel both private investment and public funds into the transition to a climate-neutral, climate-resilient, resource-efficient, and fair economy; the resulting strategy is the basis of the EU Sustainable Finance Action Plan (European Commission). Developed with the purpose of re-orienting investment towards sustainable technologies and businesses, the forward-looking plan is now well underway (EU Sustainable Finance Communication Factsheet). According to the European Commission, the progressive measures presented within the plan (and the recently-adopted sustainable finance package of April 2021) will be crucial for Europe to achieve climate neutrality by 2050, and are even expected to “make the EU a global leader in setting standards for sustainable finance” (European Commission).
One of the more important tools developed by the European Union as part of the EU Sustainable Finance Action Plan is a classification system called the “EU Taxonomy.” The system looks at a wide range of business sectors and examines economic activities within those sectors where environmentally sustainable practices may be applied. The classification system is essentially a guide for investors, companies, issuers, and project promoters alike, helping them adapt and transition to the economy of the future where resource efficiency and circularity reign king and carbon’s place is extremely limited.
Perhaps the most exciting part of the new Taxonomy is the establishment of performance thresholds for economic activities. For each activity listed, the Commission has defined what a “substantial contribution” towards at least one of the EU’s six environmental goals would look like (which include climate change mitigation, climate change adaptation, protection of water and marine resources, transition to a circular economy, pollution prevention, and the protection and restoration of biodiversity). While companies aim to meet the contribution criteria, they must ‘do no significant harm’ to any of the other 5 goals (as has been the norm across most recent EU sectoral policies relating to business performance). This ensures that a company’s actions while striving to meet the criteria for “substantial contribution” towards one goal does not negatively impact the progression towards achieving the other goals. In addition, companies must meet minimum safeguards (social standards), such as the OECD Guidelines on Multinational Enterprises or the UN Guiding Principles on Business and Human Rights, to be considered ‘Taxonomy-aligned.’
But what will drive companies to reach these performance thresholds? While some may aim to meet the ambitious criteria in hopes of achieving a better position in the market and in the eye of the consumer, the opportunity to attract investors is a strong pull. With investment firms around the world experiencing growing demand to focus on the pressing issue of climate change, while also seeing higher returns from companies committed to ESG than those that are not, investors are likely to prefer companies committed to one (or more) of the EU’s environmental goals. As companies who adopt climate-friendly practices prosper, more and more businesses will be likely to follow. While this cycle of sustainable performance and green investment perpetuates, companies who have been slacking in regards to their ESG commitments (or lack thereof) will likely struggle to find willing investors unless they adapt to the economy’s demands.
In order to facilitate the access and navigation of the EU Taxonomy for companies and investors, the European Commission has created an IT tool called the “Taxonomy Compass.” Here, companies can find their sector and the economic activity that is most applicable to their business. From there, a dedicated webpage for the activity provides criteria for contributing to one or more of the EU’s environmental goals, as well as the ‘do no significant harm’ criteria and the applicable minimum safeguards mentioned earlier. In addition, as the European Union Platform on Sustainable Finance further develops the Taxonomy, expanding its scope to social objectives and identifying activities that significantly harm or are neutral towards the environment, new substantial contribution criteria will be added to the Taxonomy Compass for ease of access and implementation.
The EU Taxonomy presents a significant opportunity for businesses, both small and large, to access increased levels of investment and experience growth while also contributing to the environmental goals of the European Union. For investors, on the other hand, the system promises superior security with unprecedented disclosure of business activities and their effect on the environment. Although adoption of the Taxonomy alone will likely be insufficient to spark the change that is necessary in the economy, it is a powerful tool that, when executed simultaneously with the other measures of the EU Sustainable Finance Action Plan, will be fundamental in increasing green investment and helping Europe become climate-neutral by 2050.
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