In 2022, the EU introduced a Taxonomy to help meet 2030 climate and energy goals. This framework is a key component of the EU’s broader ESG strategy. While the Taxonomy was designed to facilitate sustainable investments, it has been criticized as complex and lacking global alignment. In response, the European Commission tasked the EU Platform on Sustainable Finance (PSF) with recommending ways that the Taxonomy could be simplified, resulting in four core proposals to modify the tool.
Here, we highlight the Taxonomy’s history, PSF’s report proposals, and potential benefits for sustainable disclosures and investments.
Background on EU Taxonomy for Sustainable Activities
The EU introduced the Taxonomy in 2022 with its Action Plan on Sustainable Finance, a financial strategy to progress European Green Deal objectives and ambitious 2030 climate and energy targets. Hailed as a progressive and first-of-its kind framework, the Taxonomy was structured to be both a mandatory and voluntary classification tool capable of driving sustainable investments by measuring the sustainability performance of investments and business activities.
Numerous companies, public entities, and financial actors, however, criticized the Taxonomy for its complexity, imposed reporting burden, limited usability, and inadequate harmonization with other international classification systems and frameworks. For example, the tool can be difficult to apply to different economic activities because of complexities in definitions, analyses, and criteria. Inconsistencies in tool use and users’ understanding of reporting requirements have also led to significant variations in business disclosures.
PSF’s Recommendations to Modify the EU Taxonomy
To address these concerns and ensure the EU’s sustainability policies are not an obstacle to business competitiveness, the European Commission tasked PSF, an external expert advisory body, with finding ways to simplify the Taxonomy and improve its utility. PSF welcomed the challenge and after years of analysis and public consultation, issued a detailed report, with four core proposals.
- Proposal No. 1: Reduce the Corporate Reporting Burden. PSF determined that a primary obstacle to the Taxonomy’s effectiveness is its reporting burden. To reduce reporting obligations, PSF recommended subtle changes in reporting requirements, increased flexibility, and improved alignment with other financial reporting frameworks. For instance, PSF suggested simplifying operational expenditure (OpEx) reporting to align more closely with financial reporting standards. PSF also proposed a materiality threshold for corporate Key Performance Indicators (KPIs), which would allow companies to exclude immaterial business segments from their reporting.
- Proposal No. 2: Simplify and Improve Green Asset Ratio (GAR) Disclosures. PSF found that a second obstacle to Taxonomy effectiveness is the inability to compare disclosures due to limitations in the design and use of GAR disclosures. To improve these disclosures and increase sustainable investments, PSF recommended ensuring ratio symmetry, allowing estimates for non-EU and retail exposures, simplifying retail assessments, and aligning disclosures with other ESG disclosure and reporting frameworks. PSF similarly recommended a gradual integration of exposures into GAR, streamlining small and medium-sized enterprises (SMEs) reporting, and including sovereign and government agency exposures with the option to use estimates. Finally, to enhance data accessibility and usability, PSF recommends establishing safe harbors for financial reporting and providing clear guidelines on the use of estimates, proxies, and data sources.
- Proposal No. 3: Take a Practical Approach to “Do No Significant Harm” (DNSH) criteria. PSF determined that a third obstacle to the Taxonomy’s effectiveness is that DNSH criteria is overly complex and cannot be applied to financial and non-financial entities equally. To reduce this complexity, PSF recommended a review of DNSH criteria for non-financial companies, such as simplified turnover considerations, and reduced verification and documentation requirements for financial institutions. Additionally, PSF suggested introducing materiality principles to ensure proportionality in reporting while setting clearer Key Performance Indicator (KPI) thresholds for turnover and capital expenditure assessments. PSF also encouraged a temporary “comply or explain” approach for DNSH assessment of the Turnover KPI, which would alleviate some reporting obstacles.
- Proposal No. 4: Incorporate Ways for SMEs to Access Sustainable Finance Options. Finally, PSF concluded that the Taxonomy, in its current form, puts a significant reporting burden on SMEs. PSF therefore recommended numerous changes in criteria and reporting requirements to reduce, streamline, and simplify SME reporting obligations.
Next Steps for the EU Taxonomy
PSF’s report and recommendations will be a topic of discussion during European Commission meetings on EU Sustainability Policy, which are currently underway. If the European Commission chooses to adopt PSF’s recommendations, the EU Taxonomy could be overhauled through a legislation package with proposed changes.
Potential Impact on Sustainability Disclosures and Investments
While PSF’s core proposals for refining the EU Taxonomy need further examination and public consultation, they represent a positive step forward. PSF’s proposals aim to preserve the EU’s objectives of increasing sustainable investments, while addressing key challenges in Taxonomy use, such as reporting burdens and complexity.
Simplifying the Taxonomy, aligning it with other international reporting frameworks, and streamlining the process for users is welcome as it will undoubtedly facilitate more effective engagement. Having a more straightforward and practical tool for reporting, with clarified definitions and requirements, will also simplify the process for businesses to manage sustainable investments and meet the Taxonomy’s reporting requirements.
In turn, businesses may have improved access to sustainable finance options. Financial institutions will also have access to more accurate, helpful, and comparable information to inform sustainable investment decisions, making the Taxonomy a more practical tool for advancing sustainability in the European market.
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