The session brought together policymakers, lenders and investors to discuss challenges relating to EU taxonomy implementation and solutions for addressing them. As the workshop was held under the Chatham House Rule, quotes in this article have not been attributed to individual workshop participants.
The workshop served multiple purposes. It provided an opportunity for members of the sustainable finance industry to provide feedback on the recently released usability recommendations from the Platform on Sustainable Finance (henceforth referred to as the EU Platform). It gave representatives of banks, asset managers, asset owners, data providers, consultants and industry groups the opportunity to share their experiences of working to implement the EU taxonomy and their thoughts on how they would like to see the framework evolve. Finally, it allowed a member of the European Commission to respond to observations from market participants and to set out its plans for further taxonomy development.
The main areas of focus during the session were:
- Data availability and quality
- Do-no-significant-harm criteria
- Consistency between frameworks
In each section below we summarise the EU Platform’s relevant recommendations then the workshop participants’ reactions.
Whilst the focus of the workshop discussions was on implementation challenges, a number of participants took the opportunity to reaffirm their support for the EU taxonomy and what it aims to achieve. The European Commission states on its taxonomy webpage that the framework should “create security for investors, protect private investors from greenwashing, help companies to become more climate-friendly, mitigate market fragmentation and help shift investments where they are most needed.”
The workshop was held while COP 27 was taking place in Egypt. The annual COP brought renewed focus on the urgent need for the decarbonisation of the global economy. This was reflected in discussions during the session, with participants highlighting the role the EU taxonomy can play in achieving net-zero greenhouse gas emissions.
Data availability and quality
Selection of the EU Platform’s high-priority recommendations relating to data availability and quality for financial market participants’ taxonomy reporting:
- The European Supervisory Authorities (ESAs) should clearly define the term “equivalent information.”
- Alternative mapping tables for EU legislation referenced within the technical screening criteria should be provided. (These tables would map EU standards and rules to non-EU equivalents.)
- Supranational, sovereign and agency (SSAs) green bonds should be included in both the numerator and denominator of financial undertakings’ taxonomy disclosures.
- The “equivalent information” requirement should be applied to the legacy debt market.
Workshop participants described difficulties in obtaining high-quality data from investees as the most significant challenge they face in calculating taxonomy alignment figures.
The sequencing of EU regulation helps explain limited data availability. Investors are required to report on the level of alignment of their investment products with the taxonomy before companies that come under the scope of the European Union’s Non-Financial Reporting Directive (NFRD) have been mandated to report their own alignment with the EU taxonomy. In 2022, companies in the scope of the NFRD had to report only on taxonomy eligibility (share of activities covered by the taxonomy, without applying the technical screening criteria) and not on alignment. Only as of 2023 are non-financial companies required to report on alignment (see the PRI’s EU sustainable finance taxonomy briefing for more details).
Another challenge involves obtaining data on taxonomy alignment from non-EU issuers and assets that aren’t compelled by regulation to report the relevant figures.
A workshop speaker gave an overview of the disclosures made by companies to date: “Ten thousand European companies have reported eligibility, with 534 reporting alignment against the taxonomy. Twenty-five international companies have reported against the taxonomy.” Data availability on EU taxonomy alignment is currently patchy, as the overview makes clear. This is leading some investors to take a cautious approach, reporting the proportion of investments aligned with the taxonomy as zero until the coverage of data improves.
The regulation allows investors to include equivalent information from third parties in their taxonomy alignment disclosures in cases where issuers and assets are yet to publicly report. However, there has been uncertainty about what constitutes equivalent information. Workshop participants voiced support for the EU Platform’s call for the ESAs to clearly define what can be considered equivalent.
Outsourcing taxonomy data collection
Many of the investors in the workshop reported outsourcing data collection to data providers due to the amount of work involved in obtaining data on the taxonomy alignment of individual issuers and assets. Some investors shared concerns about the varying approaches taken by the data providers and called on them to be more transparent on their methodologies and to share more raw data so that investors can more easily compare assessments from different providers.
Corporate Sustainability Reporting Directive
The Corporate Sustainability Reporting Directive (CSRD) is expected to resolve many of the issues with data availability and quality.
The directive will require a far larger pool of companies to disclose taxonomy alignment than is currently required by the NFRD. Under the CSRD, all large European companies and all large third-country companies that have a subsidiary or branch in the EU will have to report on EU taxonomy alignment. The CSRD also requires reported sustainability information to be audited.
The CSRD requirements are being phased in over a number of years, with non-EU companies not being required to report until towards the end of this decade. A view expressed in the workshop is that the application of the CSRD will address many issues in time, but that challenges are likely to persist over the short to medium term.
The CSRD will go some way to requiring non-EU companies to report against the EU taxonomy, but many third-country issuers will be outside its scope, notably SMEs. This poses particular challenges for those investing in emerging markets.
The EU Platform has recommended that alternative mapping tables for EU legislation referenced within the technical screening criteria be produced to make it easier to assess alignment of non-EU entities.
The usability of the taxonomy remains a real focus for the European Commission.
A workshop participant raised the point that the development and entry into force of sustainability taxonomies that have a similar design to the EU taxonomy will facilitate data collection outside of the EU over coming years.
One participant raised the idea of having a single cross-jurisdictional sustainability taxonomy overseen by a global body, such as the International Sustainability Standards Board (ISSB). In response to the suggestion, other workshop participants highlighted the complexity and time that creating a single global taxonomy would likely entail. The work being done by the International Platform on Sustainable Finance was mentioned as a development that is set to promote interoperability and consistency between taxonomies.
The general consensus amongst the group was that taxonomies of sustainable activities are most likely to be useful to, and used by, investors when they can be applied outside of their home markets.
Asset class-specific issues
A concern for some investors in the workshop is the current lack in the EU Taxonomy Regulation and Delegated Acts of provisions for fixed income investors.
The disclosure templates for financial products do not allow investors to disclose the taxonomy alignment of their sovereign exposures in the numerator of the key performance indicators (KPIs). This is despite SSAs being significant issuers of green debt. On this basis, the EU Platform has recommended the inclusion of SSA use-of-proceeds instruments, such as green bonds, in both the numerator and denominator of financial undertakings’ taxonomy disclosures.
During the workshop session, some investors raised the issue of the costs and time associated with calculating taxonomy alignment.
These could be addressed by the launch of the European Single Access Point (ESAP). The ESAP would be a central hub into which companies would be able to report entity-level taxonomy-alignment data. This hub could allow investors to directly access the data they require. The ESAP is expected to become operational by 31 December 2024. Workshop participants expressed support for the ESAP but raised questions over how it would work in practice.
Communicating with stakeholders
One workshop participant suggested that taxonomy disclosures are currently difficult for external stakeholders – including institutional clients and retail investors – to understand. The KPIs don’t necessarily make sense to those who aren’t familiar with the taxonomy framework and/or financial jargon. Added to this, the reasons for the present low levels of taxonomy alignment for many investment products need to be clearly communicated, with issues around data availability being properly explained where necessary. The participant suggested there was a need for more education to build understanding of the taxonomy within the sustainable finance industry and beyond.
- Ensure all testing criteria have clear yes/no outcomes that can be objectively determined;
- Minimise subjective language;
- Ensure guidance is given on what a suitable yes/no outcome is for process-based tests, in the form of supplementary guidance;
- Allow for international application of EU legislation referenced in the Climate Delegated Act.
The group in the workshop raised a number of points regarding the DNSH criteria, including that their stringency leaves only a small pool of taxonomy-aligned investments.
One participant estimated that of the global universe of listed equities, only around five percent of shares have revenues that meet the EU taxonomy criteria for substantial contribution to the climate adaption and mitigation objectives. When the DNSH requirements are added, that already limited portion of shares shrinks to less than one percent of the universe.
Some in the workshop suggested the DNSH requirements should be relaxed for investors during the early years of taxonomy implementation. Others suggested that there should be a grading system in relation to the DNSH criteria. In practice, this would mean that investors would disclose the proportion of their holdings that meet the DNSH criteria (e.g. 50%, 75%). At present, the DNSH are applied on an absolute basis, so any holding that doesn’t meet them is not aligned with the taxonomy.
Some stressed the importance of upholding robust DNSH standards, while others advocated for an overhaul to the current requirements. The opinion of one participant was that “the do-no-significant-harm principle is currently too aggressive, but it should not be scrapped.”
While views varied on whether reform is required, there was relative consensus on the fact that the DNSH principle is unlikely be revised by the European Commission in the short-to-medium term.
Even though there were some calls for more significant changes, there was still broad support for the EU Platform’s recommendations to minimise subjective language in the existing DNSH criteria and to ensure all testing criteria have clear yes/no answers.
Consistency between frameworks
Selection of the EU Platform’s high-priority recommendations to promote consistency between the EU taxonomy and other regulatory frameworks:
- Seek greater alignment between the SFDR and the Taxonomy Regulation by:
- considering the use of taxonomy metrics and the underlying methodologies (even if the scope of application differs) to define environmental principal adverse indicators (PAIs);
- aligning social and governance PAIs and minimum safeguards of the Taxonomy Regulation;
- including a short list of always significant harmful social and environmental activities and term these “always principally adverse” in the absence of a taxonomy addressing always significantly harmful activities (or until such a taxonomy exists).
- Develop a simplified and easy to understand pre-contractual template which is tailored to the sustainability preferences.
- Ensure terminology that is used in the CSRD, the European Sustainability Reporting Standards and the Taxonomy Regulation / Delegated Acts is fully consistent, and identical where appropriate, with adequate references provided.
Figure 1: Assessment of Financial Products Under SFDR and Taxonomy
Source: The Platform on Sustainable Finance’s Recommendations on Data and Usability.
Multiple workshop attendees spoke of the need for greater coherence between different strands of the European Commission’s Action Plan on Financing Sustainable Growth. One participant contrasted the stringent requirements for EU taxonomy alignment with what he termed the “looser” framework for what constitutes a sustainable investment under SFDR. The SFDR definition of the term is “an investment in an economic activity that contributes to an environmental or social objective, provided that the investment does not significantly harm any environmental or social objective and that the investee companies follow good governance practices.” The speaker argued that investors are gravitating to the “looser” definition of what constitutes an environmentally sustainable investment, which may lead to greenwashing or misalignment of expectations in some circumstances. He urged policymakers to find a workable middle ground between the stringency of the EU taxonomy alignment requirements and what he sees as the relative ambiguity as to what counts as a sustainable investment under SFDR.
Another participant spoke of the work involved in conducting overlapping DNSH assessments. Under current rules, investees need to be assessed at entity level based on principal adverse impacts. Investors also need to assess economic activities of the underlying holdings against the DNSH criteria set out in the Climate Delegated Act under the EU Taxonomy Regulation. The EU Platform identified this issue in its analysis and has recommended the potential use of taxonomy metrics and the underlying methodologies (even if the scope of application differs) to define environmental PAIs within SFDR.
There was wide support among workshop participants for the EU Platform’s proposed measures for better integrating the different pieces of EU sustainable finance regulation.
The Platform on Sustainable Finance has an advisory role to the European Commission. Now that it has submitted its recommendations on usability and data, the Commissionwill need to assess how it can take these recommendations forward (either via legislative change or guidance).
We are at a critical moment. We must not let the ambition plateau; we need to keep moving forward.
Service provider participant
The recommendations from the EU Platform were welcomed by workshop attendees, with one describing them as “a step in the right direction.” The view was expressed that if the EU Platform’s recommendations are fully enacted, and the CSRD comes into force, then this will resolve many – although not all – of the current taxonomy usability issues.
Concern does remain about data availability from corporate issuers that: aren’t domiciled in the European Union; don’t have significant operations or subsidiaries in the EU; and don’t have securities listed on EU exchanges. Some participants expressed the view that additional measures are needed to ensure the EU taxonomy can be used to assess non-EU issuers and assets, notably those in emerging markets, as they have a particularly important role to play in achieving the Sustainable Development Goals.
It was suggested that international cooperation on taxonomy development should be a priority over coming years.
In the immediate future, the European Commission is taking a series of actions to deal with current usability challenges:
- The EU Taxonomy Compass – a searchable database on the eligible economic activities that contribute to the taxonomy’s environmental objectives – is to be updated.
- The Delegated Act that specifies the disclosure obligations under Article 8 of the Taxonomy Regulation will undergo a legislative review.
- New members will join the Platform on Sustainable Finance, whose next mandate will run from Q1 2023 to Q4 2024. The EU Platform will continue to have a dedicated workstream on data and usability and will provide expert opinion on the development of the taxonomy.
In December 2022, the European Commission published an FAQ on the EU Taxonomy Climate Delegated Act, and another on the Article 8 Delegated Act, to provide additional clarity and aid implementation.
Progress is clearly being made, but substantial work still needs to be done to ensure that the market can harness the full potential of the EU taxonomy. UNEP FI and the PRI will continue to seek to provide support to their members and signatories as they work to implement the framework.
This workshop on taxonomy implementation formed part of a series of sessions the PRI is running on the EU Sustainable Finance Action Plan. Future sessions will cover disclosing PAI indicators under SFDR and other related topics. If you are a PRI signatory and wish to participate in future sessions, please contact us.