Welcome to the first edition of our ‘Reimagining CEE’ series, regular Law-Now e-alerts discussing ESG-related updates with a particular focus on the impact on businesses across Central and Eastern Europe.

Over the last two years, the abbreviation ESG and the word “taxonomy” have been on everyone’s lips, and they are about to become even more frequent in almost every business conversation, especially in CEE. The latest reason for this is the fact that the EU Taxonomy Regulation[1] took effect on 1 January 2022 regarding reporting on climate change mitigation and adaptation. This reporting has to be prepared from this year. The new obligation applies to large financial and non-financial companies subject to the transitional rules.

How does EU Taxonomy impact banks and businesses?

The EU Taxonomy Regulation is a 2020 piece of EU law which introduced a classification system setting out the criteria for recognising economic activities as environmentally sustainable. The primary purpose of this regulation is to give financial institutions (including banks, insurance undertakings and investment firms) an instrument which allows a standardisation of investments and comparison between those that are referred to as sustainable. Thus, if financial institutions claim to be financing sustainable targets, these should meet the EU Taxonomy Regulation requirements. Moreover, financial institutions have report appropriately.

But what does the EU Taxonomy Regulation mean for business? First, businesses obviously have to take it into account if they want to get financing, as this is what banks will look at. On the other hand, the EU Taxonomy Regulation added non-financial reporting requirements for businesses which applies right now. Thus, this is not a case of changes in the distant future but requirements to comply with immediately.

What is a sustainable investment?

A sustainable investment is an investment in one or several economic activities that qualify as environmentally sustainable. To qualify as environmentally sustainable, the economic activity has to (a) contribute substantially to one or more environmental objectives, (b) not significantly harm any environmental objectives, (c) be carried out in compliance with the minimum safeguards, and (d) comply with the technical screening criteria that the Commission has established.

The EU Taxonomy Regulation establishes 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.

For each objective, screening criteria are to be established in delegated acts. The first delegated act was adopted on 4 June 2021 and it regards climate objectives such as climate change mitigation and climate change adaptation. This delegated act establishes the criteria for activities such as manufacturing, energy, waste management, transport, and construction.

The remaining four objectives will be covered by another delegated act to be adopted in the first half of 2022. On 3 August 2021, the EU Platform for Sustainable Finance published a draft report with preliminary recommendations for technical screening criteria regarding the remaining four objectives. After feedback period, the report was to be submitted to the Commission in November 2021. However, the report is not an official Commission document and it is yet to be seen to what extent the Commission will take its recommendations into account.

Who should report what under EU Taxonomy?

Reporting under the EU Taxonomy Regulation is mandatory for financial and non-financial companies subject to publishing non-financial information under the Non-Financial Reporting Directive[2] (the NFRD). This includes large public-interest companies (including companies listed on regulated markets, banks and insurance companies) with more than 500 employees. These large companies must provide information on how and to what extent their activities are related to business activities that qualify as environmentally sustainable.

In 2022, mandatory reporting under the EU Taxonomy Regulation will be limited only to climate objectives: climate change mitigation and adaptation objectives. If the delegated act regarding the remaining objectives is issued in 2022, from 1 January 2023 mandatory reporting will also include the remaining objectives.

Essentially, large financial and non-financial companies need to provide information to investors about the environmental performance of their assets and economic activities. The scope of reporting in 2022 is limited. In 2022, non-financial undertakings need only disclose the proportion of EU Taxonomy-eligible and EU Taxonomy non-eligible economic activities in their total turnover, capital and operational expenditure, and qualitative information accompanying the KPIs. As of January 2023, non-financial entities will be obliged to report eligibility and alignment. The full reporting requirements will apply from this date.

Slightly different transitional rules apply to financial institutions, for which the transition period is longer and reporting in both 2022 and 2023 needs to disclose only EU Taxonomy-eligibility. However, from January 2024 financial entities will be obliged to report both taxonomy eligibility and alignment. The full scope of mandatory reporting for financial entities will start in January 2026.

Do nuclear energy and gas count as environmentally sustainable?

The range of activities included in the EU taxonomy is controversial for some, particularly regarding the omission of gas and nuclear energy. In December 2021, the European Commission started consultation on a draft of the complementary Delegated Act of the EU Taxonomy Regulation regarding certain gas and nuclear activities. It includes three fossil gas activities: electricity generation, high-efficiency cogeneration, and district heating and cooling. The gas activities are listed as transitional. Regarding nuclear activities, the draft includes demonstration units for advanced nuclear technologies, the construction of new nuclear power plants using best available technologies, and electricity generation from existing installations. The draft has not been adopted yet. This is still very important development for CEE which is coal dependent to a large extent and currently looking for new sources of energy generation. Opening the EU Taxonomy to nuclear and gas energy seems to be crucial for this purpose at least for the transitional period.

How will the EU Taxonomy reporting evolve?

Numerous factors may yet impact and further modify the reporting obligations under the EU Taxonomy Regulation. One of them concerns the fact that, on 21 April 2021, the Commission adopted a proposal for a Corporate Sustainability Reporting Directive[3] (the CSRD). The purpose of the CSRD is to amend the existing reporting requirements of the NFRD. Among the proposed changes, it is worth pointing out that the CSRD extends the scope of entities subject to the non-financial reporting obligation to all large companies regardless of whether they are listed on regulated markets - it will be sufficient to have basically more than 250 employees instead of 500. The criteria are binding on businesses across the board, no matter the sector or geography of operation, and it will therefore impact businesses operating in Central and Eastern Europe as well. Starting in 2026, it will further extend to small and medium-sized companies listed on regulated markets (except micro-enterprises). This in turn means that all such businesses will need to report under the EU Taxonomy Regulation, thus significantly widening its applicability.

What does this mean for banks and businesses?

Since the EU Taxonomy has already come into effect, now is the perfect moment to check whether from the legal perspective the reporting obligations are applicable to a given company and how to approach it. Many banks and businesses in CEE have already started looking at it. Even though the EU Taxonomy has already come into effect, there is still time to implement compliance measures, be them organisational changes, such as designating people responsible for ESG issues in the organisation, or implementing systems to capture the information that needs to be reported.

This may also be a good time to rethink the strategy of the company and consider making changes to its policies in order to focus more on environmental sustainability in line with the criteria set out in the EU Taxonomy Regulation or change investing strategies. This will allow better reporting and as a result enhance the ability to stay on top of the business opportunities which will more frequently concern sustainable companies over those that do not perform well regarding ESG. All this in particular concerns the CEE companies, which had already gone a long way to upgrade their environmental operation, but now will be challenged even further.