The Taxonomy Regulation was agreed at the political level in December 2019 and introduces an EU-wide taxonomy of environmentally sustainable activities and new disclosure requirements for certain financial services firms, including portfolio managers and AIFMs, offering financial products as environmentally sustainable investments (or as investments having similar characteristics). The Taxonomy Regulation will oblige managers in scope to make statements about how their financial products and activities are aligned with the taxonomy it specifies. It was published on 17 December 2019, and will come into force 20 days after its publication in the Official Journal of the European Union. It is not yet confirmed when it is expected to be published. However, it will apply only once all of the EU delegated acts, implementing measures and regulatory technical standards (“RTS”) (which have not yet been drafted or published) have come into force.

It is currently expected that the delegated acts concerning climate-related environmental objectives will apply from 31 December 2021, and the four remaining objectives will apply from 31 December 2022. (See “Further legislative developments” below.)

Overview - Taxonomy Regulation

In March 2018 the European Commission (“Commission”) developed a framework, “Action Plan on Financing Sustainable Growth,” to create a common language for sustainable finance (a sustainability taxonomy) which, together with the requirement for financial market participants to disclose the degree of environmental sustainability of their products, demonstrates that the EU is moving towards a clear framework for sustainable and long-term investments.

A key objective of the Action Plan is to reorient capital flows towards sustainable investment to achieve sustainable and inclusive growth. An EU-wide taxonomy is expected to have the benefits of both preventing the fragmentation of different Member States' systems and avoiding the practice of "greenwashing" – i.e., where a firm gains an unfair competitive advantage by marketing a financial product as environmentally friendly when, in fact, it does not meet basic environmental standards.

The Taxonomy Regulation therefore forms a key part of the Commission’s Action Plan on sustainable finance and is the backbone of a suite of three legislative measures to implement the action plan’s ESG strategy.

Additional legislative measures to supplement the Regulation have been developed which seek to impose new disclosure and transparency requirements concerning how institutional investors and asset managers integrate ESG factors into their risk and investment decision-making processes (the “Disclosure Regulation”)[1] and to establish a new category of benchmarks to assist investors in comparing the carbon footprint of their investments (the “Low Carbon Benchmarks Regulation”). The three Regulations form part of the capital markets union (“CMU”), an initiative of the Commission intended to strengthen EU capital markets.

The Taxonomy Regulation establishes criteria for determining whether an economic activity is environmentally sustainable for the purposes of establishing the degree of environmental sustainability of an investment.

In summary, it will provide businesses and investors with a common language to identify what degree economic activities can be considered environmentally sustainable (or "green"). It also obliges financial market participants and large public-interest entities to make statements about how their financial products and activities align with the taxonomy it specifies.

To be environmentally sustainable, an activity must satisfy four tests:

  • It must substantially contributeto one or more of the specified environmental objectives outlined in the Regulation (climate change mitigation; climate change adaptation; sustainable use and protection of water and marine resources; transition to a circular economy, waste prevention and recycling; pollution prevention and control; and protection of healthy ecosystems).
  • It must be carried out in compliance with minimum social safeguards.
  • It must do no significant harm (“DNSH”) to any of the other listed environmental objectives, and
  • It must comply with the technical screening criteria, which define what “substantially contribute” and DNSH mean to an environmental objective.

Technical Expert Group – Final Report

In June 2018, the Commission set up a technical expert group on sustainable finance (“TEG”) to assist it in determining whether an economic activity is environmentally sustainable under the Regulation. The TEG published its final report on the EU taxonomy on 9 March 2020. It contains recommendations relating to the overarching design of the taxonomy, as well as guidance on how firms in scope can make disclosures using the taxonomy. The report sets out the TEG's final recommendations to the Commission and contains:

  • Recommendations relating to the design of the taxonomy. The report focuses on what enabling activities are, the treatment of life-cycle considerations, and minimum safeguards. It also considers climate change mitigation and climate change adaptation (Chapter 2).
  • Guidance on how users of the taxonomy can develop taxonomy disclosures and provide direction on the disclosures that firms will need to make, including details about narrative disclosures, the presentation of disclosures and due diligence considerations (Chapter 3).

The technical annex in the report contains an updated list of screening criteria for 70 climate change mitigations and 68 climate change adaptation activities, including criteria for DNSH and other environmental objectives. It also includes an updated methodology section to support the recommendations on the technical screening criteria.

Further legislative developments

The Taxonomy Regulation will come into force 20 days after its publication in the Official Journal, with the requirements applying after the adoption of certain Delegated Acts. Delegated Acts will be developed by the Commission to further specify elements of the Taxonomy Regulation. In particular, Delegated Acts containing technical screening criteria will be developed in two phases:

  • Technical screening criteria for activities that substantially contribute to climate change mitigation or adaptation will be adopted by the end of 2020 and enter into application by the end of 2021.
  • The second set of technical screening criteria (covering economic activities substantially contributing to the other four environmental objectives) will be adopted by the end of 2021 and will enter into application by the end of 2022.

By 1 June 2021, the Commission will adopt a Delegated Act specifying how the corporate disclosure obligations should be applied in practice and will consider differences between non-financial and financial companies.

According to the UK Government’s current Brexit timetable, the implementation period agreed upon with the EU will have expired by the time the key aspects of the Taxonomy Regulation take effect. However, the UK Government has indicated that it will seek to match the ambition of the EU's sustainable finance Action Plan and appears to recognise that clear and consistent frameworks, such as green definitions and standards, will be important to ensure confidence in the effective functioning of the green financial sector. It is therefore prudent for UK firms to adhere to the plan that the provisions of the Taxonomy Regulation and related EU legislation will be implemented in the UK until such time as the UK Government indicates otherwise.