For anyone looking to get financing in the European Union, you will have heard of the words “EU Taxonomy.”

Originally launched in 2018, the EU taxonomy aims to standardise the way financial institutions assess investments and better drive the transition to a low-carbon economy.  

Why do we need an EU taxonomy?

The OECD estimates that to meet the Paris Agreement goals, we need to invest 6.35 trillion Euros annually in infrastructure.

To invest that amount of money without certainty that it is helping us meeting the Paris Agreement would be folly. And yet, is it easier said than done? How can investors ensure that money is going into technologies and projects that are genuinely shifting the needle towards a low carbon future, as opposed to projects that are not making an impact or creating a problem elsewhere?

Anyone that has been in the sustainability field for long enough knows that there are many different ways to report and analyse the environmental impact of projects, and without some level of standardisation and agreement on definitions and boundaries, you could be looking at two very different answers to the same problem.

That’s why the EU Taxonomy is so important. It gives investors a common language and understanding of a very complicated sector, and creates a comparable framework and basis to work from.

Why now?

The European Green Deal announcement in December 2019 highlighted the importance of green finance and the need to align financial signals and capitals flows and help accelerate green investment. The Commission spent nine months developing a sustainable finance strategy which would help investors classify and verify sustainable investments – the EU taxonomy is part of this effort.

Even before the Green Deal passed, the European Parliament adopted regulation in April 2019 mandating disclosure relating to sustainable investments and sustainability risks. Under this regulation, financial players must disclose the sustainability impacts of investments.

Without a common language and before this regulation, it was easier to hide investments that were not contributing towards climate action. This can’t happen anymore if we are to meet our global net zero targets, so the need to report accurately and transparently on carbon-heavy investments is critical, as well as sustainable investments.

What does the EU taxonomy include?

The EU Taxonomy is a classification system for investors and businesses alike to report on the progress of meeting the screening criteria, and the achievements of meeting sustainability targets.

The taxonomy was originally developed to help investors classify low carbon investments in the following sectors:

• Agriculture, forestry and fishing
• Manufacturing
• Electricity, gas, steam and air conditioning supply
• Water, sewerage, waste and the related remediation
• Transportation and storage
• Information and Communication Technologies
• Buildings, construction and real estate

Within these industries, the taxonomy covers six key impact areas:

• Climate change mitigation
• Climate change adaptation
• Sustainable and protection of water and marine resources
• Transition to a circular economy
• Pollution prevention and control
• Protection and restoration of biodiversity and ecosystems

These areas encompass economic activities that are contributing to the key environmental objectives that the EU has identified as critical to achieving its commitment for carbon neutrality and ultimately its commitment to the Paris Agreement.  

The taxonomy asks investors to do three things with investments that are classified as sustainable within those sectors. Financiers must analyse investments across the identified impact areas and ensure that investments:

• Substantially address at least one of the six objectives
• Do no significant harm to any of the other five environmental objectives (so one contribution should not be harming other areas)
• Comply with minimum safeguards

While in and of itself, the taxonomy is for classification, it is also tied to other financial mechanisms, such as the EU Green Bond standard, low carbon benchmarks and other corporate disclosures.

The final taxonomy, which was issued in March 2020, is currently being rolled out across banks and financial institutions. For more information, visit the European Commission website.

As more and more countries set net zero emissions targets, the taxonomy will continue to gain importance as international finance takes a bigger role for the transition.

Next month we will look at how EDGE aligns with the EU taxonomy, so stay tuned!