EU Taxonomy: Next step of CSRD & core reporting requirements
The EU Taxonomy (EUT) is a key requirement of the Corporate Sustainability Reporting Directive (CSRD) and the Sustainable Finance Disclosure Regulation (SFDR), forming part of the core regulations intended to drive the ambitions of the EU Green Deal. The EUT applies to all entities in scope of CSRD, as well as to additional financial market participants. Importantly, under CSRD, the process by which firms have reported against EUT, along with the disclosures themselves, are subject to mandatory independent limited assurance reporting. EUT is complex and time-consuming, therefore this blog provides a high-level guide to the steps companies should consider in approaching the need to report under EUT. Please refer to our blogs for further detail on application of CSRD.
EU Taxonomy reporting requirements
The EUT requires undertakings to identify, classify and report on the extent to which their economic activities are “sustainable”. To be considered “sustainable” in line with the European Green Deal objectives, the economic activity must meet:
1. the technical screening criteria (the criteria that defines whether an economic activity can:
- substantially contribute to an environmental objective, and
- do no significant harm (DNSH) to other environmental objectives
2. certain minimum social safeguards.
The key steps involved in EUT reporting require consideration of the following elements for each economic activity:
Step 1: Identification
To identify economic activities that might possibly be classified as environmentally sustainable, entities must first identify all business activities (internal and external) and map these to financial information. External activities are those that relate to the core products or services provided by an entity, i.e., activities that generate revenue, whereas internal activities are those that are not directly related to revenue generation but constitute internal activities reflected in investments and operating expenses, for example non production buildings and company vehicles.
Step 2: Eligibility
Once the comprehensive list of economic activities has been collated, the taxonomy-eligibility of each activity must be considered. When determining whether an economic activity is eligible, entities should consider whether the identified activity meets the “description of the activity” as listed in the respective delegated acts1. It should be noted that an eligible activity is one that is able to substantially contribute to one or more of the environmental objectives.
Step 3: Assessment
The activities identified in step 2 as being taxonomy eligible then need to be assessed for taxonomy-alignment (i.e., whether they are environmentally sustainable). This consists of three elements:
1. Firstly, entities must verify the substantial contribution (SC) of each activity to at least one of the six environmental objectives, demonstrated by meeting the relevant technical screening criteria as provided in the delegated acts (specifically for each activity).
2. Secondly, whilst verifying the SC of an activity, entities will need to ensure each activity does no significant harm (DNSH) to any other environmental objectives, once again by meeting the relevant technical screening criteria provided by the Delegated Acts. This ensures that the activity does not prevent another environmental objective from being achieved. The criteria used to identify if an activity does no significant harm are subdivided into generic and activity-specific.
3. Thirdly, in assessing whether an economic activity is taxonomy-aligned is to ensure compliance with minimum safeguards (MS). The purpose of the MS is to prevent activities and investments from being regarded as 'sustainable' if they don’t meet certain socials standards.
Step 4: Reporting
As part of final preparations for EUT reporting, entities must calculate KPIs indicating the percentage of economic activities that are taxonomy-aligned – per the considerations explored in the steps above. This is performed using mandatory reporting templates (available in Annex 2 of the Disclosure Delegated Act) and illustrates the extent to which an entity’s activities qualify as environmentally sustainable. The nature of KPIs to be disclosed differs depending on the nature of the undertaking. Non-financial entities are required to disclose three KPIs showing the percentage of taxonomy-aligned economic activities for turnover, capital expenditure (CapEx) and operating expenditure (OpEx), while financial undertakings are required to disclosure a GAR (Green Asset Ratio). These reporting templates should also reconcile to the financial statements produced, i.e., the total turnover, CapEx and OpEx reported by the entity.
Key Consideration
An economic activity can only be described as ‘green’ in taxonomy reporting once all four elements have been passed – eligibility, substantial contribution, do no significant harm and minimum safeguards. The key takeaway to meet EUT reporting requirements alongside existing sustainability reporting frameworks is to begin preparations early. As with CSRD early adopters, entities should think ahead for EUT and not wait until mandatory application, especially considering limited assurance requirements. As this blog has indicated, the definitions of what counts as eligible, aligned and meeting minimum safeguards, can be lengthy and subjective.
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References
1The EU’s Delegated Acts include the Climate Delegated Act, the Environmental Delegated Act, the Complementary Climate Delegated Act and the Commission Delegated Regulation 2023/2485.
