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European Commission publishes final climate change taxonomy delegated act

The April 2021 sustainable finance package 

The European Commission has published today (21 April) the final version of the delegated act containing the technical screening criteria for climate change adaptation and mitigation under the Taxonomy Regulation (see Commission press release).

This forms part of a wider package of other sustainable finance documents published today:

This blog post focuses on the Taxonomy Climate DA. 

Separate blog posts on the Corporate Sustainability Reporting Directive (CSRD) proposal and the amendments to sectoral legislation will follow shortly.

Background: Taxonomy Regulation in a nutshell

The Taxonomy Regulation sets out an EU-wide framework (a classification system) according to which investors and businesses can assess whether certain economic activities are “sustainable”. Think of it as an EU dictionary of what activities may and may not be called green or sustainable. The initial focus has been on defining what is sustainable in climate terms but the intention is to come up with rules on other environmental sustainability objectives, and to extend the taxonomy to social objectives at a later stage.

The Taxonomy Regulation is one of the pillars of the EU’s sustainable finance and climate change agenda and forms part of a wider package of sustainable finance legislation, which includes the Disclosure Regulation (SFDR) and the Low Carbon Benchmarks Regulation (see Sustainable Finance Sources: survival guide).

The ultimate aim is to encourage the flow of capital from the financial sector to companies engaged in, or transitioning to, more sustainable activities so that the EU can meet its climate change goals. That’s what the EU sustainable finance agenda and the European Green Deal are all aiming for: carbon neutrality by 2050. And in order to do that, the EU needs investors to redirect a vast amount of capital into the right type of projects and companies. Investors say they need better information on which to base their investment decisions so that they are not led astray or discouraged by “greenwash” claims. The EU taxonomy is designed to combat greenwash and help everyone identify what is or is not green/sustainable.

The taxonomy is not a mandatory list of activities to invest in. The Commission has been at pains to make it clear that: “While the EU Taxonomy can guide market participants in their investment decisions, it does not prohibit investment in any activity. There is no obligation for companies to be Taxonomy-aligned and investors are free to choose what to invest in.”

So the Taxonomy Regulation does not require parties to invest in taxonomy-eligible activities or prevent them from doing so. Rather, it provides the toolkit for assessing whether a financial product or business is environmentally sustainable. The intention is to provide a clear long-term incentive to direct financial flows toward green investments.

The Taxonomy Regulation also introduces a mandatory requirement (Article 8) on financial and non-financial companies to disclose information on how, and to what extent, their products and businesses are aligned with the taxonomy - so that investors can make more informed decisions. This disclosure requirement is in effect a nudge to corporates and financial institutions to demonstrate sufficient redirection of capital into environmentally sustainable activities. 

In order for an economic activity to qualify as “environmentally sustainable” under the taxonomy, the activity must satisfy four tests:

  1. it must contribute substantially to at least one of the environmental objectives;
  2. it must “do no significant harm” (DNSH) to any of the other environmental objectives;
  3. it must be carried out in compliance with minimum social and governance safeguards; and
  4. it must comply with technical screening criteria to be adopted under the Regulation.

The Regulation sets out six environmental objectives:

  1. climate change mitigation;
  2. climate change adaptation;
  3. water;
  4. circular economy;
  5. pollution control; and
  6. biodiversity.

The Commission needs to adopt technical screening criteria (TSC) for each of the six environmental objectives, fleshing out in detail what it means for an economic activity to substantially contribute to an environmental objective and DNSH to the other objectives. This will be done through delegated acts (DAs). The taxonomy cannot apply in practice until the TSC for the relevant objectives have been adopted.

For more information on the Taxonomy Regulation, see EU Taxonomy Regulation: a detailed analysis.

Taxonomy Climate DA: what’s what 

After months of protracted and painful consultations and negotiations, the Commission published the final DA with the TSC for climate change adaptation and mitigation on 21 April. The DA is accompanied by Annex I and Annex II

The DA should be alongside the accompanying Communication on EU taxonomy, corporate sustainability reporting, sustainability preferences and fiduciary duties.

The Commission estimates that the economic activities of around 40% of EU listed companies in sectors which are responsible for almost 80% of direct greenhouse gas emissions in the EU will be covered by this DA. 

The TSC are meant to be dynamic and will be subject to regular review so that new sectors and activities, including transitional and enabling activities, may be added to the scope over time by amending this DA. Stakeholders will have the opportunity to suggest activities to be included in the TSC via a web portal, which will be established in mid-2021 on the European Commission website. The Commission, with input from the Platform on Sustainable Finance (PSF), will assess the suggestions.

The Taxonomy Climate DA will be formally adopted at the end of May once translations are available in all EU languages. We don't expect the content to change substantively in the adopted versions that will be published in May, as the text has been politically agreed.

Once formally adopted, the DA will be scrutinised by the European Parliament and the Council for four months, which can be extended by an additional two months. If the DA survives the scrutiny process, the climate TSC will then apply from 1 January 2022.

The EP and Council do not have the power to amend the DA – they must either approve or reject it, on qualified majority voting rules, so no one single Member State can veto the DA on its own. 

What about natural gas and nuclear power?

The biggest question on everyone’s minds has been whether natural gas and nuclear power will be included in the taxonomy and under what conditions.

We already knew that a decision on nuclear power would come later in the year and would be subject to a supplementary DA.

What was much less clear is what would happen with natural gas. Initial leaked drafts of the Taxonomy DA in recent weeks suggested that natural gas would be included in the taxonomy but this has now been removed to allow for further discussion. The conditions under which natural gas is capable of making a substantial contribution to the net zero transition is proving to be hugely controversial, not just across industry but also amongst Member States and EU officials.

The Commission Q&A published alongside the Taxonomy DA says the following:

Is nuclear power included or excluded from the EU Taxonomy?

The Taxonomy Regulation reflects a delicate compromise on whether or not to include nuclear energy in the EU Taxonomy. In 2020, the Commission launched in-depth work to assess the issue. As a first step, the Joint Research Centre, the in-house science and knowledge service of the Commission, drafted a technical report on the ‘do no significant harm' aspects of nuclear energy. This report is currently being reviewed by two sets of independent experts, the Group of Experts on radiation protection and waste management under Article 31 of the Euratom Treaty and the Scientific Committee on Health, Environmental and Emerging Risks on environmental impacts. The two Committees have three months to issue their assessment. The two assessment reports, along with the JRC report, will inform the Commission's decision. As soon as this process is complete, the Commission will follow up based on its results in the context of the Taxonomy Regulation.

Is natural gas included or excluded from the EU Taxonomy?

The Taxonomy Regulation neither includes nor excludes natural gas in the EU Taxonomy. The inclusion of natural gas has been subject to a technical assessment and public feedback, just as for other sectors. In this context, public feedback revealed a wide range of views among stakeholders on whether and how natural gas-based energy technologies should be recognised in the EU Taxonomy, notably as a potential transitional activity facilitating the switch from coal and oil to renewables.

The complementary Delegated Act, to be adopted later this year, will cover natural gas and related technologies as transitional activity in as far as they fall within the limits of the EU Taxonomy Regulation. 

In addition, the Commission will consider specific legislation covering the gas activities that contribute to reduce greenhouse gas emissions but cannot be covered within the EU Taxonomy as they do not meet the screening criteria. All this will be based on technical and scientific expertise. 

According to the Commission Communication, the Commission will adopt a complementary DA covering activities not yet covered in the current DA, such as agriculture, certain energy sectors and certain manufacturing activities. This DA will cover nuclear energy, subject to the results of the expert review mentioned above. It will also cover natural gas and related technologies as transitional activities, insofar as they fall within the limits of Article 10(2) of the Taxonomy Regulation. The  Communication states that the "merits of a sunset clause for transitional activities will be  considered in this context". And that the Commission will adopt this complementary DA "as soon as possible after the  end of the specific review process expected in summer 2021". 

The Commission will also consider separate legislation to support the financing of certain economic activities, primarily in the energy sector (including gas), that contribute to reducing greenhouse gas emissions and support the transition towards climate neutrality but which do not meet the climate TSC in the taxonomy.

What about the TSC for the other four environmental objectives in the taxonomy?

The TSC for the other four remaining environmental objectives are being developed by the PSF, which replaced the TEG last year.

Our understanding is that the PSF is expected to consult on draft recommendations on these TSC in April 2021 and submit its final recommendations to the Commission in May 2021. The Commission is then expected to consult in July 2021 on a draft DA with TSC for the remaining four environmental objectives. Although it's possible there may be some slippage in these timings. 

The DA with the TSC for the remaining four environmental objectives needs to be adopted by 31 December 2022 so that it can start applying from 1 January 2023.

The European Commission has today adopted an ambitious and comprehensive package of measures to help improve the flow of money towards sustainable activities across the European Union. By enabling investors to re-orient investments towards more sustainable technologies and businesses, today's measures will be instrumental in making Europe climate neutral by 2050.