EU Commission publishes sustainable finance package including Taxonomy Delegated Acts and FAQ

On 13 June 2023, the European Commission published a package of measures on the development of the EU sustainable finance framework.

The Commission acknowledges that, while the existing sustainable finance framework is beginning to work as intended, companies are facing challenges when transitioning to a climate neutral and sustainable economy. These challenges include identifying solutions where green technologies are not yet available, articulating sustainability objectives and actions as part of their business strategies, and complying with higher environmental standards. It also acknowledges that complying with disclosure and reporting requirements is also challenging. 

Therefore, the Commission has published a package of measures that aims to:

• ensure the EU sustainable finance framework continues to support companies and the financial sector, while encouraging the private funding of transition projects and technologies;
• increase the transparency of sustainable investments; and
• ensure the usability of the framework for companies of different sizes, business models and with different starting points in the transition.

The package is accompanied by a press release, Q&A and Factsheet and includes the following documents:

Communication on sustainable finance framework that contains an overview of the package of measures, as well as recently published ESRSs under CSRD.

• In particular, the Communication indicates that a consultation on assessing the SFDR will be launched in autumn 2023, which will focus on assessing shortcomings in the SFDR in order to improve legal certainty, enhance usability and improve the legislation's role in mitigating greenwashing.
• In addition, the Commission plans on continuing to provide guidance to support the application of rules in a clear and effective way. It will also assess gaps and usability concerns and how to address them. Specific focus will be placed on assessing how to make the sustainable finance framework more usable and inclusive for SMEs. Another priority will be to continue work on facilitating transition finance, including by exploring how to better integrate the taxonomy into the framework in a simple and user-friendly way. The Platform on Sustainable Finance and the European Supervisory Authorities (ESAs) will provide input into this work.
• The Communication also says that it is the ultimate intention of the Commission that when a company reports sustainability information in accordance with the European sustainability reporting standards (ESRS) under the CSRD, they will be deemed to be compliant with global standards, which is why the Commission has been working closely with the International Sustainability Standards Board (ISSB) and the Global Reporting Initiative (GRI). For more information on the ESRSs, see our previous blog post.

The Communication is accompanied by a Commission staff working document which provides an overview of the key pillars of the regulatory sustainable finance framework and summarises actions taken to enhance the usability of the Taxonomy and the wider sustainable finance framework.

• In particular, the Commission says it plans to adopt another guidance document relating to the Taxonomy Regulation by the end of 2023, which will focus on taxonomy alignment reporting obligations for financial undertakings that are required to report their green assets ratio (GAR) and other KPIs from 1 January 2024.
• It also says the Taxonomy Compass and Taxonomy Calculator will be expanded to cover activities under the wider environmental objectives.
• As part of the future review of the Taxonomy Disclosures Delegated Act, the Commission will assess whether and how to include entities outside the scope of Taxonomy reporting in the KPIs of financial institutions, including SMEs. The Commission is working with the Platform on Sustainable Finance (PSF) and the ESAs to monitor reporting under Article 8 of the Taxonomy Regulation.
• The PSF has been tasked to deliver recommendations to the Commission:

• to ensure the Taxonomy criteria and disclosures are usable on the ground for in-scope entities; and
• to enhance the usability of the Taxonomy for non-EU businesses or economic activities conducted outside the EU.

Recommendation on transition finance (together with an Annex) that provides guidance and practical examples to companies and the financial sector on how they can use the various tools in the EU sustainable finance framework (including the Taxonomy) to approach transition finance and manage their climate change and environmental risks.

• “Transition finance” is understood as the financing of climate and environmental performance improvements to transition towards a sustainable economy, at a pace that is compatible with the EU’s climate and environmental objectives. The Recommendation provides definitions of “transition”, “transition finance” and “transition plan”. Market participants can apply this Recommendation to both the climate and environmental transition.
• Recommendations are given for each type of market participant, in particular:
  • Undertakings are encouraged to use sustainable finance tools, such as the Taxonomy, not only to disclose Taxonomy-aligned activities and capital expenditures, but also as a forward-looking tool for their transition process, using the criteria of the Taxonomy as reference points for setting targets.
  • The Commission acknowledges that transition plans are currently not mandatory, but they are emerging as one of the key forward-looking tools. Undertakings, especially those with activities that involve material impacts or complex transition pathways, can develop transition plans at either the undertaking level or activity level or both, to articulate transition targets, milestones, actions and resource needs in a structured and consistent way. 
  • The transition finance needs of an undertaking are defined as planned capital and operating expenditure relating to achieving climate and environmental targets as well as current or targeted revenue related to the transition. Undertakings can determine their transition finance needs by voluntarily using the Taxonomy, alongside other science-based reference points, when setting transition targets for specific economic activities in economic sectors covered by the Taxonomy Delegated Acts.
  • Undertakings are encouraged to use transition-related financing instruments to raise transition finance, such as green or other sustainability loans, green or other sustainability bonds (with special mention of the European Green Bond Standard which could be considered to finance economic activities that will become Taxonomy-aligned in 5 (exceptionally 10) years), equity financing or specialized lending solutions (leasing, structured finance solutions, project financing and blended finance instruments). However, the Recommendation does not go into any further detail on specialised lending solutions.
  • The Recommendation notes that financial intermediaries can contribute to the financing of the transition by reflecting transition financing objectives in their lending or investment strategy while investors and asset owners can develop similar approaches for their own assets. Financial intermediaries are encouraged to engage with clients and investee undertakings on transition, including through transition-specific financing solutions.
    Financial intermediaries and investors are encouraged to assess how their transition targets and transition finance objectives align with and contribute to their risk management strategies, to address financial risks arising from misalignment with the transition.
  • It also notes that SMEs interested in raising transition finance will need proportionate arrangements (given their size, administrative capacity and resources) and are therefore encouraged to engage with financial intermediaries and investors to explore the available financing options and support services. Large undertakings are strongly encouraged to support in a proportionate manner the SMEs in their value chain that are interested in transition financing, in assessing transition finance needs and (where relevant) obtaining key sustainability information, whether or not they fall within the scope of mandatory sustainability reporting.
  • Member States are encouraged to raise awareness among market participants of the need to finance investments in the green transition and of the existing standards, principles and safeguards that can ensure the credibility and environmental integrity of such investments. The Commission notes that Member States could encourage cooperation between market participants to share best practices in providing or seeking transition finance and addressing common challenges. Member States could also encourage and promote innovative sustainable finance products and services tailored to SMEs, taking into account the principle of proportionality as well as encouraging multilateral development banks and national promotional banks to support these efforts by offering technical assistance.
  • The Recommendation is non-binding and does not impose any new obligations. The draft Recommendation has been “approved in principle”, with its formal adoption in all official languages of the EU taking place later when the language versions are available. 
  • UPDATE: The Recommendation was published in the Official Journal of the EU on 7 July 2023. 

Proposal for the regulation of ESG ratings providers –see our previous blog post.

Taxonomy Delegated Acts which contain technical screening criteria for the remaining four environmental objectives under the Taxonomy Regulation (known as “Taxo4”) and amend the existing Taxonomy Climate Delegated Act to include climate adaption and mitigation technical screening criteria for additional economic activities (such as some manufacturing activities and some transitional activities in the transport sector). 

• The Commission notes that both drafts have been “approved in principle” and their formal adoption in all the official languages of the EU will take place later on, as soon as the language versions are available. Once the Commission has formally adopted the two Delegated Acts, the European Parliament and Council will then have four months (which can be extended by an additional 2 months if either party requests it) to scrutinise the Delegated Acts. They do not have the power to amend the Delegated Acts – the most they can do is veto it. 
• Provided neither the European Parliament nor the Council object to either of the Delegated Acts, these would then be published on the Official Journal of the EU and would apply from 1 January 2024. 
• We have published a separate blog post about these Delegated Acts.

FAQs on the EU Taxonomy and links to the SFDR which:

• address certain issues related to minimum safeguards – in particular, the Commission has clarified that, in the context of Article 18(2) of the Taxonomy Regulation, the link between the minimum safeguards and the principle of “do no significant harm” (DNSH) of the SFDR is to be understood, as a minimum, through the SFDR principal adverse impact (PAI) indicators for social and employee matters, respect for human rights, anti-corruption and anti-bribery matters listed in table 1 in Annex I to the SFDR – with exposure to controversial weapons being the additional “uplift” required due to the consideration of the SFDR PAIs; and
• clarify that investments in “environmentally sustainable economic activities” within the meaning of the EU Taxonomy can be assumed to pass certain aspects of the test for being a “sustainable investment” within the meaning of the SFDR (including automatically qualifying when the investment is solely in Taxonomy aligned economic activities). This clarification intends to encourage the use of the taxonomy framework as a base for a common understanding of what environmental sustainability means in EU financial products and use of proceeds instruments. The clarification is surprising given the proposal for a Taxonomy “safe harbour” in the ESA’s recent consultation paper on amendments to the SFDR RTS, and earlier commentary that the Taxonomy and SFDR tests should be applied separately. The position of the FAQ seems to be that this proposed “safe harbour” already exists. It is worth watching how this apparent discrepancy is resolved.
  

Taxonomy User Guide, which is designed to help non-financial and financial undertakings assess their Taxonomy eligibility and alignment. It is meant to be a practical reference guide, focussing on key implementation steps and specific illustrative "use cases". It includes three sections:

• a section on "context", including relevant policy developments and an introduction of the EU Taxonomy;
• a section on "how to navigate the EU Taxonomy", including an overview of the key implementation steps and practical “use cases” covering main challenges and potential benefits; and
• "conclusions", including key takeaways, links to other reporting initiatives and further developments.