Navigation through the Rules of Sustainable Financing will be easier, the EU prepared the “Taxonomy Compass”

Symbolically on the Earth Day, the European Commission introduced a robust package of new measures aiming to support sustainable finances. These included the first set of technical criteria describing which economic activities most contribute to the meeting of the EU objectives relating to climate protection. The EU Taxonomy is thus more specific. The Commission additionally prepared a proposal of the Directive on reporting on the sustainability of companies that is to expand the requirements for reporting. And the sustainability of finances in the past quarter was additionally supported for example by the Platform on Sustainable Finance that introduced a set of its recommendations on how to improve the taxonomy in the future.

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The European Commission plans to expand the rules for non-financial reporting

In April 2021, the European Commission adopted a comprehensive package of measures that aim to redirect the financial capital towards more sustainable activities:

  • Delegated Regulation on the EU Taxonomy relating to climate which brings the first set of technical screening criteria for determining the conditions under which an economic activity qualifies as contributing substantially to climate change mitigation or climate change adaptation. As such, two (out of six) environmental objectives listed in Regulation (EU) 2020/852 on the establishment of a framework to facilitate sustainable investment are met.
  • Proposal for a Corporate Sustainability Reporting Directive (CSRD) which reviews the existing rules of non-financial reporting introduced by Directive 2014/95/EU on disclosure of non-financial information.
  • Six amending delegated acts on fiduciary duties, investment and insurance advice and investment and insurance product oversight and governance will ensure that financial firms include sustainability in their procedures and their investment advice to clients.

The Regulation on Taxonomy in climate protection includes economic activities falling into carbon intensive sectors such as power industry, manufacturing, forestry, transportation and construction industry. The determined criteria will help companies and participants in the financial market in the meeting of the obligations relating to the disclosure of information, and the making of investment decisions and planning of the transformation towards sustainability. The activities that significantly contribute to other objectives listed in the Regulation on Taxonomy in climate protection will be discussed by separate delegated acts.

As the new criteria are rather robust and they will further expand after the adoption of other acts, the Commission prepared The EU Taxonomy Compass. The compass is supposed to help its users in the orientation in the taxonomy and individual technical criteria. The compass enables search by sectors and by individual economic activities.

Pursuant to the CSRD, the requirements for the reporting on the impact of business models and strategy of obligated companies on the transfer to a sustainable and carbon neutral economy is to be expanded, according to binding standards of the EU for reporting on sustainability. The Commission considers that the CSRD would be the basis of a constant flow of information on sustainability for the involved entities, and information disclosed by entities would thus be available to banks, insurers, rating agencies, end investors and non-government organisations. The CSRD is supposed to additionally apply to all large and listed companies, which is up to 50,000 companies compared to approximately 11,000 companies to which the NFRD applies.

The above-mentioned six amending delegated acts build on the effectiveness of the Sustainable Finance Disclosure Regulation and Regulation amending the regulation on benchmarks adopted in March 2019. Changes resulting from these acts will take effect in October 2022. Amending acts bring the following changes for individual areas of financial services provision:

  • Fiduciary duties: amendment clarifying the duties of a financial company in an assessment of risks relating to sustainability.
  • Investment and insurance advisory: advisors will have to discuss the preferences of clients in sustainability when assessing the suitability of clients for investment.
  • Investment and insurance product oversight and governance: factors of sustainability will have to be taken into account in the proposal of financial products.

Platform on Sustainable Finance prepared a set of recommendations for an improvement in taxonomy

The European Commission commissioned the Platform on Sustainable Finance to provide it with advisory regarding the existing and potential use of taxonomy that would allow financing of the transition to sustainable economy. The PSF prepared the Transition Finance Report in which it summarises its conclusions and recommendations and groups them into three categories:

  • Increase in the reach of the current taxonomy framework while maintaining its integrity
  • Opportunities for the development of the future taxonomy framework
  • Use of other policies and tools for further support of transition financing

Although numerous requirements relating to the taxonomy are being finalised, the PSF identified several key areas for development of the current framework. The PSF considers it important for the Commission to better communicate the purposes and objectives of the taxonomy with the involved parties. Pursuant to that, it recommends to the Commission to provide the involved parties with a comprehensive overview regarding new reporting obligations in sustainability according to the SFRD, the NFRD and the Taxonomy Regulation as the new obligations may be confusing for them. Other proposals comprise the inclusion of more supporting activities in accordance with Article 16 of the Taxonomy Regulation focusing on energy efficiency, across the sectors.

The PSF sees the opportunities for development of the future taxonomy framework in the clarification of criteria and definitions which relate to the objectives of the regulation. According to the PSF, clear criteria would facilitate decision making to the companies and investors regarding the transition towards an increased sustainability. Creation of criteria for the activities that significantly damage the objectives of the regulation on taxonomy or, on the contrary, have a small or no impact on it, would be beneficial for the development in the taxonomy. Similarly, it would be appropriate, according to the PSF, to include the activities allowing the companies to discontinue operations of significantly damaging activities in the taxonomy. The first proposals in this area were published in mid-July but we will have to wait for the final report till autumn 2021.

As to the policies and tools outside the taxonomy framework, the PSF recommends to the Commission to clarify the connection between the EU standards for green bonds and the taxonomy and explain how companies may voluntarily publish the level of the compliance of its green bonds with the taxonomy. The PSF proposes, in addition to the taxonomy criteria, to use other tools and methodologies that would allow to define the transformation related to the climate on the level of companies such as for example metrics of the working group for the disclosure of financial information relating to climate or benchmarks of the EU for the economy transformation relating to climate.

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