Future-Proof Business Through EU Taxonomy Alignment

Carolina Angarita-Cala

25.03.2024



Future-Proof Business Through EU Taxonomy Alignment

Since the beginning of the decade, the EU has been focused on improving the market for sustainable investment, while increasing transparency and investor protection. A significant body of work has been undertaken to identify and reduce the risk of greenwashing*, mostly through regulation, while accelerating investment into a more sustainable economy. This decade alone, the European Commission (EC) is mobilising at least 1 trillion euro of sustainable investment, with disclosure and clear definitions to ensure capital flows into environmentally sustainable economic activities a key priority.

 

These measures can have far-reaching implications for financial advisors. The EU Taxonomy Regulation (TR) for classifying green investments, for example, aims to boost private sector investment in sustainable projects. The TR is an impressive body of work where all economic activities have been classified using science-based criteria to understand their impact on the environment, and how effectively they contribute towards achieving environmental objectives. Simply put, Taxonomy-aligned investments offer the most accurate and comprehensive description of what works when it comes to solving an environmental challenge.

 

The six objectives or areas of focus in the TR are: (1) climate change mitigation, (2) climate change adaptation, (3) pollution prevention, (4) circular economy, (5) biodiversity conservation, and (6) sustainable use of water. Taxonomy-aligned activities must also comply with minimum social safeguards (e.g., human rights) and do no significant harm (DNSH) to any of the six environmental objectives. The DNSH principle ensures that actions taken to support one environmental objective don’t generate negative impacts elsewhere.

 

For a client wishing to invest with sustainability in mind, Taxonomy-aligned products are an option. The product’s suitability for the client will be considered alongside other aspects like returns, risk, and liquidity.

 

Taxonomy-alignment is disclosed at revenue level, as well as capital expenditure (CapEx) and operational expenditure (OpEx). Currently, disclosure is mandatory for approx. 11,000 companies in the EU, with this number increasing to c. 60,000 companies in 2026. This data is audited and included in companies’ annual reporting.

 

Taxonomy alignment creates a common language and criteria across a company’s value chain, mitigating disruption and delay, as well as building resilience. It is likely that companies outside the scope of mandatory disclosure will be affected indirectly through larger partners in the supply chain, as the purchase or sale of goods and services to those larger firms will form part of their Taxonomy alignment. This will also have implications for access to capital, as financial services providers seek to fulfil their own Taxonomy-related disclosure. Therefore, voluntary alignment with the Taxonomy may make strategic sense for many firms not subject to mandatory alignment.

 

The Stick and the Carrot

 

What appears to be a regulatory burden, is in fact helping future-proof businesses in the EU. Reporting on taxonomy-alignment gives a clear picture of where a company stands in relation to EU sustainability goals. The goal of carbon neutrality by 2050, with an interim target to cut emissions in half by 2030, is enshrined in the EU Climate Law. That interim date is just six years away.

 

Stronger incentives for investors to be green are expected in the coming years. A carbon price that impacts companies’ revenues beyond the current scope of the EU’s main carbon pricing scheme (which currently covers just under 50% of emissions in the EU) will help focus investors’ minds. A company’s ability to pass on the cost of carbon to consumers will be based on its pricing power and competitive position, while its strategic direction will be apparent through increases in R&D and capital expenditure costs for decarbonisation plans.

 

The Taxonomy Regulation is designed to steer companies as they adapt their business strategy to climate change, while providing investors early exposure to economic activities that will withstand any economic shocks caused by the energy transition.

 

* Unsubstantiated claims about the environmental characteristics of a product or service.

WARNING:

Not all investments are necessarily suitable for all investors and specific advice should always be sought prior to investment, based on the particular circumstances of the investor.