ESG Newsletter 4/2024 – ESG Legislation: Details on the EU Taxonomy and European Standards

EU Taxonomy

The EU Taxonomy is a system of classification of economic activities developed by the European Union as part of the Roadmap for Sustainable Finance. The aim is to provide investors, businesses and governments with a clear framework for assessing which economic activities are 'sustainable' in line with the EU's environmental objectives, in particular the objectives of the European Green Deal (to achieve carbon neutrality by 2050), and thus help them to focus their decision-making on environmentally and climate-friendly projects.

The purpose is, among other things, to contribute to the transformation of polluting sectors, to support the transition to a zero-emission economy and to avoid "greenwashing", the misleading labelling of projects as sustainable. The EU taxonomy applies to all companies subject to non-financial disclosure.

The EU Taxonomy includes six environmental objectives:

1) climate change mitigation,

2) adaptation to climate change,

3) sustainable use and protection of water and marine resources,

4) transition to a circular economy,

5) pollution prevention and control,

6) protection and restoration of biodiversity and ecosystems.

The taxonomy is based on the latest scientific and industry experience. It is a flexible and dynamic set of criteria that adapts to different investment styles and strategies and responds to changes in technology, science, data and activity.

For the first two climate targets (issued 2021), mitigation and adaptation, large companies are required to report on the eligibility of their activities from 2022, and the obligation to report on alignment applies from last year.

For the new environmental targets (issued 2023), i.e. water and marine resources, circular economy, pollution and biodiversity, reporting will start from 2024 on eligibility and from 2025 on alignment of the company's activities with the taxonomy.

Taxonomy reporting partially overlaps with disclosure obligations under the CSRD.

To be eligible, an economic activity needs to be found in at least one of the six environmental objectives of the taxonomy. Companies need to know their eligibility potential well, i.e. map all their economic activities and compare them with those listed in the EU Taxonomy. Eligibility mapping tends to be particularly burdensome for companies with many activities, e.g. groups reporting at a consolidated level or large companies with extensive supply and customer chains. Companies should not only examine their core business activities, but it is recommended to pay attention to capital and operating expenditures, which can significantly increase the level of eligibility.

An eligible activity is is aligned with the EU Taxonomy if it meets all three criteria listed for each economic activity included: it contributes substantially to one of the six climate objectives of the Taxonomy, i.e. it meets the specified technical screening criteria (TSC), it causes no significant harm (Do No Significant Harm / DNSH) in relation to the other environmental objectives and it meets the minimum social safeguards (MSS) as described in the Taxonomy Regulation (e.g. No human rights violations in the conduct of economic activity).

Firms report according to the rules set out in the EU Taxonomy Regulation. Mandatory indicators are turnover, cost of capital and operating expenses (CapEx and OpEx) related to the identified sustainable activities of the company. In particular, eligible activities (eligibility) and activities for which alignment has been demonstrated are disclosed. Companies are required to disclose the accounting practices used and declare the avoidance of double counting, as well as add relevant contextual information for reporting users to better understand the reported data.

The core Regulation EU 2020/852 of the European Parliament and of the Council of 18^th June 2020 establishing a framework to facilitate sustainable investments and amending Regulation (EU) 2019/2088 must be complied with in line with many other complementary regulations, e.g. Delegated Regulation on Disclosure, Delegated Regulation on Climate, Delegated Regulation on Environment, Delegated Regulation on Climate, etc.

ESRS – European Sustainability Reporting Standards

In July 2023, the European Commission published the final delegated act on Set 1 in all EU languages, laying the groundwork for addressing sustainability issues across Europe. The standards are based on the Sustainability Reporting Directive (CSRD) and the final version is published in the Official Journal of the EU (effective 1^st January 2024).

The general requirements can be found under ESRS 1. They define the main principles applicable to sustainability reporting under the ESRS, include no disclosure requirements, describe the structure of the standards, explain the writing principle and basic concepts (e.g. what constitutes double materiality) and set out general requirements for the preparation and presentation of sustainability information. They define the qualitative characteristics of the information and include transitional provisions applicable to this first set of standards.

General disclosures are found under ESRS 2 and define the disclosure requirements for information that companies must provide at a general level. These requirements cover all sustainability materiality issues such as governance, strategy, IRO (Impact, Risk & Opportunities) management and include minimum disclosure requirements for policies, actions, metrics and targets.

Environmental, social and governance factors are then addressed in standards E1-E5, S1-S4 and G1.

Each standard, with the exception of ESRS 1, includes four areas for reporting, which are governance, strategy, management of impacts, risks and opportunities, and metrics and targets.

EFRAG has issued a second set of explanations and responses to technical questions from stakeholders on the ESRS, and plans to issue similar explanations towards the end of each quarter.

At the same time, in early 2024, the Council and the European Parliament reached an interim agreement on a directive on deadlines for the adoption of sustainability reporting standards for certain sectors and certain third country companies. This agreement will give companies more time to prepare for the sectoral European sustainability reporting standards and the specific standards for large companies outside the EU, which will be adopted in June 2026, two years later than the originally planned date.

Authors: Zuzana Rozsívalová and Karolína Gajdíková, ESG department Mazars in the Czech Republic