EU advisers flag issues with new taxonomy objectives, reporting requirements

Companies and financial institutions will need to comply with the new rules by January 2024.

EU taxonomy reporting requirements could incentivise companies and investors to focus only on mitigation, the influential Platform on Sustainable Finance (PSF) warned yesterday.

The PSF – which is an independent group advising the EU on the taxonomy and other sustainable finance matters – also argued that the design of the taxonomy’s remaining four environmental objectives will need to be revised to ensure sufficient clarity and ambition.

The group gave the feedback in response to a European Commission (EC) consultation over its proposed criteria for the four objectives, known informally as Taxo4, as well as amendments to disclosure requirements published earlier last month.

The feedback marks the first official output of the platform’s second iteration, which has shifted its focus from devising eligibility rules for the taxonomy towards implementation and usability.

Under taxonomy reporting rules, non-financial companies are required to choose one of the six taxonomy environmental objectives when reporting the proportion of revenues, capex and opex aligned to the taxonomy – even when they contribute to more than one objective. This is to avoid double-counting.

According to the PSF, this means that climate change mitigation “is likely to be the preferable option” at the expense of other objectives, given the overwhelming capital market interest in decarbonisation.

Companies could also have less incentive to meet a varied combination of other objectives once they are aligned to a single one, as the proportion of alignment will not vary.

Consequently, “much needed investments in adaptation could be disincentivised”, the PSF said. In addition, biases in company reporting mean asset managers may lack information to build out environmental thematic funds, such as on water and biodiversity, undermining the ability to finance these areas.

A disclosure template proposed by the PSF would allow companies to attribute revenue and expenditure contribution to all relevant objectives while reporting a single financial value. This would give flexibility for financial institutions to select key environmental objectives for exposure based on the aim of specific investment products.

The PSF acknowledged that its proposal “will require time and thorough analysis” and may only be feasible at a later stage.

The advisory group separately highlighted examples where it considered the European Commission’s Taxo4 draft ambition level to be insufficient – “and hence inconsistent with the taxonomy regulation” – as well as not described with sufficient clarity and left to the discretion of report preparers.

This includes proposed minimum performance thresholds for plastic recycling and urban wastewater treatment. The PSF noted these were on par with the market average and minimum regulatory requirements respectively, and therefore would not substantially contribute to an environmental objective.

According to the PSF, a number of green activities included in Taxo4 did not specify minimum thresholds, such as a requirement that the manufacture of electrical equipment “demonstrated superior recyclability” and the use of “compostable materials” in plastic packaging.

The platform also noted that the draft taxonomy included eligibility criteria applied to the use of an activity’s output, rather than activity-level requirements. This would make them “enabling” activities as defined by the taxonomy regulation rather than purely green. Examples of this include the manufacture and leasing of aircraft.

Finally, the PSF urged the commission to refrain from letting companies interpret the level of ambition within Taxo4 criteria for themselves, as it would “make taxonomy-alignment comparability for these activities impossible”.

The platform argued that financial institutions should be allowed to make partial disclosures on their proportion of taxonomy-eligible exposures when taxonomy reporting rules come into effect from January 2024 for both financial and non-financial companies.

Due to the simultaneous reporting deadline, financial institutions will not have access to the actual reported figures from their undertakings, for at least a year, and are not permitted to use estimates.

An industry observer and an ESG-focused lawyer both told Responsible Investor that the requirement to start reporting against the newly proposed Taxo4 activities by next year was earlier than expected.

“It was a surprise in the sense that it is quite soon given the TSC for the four remaining objectives are only just being consulted on,” the lawyer said.