EU Taxonomy: What happened last week and what does it mean for investors?

RI looks at the details of disclosure and verification requirements, and industry reactions, following the controversial decision to label some nuclear and gas green in the EU Taxonomy

On Wednesday last week, the European Commission pushed ahead with its controversial plans to classify some nuclear and natural gas activities as being eligible environmentally sustainable activities under the EU’s Taxonomy framework.

The decision to adopt the long-awaited complementary climate rules for the Taxonomy was widely expected – as was the huge backlash seen from NGOs, some member states and investors. The European Parliament and Council of member states now have four months to scrutinise the rules – which they can decide to veto.

The controversial sectors are included in the Taxonomy “under clear and tight conditions”, according to the Commission, and as so-called ‘transitional’ activities. The transitional category in the EU Taxonomy was originally created for sectors without green alternatives, such as steel and cement.

Here’s RI’s take on some of the key things to come out of last week’s developments:

Disclosure rules strengthened  

On disclosure, the Commission has mandated extensive reporting requirements associated with nuclear and gas after investors and other stakeholders raised concerns over the need for additional transparency.

Europe’s sustainable investment trade association Eurosif said the inclusion of gas and nuclear undermines the credibility of the Taxonomy, but welcomed the disclosure developments: “We acknowledge that the final version of the Complementary [act] features significant improvements to the entity-level disclosures, ensuring they reflect exposures to natural gas and nuclear energy adequately and removing exemptions from reporting for banks,” it said.

Companies reporting their alignment to the taxonomy will now have to provide details of their individual exposure to gas and nuclear – broken down by the proportion of activities which meet the Commission’s criteria on emissions, waste disposal and others, and those which do not.

Other than nuclear and gas, companies reporting their alignment under Article 8 of the taxonomy regulation for other activities do not have to provide details on their specific sector-wide exposure.

However, the Commission did not amend Article 8 disclosure rules, which would require companies to report the revenue and Capex associated with taxonomy-aligned activities, to make a distinction between nuclear and gas activities which are more environmentally sustainable despite calls from its taxonomy advisers.

Earlier, the EU’s independent Platform on Sustainable Finance had said that only Capex which had led to emissions reductions should be considered taxonomy-aligned, while revenue could only be reported as green once activities “had reached sustainable performance levels” by meeting the taxonomy’s overall 100g CO2e/kWh emissions threshold.

Question marks and potential investor risks around verification requirements  

The adopted act sets out that “to increase investor confidence”, compliance with the climate rules for gas and nuclear must be verified by an independent third party.

In a press conference last week, EU Commissioner Mairead McGuinness was pressed on what this actually means and how it will be implemented.

Asked whether there would be any sanctions or penalties in place for an entity that has reported Taxonomy-alignment but is found not to have met the criteria, the Commissioner said: “I won’t give details, but it’s certainly clear that in order for us to be credible we can’t just take the word of the investor or corporate […], it has to be verified with external auditors.”

She hinted at “follow-ups, should there be any breaches” and added “I would have thought one of the most effective measures […] is to be ‘outed’”, meaning if anyone had “misled the investment community” that could be disclosed. She also said there will “be a role” for national competent authorities, but did not develop on this.

Eurosif’s Executive Director Victor van Hoorn told RI: “Compliance with some of the criteria for gas and nuclear, such as the future mix of renewable and fossil gases, can only be fully observable in the future. It will simply be quite challenging, also for a third-party verifier to categorically confirm that a project complies with all the criteria now”.

Sebastien Godinot, Economist, WWF European Policy Office and member of the Platform on Sustainable Finance, agreed, saying several criteria for the technologies are “unverifiable” because of the long time horizons to fulfil them.

“This creates an incredibly high risk for financial institutions: they can report taxonomy-alignment for gas-/nuclear investments as from 2024, but […] what if the criteria are finally not met? The financial institutions will have misled their own clients for years or decades, doing greenwashing themselves.”

“The Act does not provide any concrete way to fix this risk: it only requires external auditors to assess whether the gas/nuclear criteria are met every year, but it does not provide a forward-looking assessment about whether the criteria will be met for the required long timeline,” he added.

A Commission spokesperson had not replied to a request for more detail or a response to the criticism at the time of publication.

Many Platform proposals rejected 

The Platform argued for nuclear and gas to be included under an ‘intermediate’ or ‘Amber’ taxonomy encompassing activities that do not meet the conditions of either a green or polluting (brown) taxonomy, which was not taken up by the Commission. The Platform has indicated that it will publish proposals for an Amber taxonomy in the coming weeks.

The Commission also rejected a proposal by the Platform to disaggregate exposure to EU and non-EU entities when reporting nuclear and gas activities.

In response to the Commission’s final ruling, Platform head Nathan Fabian said that while he welcomed the additional disclosure requirements, the “departure from a science-based approach …risks weakening the integrity of sustainable finance”

“There may be a role for [gas and nuclear] in a transitioning economy but with the weak technical screening criteria in the [legislative text], their place is not in the green Taxonomy.”

The feedback was echoed by French ESG specialists Mirova who told RI: “The EU’s decision appears aimed at meeting the demands of the public sector and not based on a scientific consensus on what is green for investors which was the initial objective of the taxonomy.

“However, there seems to be little chance of the proposed legislation not being adopted, so we will have to live with it so that the formidable tool that is the taxonomy can be useful”.

Parliament committee head joins NGOs in disappointment over looser criteria 

Shortly after the act was published last week, NGOs including E3G and WWF pointed out that the final text proposes looser criteria for the sectors than previous drafts. For example, a previous requirement for gas power plants to start shifting to low-carbon or renewables by 2026 was dropped.

French MEP Pascal Canfin, the Chair of the Parliament’s environment committee and previously co-chair of the European Parliament team which negotiated the Taxonomy regulation more than two years ago, also called out this move – despite more broadly being supportive of gas and nuclear’s inclusion in the taxonomy under strict conditions as transitional sources of energy.

“I regret the last minute adjustments made by the European Commission – regarding the removal of the intermediary target (2026 / 2030) on blending,” he said in a post on LinkedIn.

But he said other requirements, for example those he proposed last year on additional disclosure rules for gas and nuclear activities, will ensure the technologies’ inclusion does not “put at risk the use and the credibility of the taxonomy, because it ensures transparency and traceability”.

Reputational damage and international impact  

Jakob Thomä, an Executive Director at EU thinktank 2 Degrees Investing Initiative’ said: “I think the decision could result in a huge reputation hit for the Commission but the effects on broader policy could potentially be even more dramatic. One area this may come into play is climate diplomacy and trade deals, where the EU could find it harder to promote stringent climate standards regionally and globally.”

“While we sometimes think of sustainable finance regulations as only applying to a small section of the market, the taxonomy is different as it applies to the entire economy and is therefore very much of interest to global stakeholders”.

Thomä pointed to recent statements by the Australian gas industry which justified increased exploration for gas on the basis of the EU’s move to classify the fossil fuel as green as an indication of the taxonomy’s influence.