Half of DNSH criteria face usability challenges, warn EU taxonomy advisers

A critical element of the EU’s green taxonomy may need to be reworked to ensure it can be applied broadly, according to advice from the Platform on Sustainable Finance (PSF).

Green activities must pass a series of hurdles to be considered taxonomy-aligned, including one confirming that they do not come at the expense of other environmental objectives. This is known as the taxonomy’s Do No Significant Harm (DNSH) requirement and encompasses nearly 300 unique tests, although not all will be relevant to any specific activity.

The latest PSF analysis suggests that half of these “are not recommendable from a usability perspective”, with 41 percent depending on EU-only legislation and therefore difficult to execute outside the bloc and in EU states with diverging regulatory interpretations.

A further 9 percent “state ambitions which cannot be assessed”. As an example, the PSF cites the circular economy DNSH criteria, which requires peat extraction to be “minimised” without clear reference points or benchmarks.

“In its current form, some of the DNSH testing criteria create substantial interpretation and usability challenges. If left unaddressed, this could impact the goal of generating complete, comparable and reliable disclosure,” said the PSF.

The feedback may be the last to be delivered by the PSF, an independent advisory body set up to assist future development of the green taxonomy, before it is reappointed by the European Commission later this year. It was presented in one of two reports released yesterday, addressing data and social safeguards respectively.

Details of the next iteration of the PSF, known as Platform 2.0, have not yet been made public but it is expected to be leaner than the current 50-strong membership, and to focus on making the taxonomy more user-friendly.

PSF members have also warned that financial institutions “should err on the side of the planet” when reporting estimates as part of their ESG fund disclosures and obey the “precautionary principles”, meaning that “estimations should not be larger than the true reported taxonomy-alignment value of a company”.

For corporates, the PSF suggested that the EC could consider mechanisms to prevent issuers shopping around to secure the most favourable assessments on taxonomy-alignment from commercial providers. It also identified a mid-cap bias for third-party taxonomy metrics compared with large-cap firms.

The use of estimates or “equivalent information” is allowed but tightly controlled for financial sector disclosures. They must be derived from company-reported information in relation to whether an activity meets the taxonomy’s core requirements but financial institutions have more flexibility when using estimates to report on DNSH criteria and social safeguards. The latter makes up the remaining hurdle for taxonomy-alignment.

The PSF has separately backed the creation of global translations for EU regulations and taxonomy requirements to support its application outside the bloc. Interoperability – or the idea that disclosures made against a green taxonomy in Asia, for example, can be easily transferred to align with that of the EU or vice versa – is fast becoming a priority to ensure that regional policies do not inhibit global capital flows.

Minimum social safeguards

The PSF has proposed a two-prong approach to assess compliance with the taxonomy’s minimum social safeguards, focusing on both processes and outcomes.

Companies must first demonstrate the implementation of adequate due diligence processes, based on disclosures made against soon-to-be-adopted EU regulations on due diligence and corporate sustainability reporting. Non-EU firms may report against equivalent metrics.

They would then need to show that they have not been found guilty of breaches against human rights, bribery, taxation and fair competition in court. Companies must also be responsive to complaints made via human rights grievance mechanisms, such as the OECD National Contact Point system, or the Business & Human Rights Resource Centre, which tracks the human rights performance of 20,000 global companies.

Failure to meet either of these criteria will be considered evidence of non-compliance with the safeguards and means that companies will not be able to claim taxonomy-alignment.

The Platform has suggested that the requirements are extended to sovereign issuers based on the ratification and implementation of global human rights conventions. A high level of corruption would also be “a sign of non-alignment”.

Martin Spolc, the EC official in charge of the bloc’s sustainable finance agenda, said the EU will assess the PSF advice for inclusion in future FAQs or guidance but has ruled out new legislative requirements. Spolc did not provide a timeline.

The two reports come weeks after five of the PSF’s member organisations staged a mass walkout, accusing the EC of interfering in the group’s work and acting against scientific evidence.