The EU Taxonomy for Sustainable Finance, Sustainable Activities & Sustainability Reporting - Last Updated: January 2, 2024

The European Union (EU) has some of the most advanced, progressive, and complex corporate and investor sustainability laws and reporting requirements in the world. Under the banner of an 'EU Green New Deal', Europe is implementing a sweeping set of sustainability measures, including the EU Taxonomy for Sustainable Activities, designed to fight climate change, support sustainable finance and innovation, and make Europe the first climate-neutral continent by 2050.

However, as we all know, big economic change also creates new compliance and reporting obligations for companies and investors, and the EU's integration of the EU Taxonomy into sustainability reporting is no different. All of Europe new sustainability rules, standards, and legislation can be challenging to track, so we’ve prepared this guide to summarize the EU Taxonomy for Sustainable Activities, EU Taxonomy reporting requirements, and what it means for organizations in 2024.

What is the EU Taxonomy for Sustainable Economic Activities?

EU Taxonomy Sustainability Reporting

The EU Taxonomy is a common classification system for sustainable economic activities, projects, and investments

Officially launched: July 12, 2020

When we refer to "taxonomy," we are defining a way to categorize or classify information. In this case, the EU Taxonomy provides a checklist or criteria to decide whether something is, or isn't sustainable, according to the EU's definitions.

The taxonomy is designed to screen and assess the sustainability of:

  • Economic sectors and industries
  • Corporate and business activity and projects
  • Investments

Unfortunately, because the EU economy is complex, the EU Taxonomy is also fairly complicated. Today, the full taxonomy is currently around 600 pages. Our goal is to summarize the basics here so the EU Taxonomy feels more clear, manageable, and actionable for your organization.

It's also important to note that while the taxonomy is primarily a screening tool, there are also EU Taxonomy-linked sustainability reporting requirements, which mandate certain EU companies and investors to disclose which of their activities do and don't meet the EU Taxonomy's criteria in their financial reporting.

How Does the EU Taxonomy Define a 'Sustainable Activity'?

The EU Taxonomy regulation defines a sustainable economic activity as any activity that:

  • Contributes substantially to at least one of the six environmental objectives listed in the Taxonomy
  • Does no significant harm to any of the other objectives, while respecting basic human rights and labor standards

The six key environmental objectives of the EU Taxonomy are:

  1. Climate change mitigation
  2. Climate change adaptation
  3. The sustainable use and protection of water and marine resources
  4. The transition to a circular economy
  5. Pollution prevention and control
  6. The protection and restoration of biodiversity and ecosystems

For example, under climate change mitigation, the EU defines creating and developing modern infrastructure for rail transport as a sustainable economic activity, because it allows more people to travel via public transportation, thereby reducing greenhouse gas (GHG) emissions from cars. Each of the six environmental objectives list different activities and criteria for what meets the definition of 'sustainable'.

Under EU law, the taxonomy is required to be reviewed and updated every three years. When it comes to defining ‘substantial contribution’ and ‘significant harm’, EU regulators note that:

  • The criteria for environmentally sustainable economic activities should be adapted regularly to reflect changes in science and technology
  • Scientific evidence and input from experts and relevant stakeholders should define ‘substantial contribution’ and ‘significant harm’ and also be updated regularly. Granular and calibrated technical screening criteria for different economic activities should be established by the EU Commission on the basis of technical input from a multi-stakeholder platform on sustainable finance

Sustainable activities can also be classified under multiple environmental objectives and benefits. For example, under the EU Taxonomy, renewable energy development, maintenance, and investment meets the criteria for (1) climate change mitigation, (2) climate change adaptation, and, likely, (3) pollution prevention and control.

EU Taxonomy Sustainable Activity & Investment

Within the EU's defined sustainable activities that contribute to its environmental objectives, the taxonomy also defines two classification categories for activities that help achieve those objectives longer-term, but may not technically be considered 'sustainable' under the taxonomy: (1) enabling activities and (2) transitional activities.

Enabling activities are activities that allow other sustainable activities to occur, like, for example, changing the electricity grid to allow more renewable energy to be used. By comparison, transitional activities are "placeholder" or "best current available option" activities where there is no technologically or economically feasible lower-carbon alternative.

Who Does the EU Taxonomy Apply to?

The taxonomy applies to companies, organizations, asset managers, and financial advisors that are legally required to report under the Sustainable Financial Disclosure Regulation (SFDR) and the Corporate Sustainability Reporting Directive (CSRD). The taxonomy can also be used as a reference by any investor, SME, bank, or organization so they can better understand whether their economic activities are considered environmentally sustainable.

At present, 13 economic sectors are covered under the taxonomy. The EU has stated that they’re working to expand the sectors beyond the ones listed below and look to cover all industries in the future:

  • Forestry
  • Environmental protection and restoration activities
  • Manufacturing
  • Energy
  • Water supply, sewerage, waste management and remediation
  • Transport
  • Construction and real estate
  • Information and communication
  • Professional, scientific and technical activities
  • Financial and insurance activities
  • Education
  • Human health and social work activities
  • Arts, entertainment and recreation

How Does the EU Taxonomy Work?

Out of the EU Taxonomy's six environmental objectives, only (1) climate change mitigation and (2) climate change adaptation have officially been designed, approved, and released for use. The other remaining four taxonomy objectives will be released over the course of 2024.

To use the taxonomy, a company or investor should review the taxonomy's classification criteria, and compare it with their investments and activity to see what percentage of activity falls under the criteria. To officially be valid or aligned under the Taxonomy as a sustainable activity, economic activity must meet four criteria:

  1. Makes a substantial contribution to at least one environmental objective: The technical screening criteria for this condition is that the activity either has a substantial positive impact or substantially reduces negative impacts on the environment
  2. Does no significant harm to any other environmental objective: The technical screening criteria for this condition is that the activity doesn’t stop other environmental objectives from being reached
  3. Complies with minimum social safeguards: Minimum social safeguards were determined by the European Parliament and the Technical Expert group. Their purpose is to ensure that each economic activity does not violate human and workers’ rights, bribery/corruption, taxation, and fair competition practices while trying to be environmentally sustainable
  4. Complies with the technical screening criteria: The technical screening criteria are specific to each economic activity and have their own principles, metrics, and thresholds that organizations must adhere to

Why is the EU Sustainability Taxonomy Important?

The taxonomy’s primary purpose is to help keep the EU on track for the climate and energy targets set in the European Green Deal. Europe is actively working to become a “green” economy and the taxonomy is meant to guide investment and business activity in more sustainable directions to help it get there. The EU Taxonomy is also part of the EU's effort to combat greenwashing activities and, instead, promote activities that are climate positive.

As a checklist, the taxonomy has two main uses: as a classification tool and as a screening tool. As a classification tool, it helps organizations, investors, and policymakers understand what is considered a sustainable activity. As a screening tool, it creates more clarity for these stakeholders around determining if investments are environmentally sustainable.

Moreover, the Corporate Sustainability Reporting Directive (CSRD) and Sustainable Finance Disclosure Regulation (SFDR) both require entities to share information on how their business activities are in alignment with the EU taxonomy.

In EU corporate financial reporting, the EU Taxonomy is linked with financial disclosure. Under the EU’s Non-Financial Reporting Directive (NFRD) and CSRD, eligible companies must track and report:

  • The proportion or percentage of their turnover (revenue) derived from EU Taxonomy activities
  • The proportion of their capital expenditures (CAPEX) and operating expenditures (OPEX) associated with EU Taxonomy activities

At the end of 2022, CDP also announced they will be piloting taxonomy questions for climate change mitigation and adaptation, starting in 2023 and 2024.

For investors, the EU Taxonomy also has important implications. On April 6, 2022 the EU adopted technical standards to be used by financial market participants when disclosing sustainability-related information under the SFDR. These regulations specify the exact content, methodology, and presentation of information that needs to be disclosed. Under these rules, financial market participants must provide detailed information about how they address and reduce any possible negative impacts that their investments may have on the environment and society in general. As of October 31, 2022, investors also need to disclose if their portfolios are exposed to gas and nuclear activities covered by the taxonomy. These new requirements are also designed to help investors assess the sustainability performance and credibility of financial products.

Need an audit-ready system for EU sustainability reporting?

Brightest helps hundreds of companies measure EU sustainability reporting KPIs and manage their ESG compliance activities in one unified system

Schedule a Demo  

Your Next Steps Understanding and Using the EU Taxonomy

In a sense, the EU Taxonomy is a "unifying framework" within the EU's 2050 Sustainable Action Plan - designed to tie together sustainable financial and corporate investment in a single classification system. As you can likely tell from the length of this article alone, there are a lot of important new EU sustainability laws and economic changes taking effect in 2024 and future years. In fairness, it can feel very complex and daunting. However, from a positive perspective:

  • Most of these regulations - including the EU Taxonomy - are being introduced and revised over several years
  • The EU recognizes it's at the forefront of global economic sustainable transition, and is looking to help member states, companies, and investors successfully adopt and implement these changes
  • There's plenty of time to implement the necessary measures, standards, process changes, and reporting capabilities to keep pace - particularly for organizations who are proactive and already investing in these areas (or starting soon)
  • There are lots of existing market resources to help organizations and investors track, manage, and report their sustainable activities more efficiently and effectively, including Brightest's software and services

For organizations in the early stages of their sustainability reporting journey, we have a few general recommendations, additional reading, and suggested next steps:

Materiality assessment - The principle of Materiality is embedded in most of these new EU legislations, particularly the concept of double materiality. Materiality essentially asks and attempts to answer a fundamental question: what are the most important (re: material) ESG and sustainability risks and considerations for a business or investment? If your organization hasn't already done so, a materiality assessment can help determine what your top sustainability goals, targets, risks, and priorities should be in relation to regulatory and investor sustainability reporting. In turn, this can help clarify where to focus, what to prioritize, and what aspects of pending or forthcoming EU sustainability legislation matter most to you.

Understand the EU Taxonomy in depth - A full, in-depth breakdown of the EU Taxonomy is outside the scope of this piece, but it is critical that, if your organization meets EU sustainability disclosure and/or due diligence criteria, you work with your leadership, directors, legal counsel, auditors, and other stakeholders to learn your organization's specific timeline and obligations to use the taxonomy. Make sure you're clear if your organization is or will be required to report on SFDR and/or CSRD, and if it currently discloses information to CDP. If yes, you’ll also need to start aligning those disclosures with the EU taxonomy. Start with the two taxonomy environmental objectives that are fully approved, and start preparing to assess your activities along the remaining four objectives so you can be ready when they're approved.

Alignment between financial and sustainability data systems and process - While this might go without saying, in order to report your organization's sustainable activities and investments, you need to know what they are - with a high degree of accuracy. Your materiality process can help guide you toward the main sustainability themes you may need to focus on and collect data around. Many organizations start their sustainability reporting with relatively simple spreadsheets, surveys, and documents, but things can get complex fast - particularly for larger companies if you're trying to track all of your sustainable and non-sustainable CAPEX and OPEX. If you're an organization with a medium-to-large or complex environmental and/or operational footprint, you likely need dedicated sustainability reporting and data management software, like the kind we design here at Brightest to help organizations stay compliant. Ongoing report archiving, version control, and governance are also important to think about, since you'll be preparing taxonomy disclosures every year.

Further reading - Our free guides to sustainability measurement, sustainability reporting, and ESG reporting provide additional, detailed guidance and insights on how to measure and report your sustainability performance. Or, if you're ready to up-level your sustainability reporting and data maturity to meet ESRS requirements, please contact us for a free assement or demo of Brightest's intelligent, award-winning ESG platform.