Economic actors across the spectrum have been calling for a harmonized disclosure tool that would enable investors and others to make informed choices on the sustainability attributes of particular investments or activities. As Jones Day recently reported, on April 15, 2020, the European Council, which includes the heads of state of European Union ("EU") countries, moved closer to answering that call by adopting a regulation (the "Regulation") containing an EU-wide classification system for environmentally sustainable economic activities. The Regulation is one of the main pillars of the European Green Deal and forms a key part of the European Commission's action plan on sustainable finance. It underpins three other legislative measures to implement the EU's ESG strategy: the Regulation on sustainability-related disclosures in the financial services sector, the Non-Financial Reporting Directive, and the Climate-Related Benchmarks Regulation.
The taxonomy is designed to determine when an economic activity qualifies as "environmentally sustainable" in order to establish the degree to which an investment in that activity is "environmentally sustainable." It also obliges financial market participants and large public-interest entities to make certain disclosures about how their financial products and activities align with the taxonomy.
To qualify as environmentally sustainable, an activity must satisfy four criteria:
It must substantially contribute to one or more of the six specified objectives outlined in the Regulation (climate change mitigation; climate change adaptation; sustainable use and protection of water and marine resources; transition to a circular economy, waste prevention and recycling; pollution prevention and control; and protection of healthy ecosystems);
It must do no significant harm ("DNSH") to any of the other listed environmental objectives;
It must comply with the technical screening criteria, which define what "substantially contribute" and DNSH mean with regard to a particular environmental objective; and
It must be carried out in compliance with minimum social safeguards (alignment with the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights, including the principles and rights set out in the eight fundamental conventions identified in the Declaration of the International Labour Organisation on Fundamental Principles and Rights at Work and the International Bill of Human Rights).
The Regulation remains to be adopted by the European Parliament at a second reading before its entry into force, expected before the end of this year. Once the European Parliament votes to adopt the Regulation, the European Commission will adopt initial delegated acts by the end of 2020 to provide technical screening criteria for reporting on the two first environmental objectives, i.e., climate change mitigation and climate change adaption. Covered entities will need to provide their first set of disclosures under the Regulation beginning January 1, 2022 (for the 2021 reporting period), for these two objectives. Subsequent delegated acts to be issued in 2021, relating to the EU's four remaining objectives (i.e., sustainable use and protection of water and marine resources; transition to a circular economy, waste prevention, and recycling; pollution prevention and control; and protection of healthy ecosystems), will require disclosure beginning January 1, 2023 (for the 2022 reporting period).
The devil will be in the details as EU bodies pass final rules. Covered entities should begin preparing their disclosure and technical screening analysis now but should remain flexible in order to cater to ESG-related regulatory and market developments.
Originally published 14 May, 2020