The European Union’s commitment to fostering sustainable economic activities has led to the establishment of the EU Taxonomy, a regulatory framework aimed at promoting environmentally sustainable investments. As companies undertook the first round of reporting under this regulation, several challenges and misalignments have come to light, revealing the complexities that lie ahead. In this blog, I will explore the key observations and emerging best practices identified by the EU Platform on Sustainable Finance and the Sustainable Finance Advisory Committee of the German Federal Government (SFB). We also discuss the current challenges faced by organizations in complying with the EU Taxonomy regulations and the need for further guidance and clarity.
Usability Challenges and Misalignments
The EU Platform on Sustainable Finance’s report on data and usability of the EU Taxonomy provides valuable insights into the challenges faced by reporting entities. The usability challenges can be broadly categorized as structural, interpretive, and technical issues. Companies often struggle with incorrect templates, number formatting, and naming conventions, leading to inconsistencies in reporting. For instance, some entities may report “green share of revenues” instead of “Taxonomy-aligned turnover.” Interpretive issues arise when companies fail to follow the correct disclosure standards, reporting ambiguous terms instead of specific Key Performance Indicators (KPIs). Additionally, technical issues emerge in determining eligible activities and meeting the technical screening criteria, which can vary across sectors.
Despite the usability challenges, the report highlights some best practices that can enhance the reporting process. Utilizing correct reporting templates and naming conventions from the outset can simplify reporting and improve consistency across disclosures. The Platform specifically recommends using the Taxonomy activity and numbering conventions found in the Delegated Act and maintaining consistency between mitigation and adaptation activities. By adhering to these conventions, companies can facilitate the comparability of data and ensure transparency for investors and stakeholders.
To ease the transition to the new reporting framework, supplementary guidelines and advice from the European Commission are encouraged. These additional resources could offer clarifications on specific reporting requirements, technical screening criteria, and eligible activities, helping companies navigate the complexities of the EU Taxonomy with greater confidence.
Challenges Faced by Asset Managers and Insurers
While some asset managers and insurers have reported their Green Investment Ratio (GIR) under Article 8, they encounter specific challenges due to limited coverage and inconsistent terminology. Data availability remains patchy, hindering accurate reporting of taxonomy alignment figures. A significant hurdle during the initial practical implementation revolves around the incomplete availability of data necessary for complying with the Taxonomy Regulation reporting. However, the Sustainable Finance Advisory Committee (SFB) endorses the approach and aims to contribute to its effective implementation by offering practical insights from various perspectives.
To improve data availability and consistency, the involvement of non-EU issuers and entities not currently mandated to report relevant figures could be crucial. Encouraging voluntary reporting from such entities could contribute to a more comprehensive understanding of taxonomy alignment across the financial industry.
Time-Frame and Legal Ambiguity Issues
One of the critical challenges pertains to the time-frame for implementing the Taxonomy Regulation. Structurally, “the SFB points out that the time between publication of regulation and required application is too short for companies to adapt adequately.” In addition, the limited data availability is explained by the sequencing of EU regulations, where investors are required to report their alignment before non-financial companies under the Non-Financial Reporting Directive (NFRD) scope do the same. As a result, the lack of data from certain sectors could hinder the ability of investors to accurately assess their investment products’ alignment with the taxonomy.
The absence of a centralized contact point for clarification and the need for international compatibility are additional challenges faced by reporting entities. A dedicated contact point within the European Commission could offer support and guidance, ensuring a more consistent interpretation and application of the Taxonomy Regulation across member states. Furthermore, harmonizing the taxonomy with international standards would foster global alignment and enhance the EU’s role as a leader in sustainable finance.
Compliance Challenges for Organizations
For companies, compliance with the EU Taxonomy Regulation has been a real challenge, mainly due to the complexity in interpreting concepts and criteria. With the regulation’s continuous evolution and integration of delegated acts, organizations must adapt to include all activities contributing to the environmental objectives. The challenges faced by organizations include a short time frame for compliance, setting up suitable processes, difficulty in sourcing information, and room for interpretation of regulatory requirements.
The short time frame between the issuance of the regulation and the reporting deadline has placed significant pressure on companies to establish robust systems and processes for identifying, assessing, and reporting on their economic activities’ taxonomy alignment. Many organizations have had to allocate substantial resources to implement these processes effectively, including upgrading reporting systems, training employees, and engaging with stakeholders to obtain the required data.
Another challenge is the difficulty in sourcing information for reporting purposes. Although the EU Taxonomy initially required only eligibility reporting for disclosures in 2022, the required information was not always directly available and needed to be determined through additional information generated within the company or requested through manual processes. This sourcing process can be time-consuming and may introduce uncertainties in the reporting.
Furthermore, the regulatory documents of the EU Taxonomy have shown a level of scope for interpretation, leading to questions and challenges concerning the proper interpretation of the regulatory requirements. This can result in varying approaches and discrepancies in reporting practices across different organizations.
Ensuring Reliable Sustainability Reporting
To ensure the reliability of sustainability reporting and minimize greenwashing risks, independent and high-quality audits are crucial. Though not mandatory yet, conducting external audits by statutory auditors is advisable to enhance the credibility of sustainability reporting. Independent audits can provide assurance to investors and stakeholders that reported taxonomy alignment figures are accurate and in compliance with the regulation.
Cracking the Code
The EU Taxonomy Regulations represent a significant step towards promoting sustainable economic activities in the European Union. However, the initial round of reporting has revealed several challenges, ranging from usability issues to data availability and legal ambiguities. To overcome these obstacles and effectively implement the Taxonomy Regulation, companies, policymakers, and stakeholders must work collaboratively to provide clearer guidance and enhance reporting processes. Only through a concerted effort can the EU Taxonomy fulfill its intended purpose of fostering a sustainable future for Europe and beyond. As the regulation continues to evolve and expand, addressing these challenges will be crucial in achieving a robust and transparent sustainable finance ecosystem that benefits both investors and the planet.