Taxonomy-aligned economic activities under the Taxonomy Regulation mean economic activities that are described in the European Commission’s delegated acts (are Taxonomy-eligible) and meet the relevant technical screening criteria (TSC).
Article 1 point 2 of Commission Delegated Regulation (EU) 2021/2178 of 6 July 2021 supplementing Regulation (EU) 2020/852 of the European Parliament and of the Council by specifying the content and presentation of information to be disclosed by undertakings subject to Articles 19a or 29a of Directive 2013/34/EU concerning environmentally sustainable economic activities, and specifying the methodology to comply with that disclosure obligation
‘Taxonomy-aligned economic activity’ means an economic activity that complies with the requirements laid down in Article 3 of the Taxonomy Regulation
‘Taxonomy-aligned economic activity’ means an economic activity that complies with the requirements laid down in Article 3 of the Taxonomy Regulation (see Article 1 point 2 of Commission Delegated Regulation (EU) 2021/2178 of 6 July 2021 supplementing Regulation (EU) 2020/852 of the European Parliament and of the Council by specifying the content and presentation of information to be disclosed by undertakings subject to Articles 19a or 29a of Directive 2013/34/EU concerning environmentally sustainable economic activities, and specifying the methodology to comply with that disclosure obligation), hence, it refers to the definition of 'environmentally sustainable economic activities'.
When it comes to terminology, investments in environmentally sustainable economic activities are investments in taxonomy-aligned activities.
Nevertheless, it is often observed that discrimination against sustainable investments outside the scope of the taxonomy (i.e. not taxonomy-aligned) should be avoided, in particular, investors should not automatically imply that sustainable investments which are not (yet) within the scope of the Taxonomy Regulation are any less sustainable.
SMSG advice to the ESA’s Joint Consultation Paper even recommends rather than use the ‘negative’ wording “investments in activities not aligned with the EU taxonomy”, to use a positive wording: “investments in activities with environmental objectives other than the EU environmental taxonomy”; “in investments with social objectives” (p. 119).
European Commission published Notice of 13 June 2023 on the interpretation and implementation of certain legal provisions of the EU Taxonomy Regulation and links to the Sustainable Finance Disclosure Regulation (2023/C 211/01), which confirms that investments in taxonomy-aligned ‘environmentally sustainable’ economic activities can be qualified as ‘sustainable investment’ in the context of the product level disclosure requirements under the SFDR - see below.
Commission Notice of 13 June 2023 on the interpretation and implementation of certain legal provisions of the EU Taxonomy Regulation and links to the Sustainable Finance Disclosure Regulation, (2023/C 211/01)
Do Taxonomy-aligned investments qualify as ‘sustainable investment’ under the SFDR?
Recital 19 of the Taxonomy Regulation clarifies that ‘sustainable investments’ under the SFDR include investments into ‘environmentally sustainable economic activities’ within the meaning of the Taxonomy Regulation.
In setting out what is required for an activity to be considered as ‘environmentally sustainable’, Article 18(2) makes a link between the Taxonomy Regulation and the SFDR via one of the required steps of the Taxonomy Regulation: the compliance with minimum safeguards. According to the guidance given under question 1 and 2 above, the social elements of the ‘do no significant harm’ principle are considered to be adhered to at entity level for an undertaking that discloses activities as ‘environmentally sustainable’ under the EU Taxonomy.
Furthermore, according to the guidance provided in questions 1 and 2 above, the SFDR do no significant harm principle and the requirement to ensure that an investee company follows good governance practices are deemed to be fulfilled for investments in Taxonomy-aligned economic activities as these comply with the Taxonomy’s minimum safeguards. The four aspects of good governance referred to in point 17 of Article 2 of the SFDR (namely sound management structures, employee relations, remuneration of staff and tax compliance (15)) can be considered to be satisfied by the provisions referred to in Article 18 of Regulation (EU) 2020/852.
Therefore, such investments in Taxonomy-aligned ‘environmentally sustainable’ economic activities can be automatically qualified as ‘sustainable investments’ in the context of the product level disclosure requirements under the SFDR. This means that investments in specific economic activities can be considered to be sustainable investments.
However, if a financial market participant (FMP) invests in an undertaking with some degree of taxonomy-alignment through a funding instrument that does not specify the use of proceeds, such as a general equity or debt, the FMP would still need to check additional elements under the SFDR in order to consider the whole investment in that undertaking as sustainable investment. This means that the FMP would still need to: (i) check whether the rest of the economic activities of the undertaking comply with the environmental elements of the SFDR DNSH principle; and (ii) assess whether she/he considers the contribution to the environmental objective sufficient.
There is no obligation for companies to be Taxonomy-aligned and investors are free to choose what to invest in (European Commission Questions and Answers on the Sustainable Finance package, 13 June 2023).
According to Article 84 of the Taxonomy Regulation, for companies (non-financial undertakings) under the scope of NFRD (and subsequent CSDR) it will be mandatory to report the proportion of turnover associated with taxonomy-aligned activities as well as CapEx and where relevant OpEx that is aligned with the taxonomy.
“Taxonomy-aligned” means that when reporting on the percentage of turnover and CapEx compliant with the EU Taxonomy, companies bound by NFRD are also deemed to assess compliance with “do no significant harm” criteria and minimum safeguards.
In addition, non-financial companies should provide for a breakdown of the Key Performance Indicators (KPIs) based on the economic activity pursued, including:
3. environmental objective reached.
For large non-financial undertakings, disclosure of the degree of taxonomy alignment regarding climate objectives began in 2023. Disclosures will be phased-in over the coming years for other actors and environmental objectives.
Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions, A sustainable finance framework that works on the ground (COM/2023/317 final) observes that at the initial stage of the transition, taxonomy alignment levels in terms of revenue will be lower, especially for certain companies and economic sectors. However, alignment levels are already expected to be higher in terms of capital expenditure. A large number of companies are reporting taxonomy-aligned capital expenditure that is materially higher than their aligned revenue, especially in high-emitting sectors where transition finance is most needed, and that average taxonomy alignment for certain sectors is significantly higher in terms of capital expenditure compared to revenue.
For instance, in the utilities sector a 70% average aligned capital expenditure compared to 40% aligned revenue and in the energy sector a 23% average aligned capital expenditure compared to 7% aligned revenue. More than 13 000 companies worldwide have set transition targets to date, with some opting for a transition plan to specify these targets.
It is noteworthy that the taxonomy recognises investments in economic activities that will become taxonomy-aligned in 5 (exceptionally 10) years. Such investments can be disclosed as taxonomy-aligned capital expenditure and can be financed through the issuance of European green bonds. Such bonds can then be included in the composition of a benchmark or of a financial product with sustainability characteristics or pursing sustainability objectives.
European Commission Recommendation (EU) 2023/1425 of 27 June 2023 on transition finance, C(2023) 3844 underlines that undertakings can also use sustainable finance tools of the Union, such as the taxonomy, not only to disclose taxonomy-aligned activities and capital expenditures, but also as a forward-looking tool for their transition process, using the criteria of the taxonomy as reference points for setting targets.
The taxonomy is increasingly being used for transition finance purposes, with many undertakings reporting taxonomy aligned capital expenditure that is materially higher than aligned revenue, especially in high-impact sectors.
Investments to reach taxonomy alignment in 5 (exceptionally 10) years are recognised as capital expenditure that is fully aligned with the taxonomy if it is accompanied by a capital expenditure plan, which is a type of activity-level transition plan.
Additionally, investments in transitional activities, as defined by Taxonomy Regulation, are investments in the best available technologies, and are therefore also recognised as taxonomy-aligned, provided they do not result in long term carbon intensive lock-ins or prevent the development of greener technologies. These are economic activities where no alternative technology currently exists and where the performance is on a transition path to climate neutrality in the future.
Expenditures for activity-based transition plans cannot be considered taxonomy-aligned if they do not fully meet the respective taxonomy criteria, but they can nevertheless be a meaningful step towards improved levels of sustainability performance and attract transition finance.
To operationalise the use of the taxonomy to raise transition finance, undertakings could specify their transition finance needs in terms of the capital expenditure of the undertaking.
When appropriate, they could also specify these needs in terms of their current and targeted operating expenditure or revenue, which is either:
(b) will be taxonomy-aligned in the future, or
(c) displays continuous performance improvements as part of a credible transition plan that is in line with the transition.
When engaging with clients and investee undertakings, the following aspects could be discussed:
(a) material sustainability impacts, risks and opportunities, and how climate and environmental impacts and risks are addressed;
(b) how the contribution to a climate or environmental objective is determined and what the time horizons for the lending or investments are;
(c) the underlying transition pathways, to ensure that the lending or investment strategy is compatible with the transition;
(d) whether or how the principle of ‘do no significant harm’ as defined in Article 17 of the Taxonomy Regulation is applied and how adverse impacts are dealt with;
(e) how sustainability performance and the transition targets and plans of undertakings will be taken into account, including in assessing the risk of stranded assets, and transition risks and physical risks more broadly.
- in order to comply with the provision under point (b) of the first subparagraph of Article 5 of the Taxonomy Regulation (the description of ‘to what extent’ the investments underlying the financial product are in economic activities that qualify as environmentally sustainable in Article 3 the Taxonomy Regulation), an explicit quantification should be provided through the numerical disclosure as a percentage of the extent to which investments underlying the financial product are taxonomy-aligned;
- information on taxonomy-eligible activities should not be provided for the disclosure of the extent to which investments underlying the financial product are in taxonomy-aligned economic activities.
Moreover, while estimates should not be used, where information is not readily available from public disclosures by investee companies, financial market participants may rely on equivalent information on taxonomy alignment obtained directly from investee companies or from third party providers.
Until the application of the RTS, the numerical disclosure referred to above could be accompanied by a qualitative clarification explaining how the financial product addresses the determination of the proportion of taxonomy-aligned investments of the financial product, for example by identifying the sources of information for that determination.
Such a clarification should be clear about the taxonomy-alignment of the investments underlying the financial product and should not disclose more information than what is required by Article 5 of the Taxonomy Regulation.
The supervisory authorities also mentioned:
“In addition to the reference to the above supervisory expectations for the sake of applying the provisions of the SFDR without the RTS during the interim period, national competent authorities are encouraged to refer financial market participants and financial advisers to the requirements set out in the draft RTS of the final reports that have been submitted to the European Commission on 4 February and 22 October 20217. The draft RTS submitted to the European Commission on 4 February and 22 October 2021 can be used as a reference for the purposes of applying the provisions of Articles 2a, 4, 8, 9, 10 and 11 of the SFDR and Article 5 and 6 of the TR in the interim period”.
KPI for the disclosure of the extent to which investments are aligned with the taxonomy
KPI for the disclosure of the extent to which investments are aligned with the taxonomy is based on the share of the taxonomy-aligned turnover, capital expenditure CapEx or operational expenditure (OpEx) of all underlying non-financial investee companies. OpEx of underlying non-financial investee companies as one of the possible ways to calculate the KPI has met negative views of market participants. They suggested that OpEx offers little value, introduces difficulties in the context of accounting and suffers from lack of data. OpEx is not defined in IFRS or US GAAP and this could lead to less comparable figures. In exchange, they considered turnover and CapEx disclosures as sufficient.
ESA’s Final report of 22 Pctober 2002 on taxonomy-related product disclosure RTS with regard to the content and presentation of disclosures pursuant to Article 8(4), 9(6) and 11(5) of Regulation (EU) 2019/2088, JC 2021 50, p. 37
Taxonomy-aligned activities are expressed as a share of:
- turnover reflecting the share of revenue from green activities of investee companies
- capital expenditure (CapEx) showing the green investments made by investee companies, e.g. for a transition to a green economy.
- operational expenditure (OpEx) reflecting green operational activities of investee companies.
ESA’s Final report of 22 october 2021 on taxonomy-related product disclosure RTS with regard to the content and presentation of disclosures pursuant to Article 8(4), 9(6) and 11(5) of Regulation (EU) 2019/2088, JC 2021 50
Draft Commission Delegated Regulation amending the regulatory technical standards laid down in Commission Delegated Regulation (EU) 2021/XXX as regards the content and presentation of information in relation to environmentally sustainable financial product disclosures in precontractual documents and periodic reports
Calculation of the taxonomy alignment of investments
1. The taxonomy alignment of investments shall be calculated in accordance with the following formula:
market value of all taxonomy-aligned investments of the financial product
𝑚𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑎𝑙𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡𝑠 𝑜𝑓 𝑡h𝑒 𝑓𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙 𝑝𝑟𝑜𝑑𝑢𝑐𝑡,
where ‘taxonomy-aligned investments of the financial product’ shall be the sum of the market values of the following investments of the financial product:
(a) for debt securities and equities of investee companies,where a proportion of activities of those investee companies is associated with Taxonomy-aligned economic activities, the market value of that proportion of those debt securities or equities;
(b) for debt securities other than those referred to in point (c) where a proportion of the proceeds are required by their terms to be used exclusively on Taxonomy-aligned economic activities, the market value of the proportion of those proceeds;
(c) for green bonds issued under Union legislation on environmentally sustainable bonds, the market value of those green bonds;
(d) for investments in real estate assets which qualify as Taxonomy-aligned economic activities, the market value of those investments;
(e) for investments in infrastructure assets which qualify as Taxonomy-aligned economic activities, the market value of those investments;
(f) for investments in securitisation positions with underlying exposures in Taxonomy- aligned economic activities, the market value of the proportion of those exposures; and
(g) for investments in financial products referred to in Article 5 and Article6 of Regulation (EU) 2020/852, the market value of the proportion of those financial products representing the taxonomy alignment of investments calculated in accordance with this Article.
The calculation shall be performed by applying the methodology used to calculate net short positions laid down in Article 3, paragraphs 4 and 5 of Regulation (EU) No 236/2012 of the European Parliament and of the Council.
2. For the purposes of point (a) of paragraph 1, the proportion of activities of investee companies associated with Taxonomy-aligned economic activities shall be calculated on the basis of the most appropriate key performance indicators for the investments of the financial product using the following information:
(a) for investee companies referred to in Article 8(1) and (2) of Regulation (EU)2020/852, on the basis of the disclosures made by those investee companies in accordance with that Article; and
(b) for other investee companies, on the basis of equivalent information.
3. For disclosures referred to in Articles 16a(1)(a) and 25(1)(a), in the case of investee companies that are non-financial undertakings referred to in Article 8(2) of Regulation (EU) 2020/852 and other non-financial undertakings, the calculation referred to in paragraph 2 shall use the same type of key performance indicator for all non-financial undertakings, which shall be turnover.
By way of derogation from the first subparagraph, where a more representative calculation of the taxonomy alignment is given by capital expenditure or operating expenditure due to the features of the financial product, the calculation may use the most appropriate of those two indicators.
4. In the case of investee companies that are financial undertakings subject to Article 8(1) of Regulation (EU) 2020/852 and for other financial undertakings, the calculation referred to in paragraph 2 shall use key performance indicators referred to in points (b) to (e) of Section 1.1 of Annex III of Commission Delegated Regulation (EU) 2021/XXX [insert reference to Article 8 Taxonomy Regulation Delegated Act] .
5. For disclosures referred to in point (ii) of Article 16a(1)(a), point (ii) of Article 25(1)(a), point (iii) of Article 61a(b) and point (iii) of Article 67a(b), paragraphs 1 to 4 shall apply except that the sovereign exposures shall be excluded from the calculation of the numerator and of the denominator of the formula contained in paragraph 1.’
Share of taxonomy-aligned investments in pre-contractual disclosures
Some asset managers opposed the ex-ante identification of a quantitative percentage of taxonomy-aligned investments and urged to allow for a more qualitative disclosure of taxonomy-alignment instead. It was argued that pre-contractual disclosures should not reflect data at a specific date but should focus on the strategy and what the portfolio manager is bound to do when making investment decisions. The data should rather be included in the periodic report.
Many stakeholders suggested that the quantitative taxonomy-alignment ratio (pie chart) should be accompanied by a qualitative segment explaining how the Financial Market Participant plans to increase its share of taxonomy-aligned investments in both the pre-contractual and periodic disclosures.