De-tangling the EU Taxonomy

The EU Taxonomy Regulation (2020/852/EU) establishes an EU-wide classification system for environmentally sustainable economic activities. The regulation contains six objectives, designed to support the EU’s Green New Deal and 2030 climate and energy targets:

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.^[1]

The Taxonomy Regulation complements and underpins other regulations - such as the Non-Financial Reporting Directive (NFRD), Sustainable Financial Disclosure Regulation (SFDR), and the upcoming Corporate Sustainability Reporting Directive (CSRD) - by providing clear, standardized definitions of what is ‘environmentally sustainable’ from an EU perspective, so that organizations and private investors can more confidently assess and direct their investments and reporting processes in this area.

“First and foremost, it’s important to know that the EU Taxonomy is a mandatory disclosure exercise for companies that are in scope,” says Walter Jacob, Senior Counsel at KPMG Law. “Since its introduction in 2020, it has primarily affected larger companies with 500+ employees. However, when the Corporate Sustainability Reporting Directive (CSRD) comes into effect in 2026, the scope of companies required to comply with EU Taxonomy regulation will widen to also include companies with 250+ employees, exceeding EUR 20 million net turnover and exceeding EUR 40 million balance sheet total (2 out of 3 criteria to be met). We therefore recommend that executives already take the opportunity to prepare for this eventuality, so that there is the maximum time available to invest strategically and allocate the necessary resources before the disclosure data is required.”

“Many companies struggle with a lack of EU Taxonomy data,” says Filippo d’Eufemia, Sustainability Manager at KPMG Advisory. “For starters, they need to identify, collect, and report data related to turnover, capital expenditure, and operational expenditure connected with environmentally sustainable economic activities. Implementing the processes to collect and analyze relevant, high-quality data in these areas can be a challenge, especially for companies that are starting from scratch.”

“The good news is that investments in this area are worthwhile,” says Walter. “Not only does it send a strong signal to investors, employees, customers, competitors, and regulators that your environmentally sustainable economic activities are credible, but it also helps to provide the foundation for fulfilling your current and future annual reporting requirements.”

“The key word here is credibility,” says Filippo. “By requiring a standardized approach to sustainability disclosures under the EU Taxonomy, this regulation takes a data-based approach to help separate the companies that are truly performing well in their ESG activities from those that still have some catching up to do. Having access to this information also provides greater security for investors, executives, and managers when making strategic decisions about where to direct their resources.”

“At present, companies in scope of the EU Taxonomy are required to report from two perspectives: eligibility and alignment,” says Walter. “In this context, ‘eligibility’ means identifying and disclosing which of the company’s activities are potentially sustainable according to the screening criteria outlined in the Taxonomy, whereas ‘alignment’ involves testing and disclosing whether these activities do in fact meet the Taxonomy’s technical screening criteria for them to be considered eligible, as well as demonstrating a significant contribution to the relevant Taxonomy objective, compliance with the ‘Do No Significant Harm’ principle and Minimum Safeguards.”

“For example,” he continues, “when a company undertakes an exercise to renovate a building to improve its energy-efficiency using more sustainable insulation, this activity could be considered ‘eligible’ for technical screening and included as a sustainable activity in the company’s EU Taxonomy disclosures. ‘Alignment’ would then mean testing whether the materials subsequently used for the building’s insulation are fit-for-purpose and meet the technical sustainability requirements necessary to achieve the targeted energy efficiency gain. To ensure standardization can be achieved across different companies and sectors, the testing criteria used to determine eligibility and alignment are detailed in the relevant section of the Taxonomy.”

“The introduction of the EU Taxonomy has taken a gradual approach,” says Filippo. “As it currently stands, in 2024, companies in scope of the EU Taxonomy are required to report on eligibility and alignment with objectives one and two: i) climate change mitigation and ii) climate change adaptation, as well as the eligibility of their activities for objectives three, four, five, and six: iii) sustainable use and protection of water and marine resources; iv) transition to a circular economy; v) pollution prevention and control; and vi) protection and restoration of biodiversity and ecosystems.
From 2025 onwards, companies in scope will be required to report on eligibility and alignment with all six EU Taxonomy objectives.

“But it doesn’t end there,” says Walter. “When the CSRD also comes into effect as from financial year (FY) 2025, the scope of companies required to report on all the above EU Taxonomy objectives will widen to include the so-called large companies. From that time onwards, all companies in scope of the EU Taxonomy and CSRD will also be required to provide independent assurance of their non-financial and EU Taxonomy disclosures within their annual report.”

“There are three key benefits linked to the EU Taxonomy,” says Filippo. “Firstly, it provides clear definitions and guidance to help executives, investors, and other stakeholders have a common language to understand how environmentally sustainable your company’s economic activities are at present. Secondly, it helps managers to improve their strategy for sustainability performance and reporting processes by providing a foundational framework for upcoming reporting requirements. Lastly, but perhaps most importantly for some companies, having the relevant data and strategy available to disclose – with an EU Taxonomy percentage by which investors can clearly understand how your company is performing - can help companies to offer greater transparency and more easily attract investment.”

He continues, “it’s important to remember that it is not just companies that are looking to validate their sustainability activities; investors are also looking for companies to direct their resources towards to improve the sustainability of their portfolios and meet their own EU Taxonomy disclosures requirements. What’s more, having standardized EU Taxonomy criteria and transparency makes it easier for investors to compare peers working in similar sectors, which means that companies cannot afford to fall behind in their EU Taxonomy disclosures.”

“EU Taxonomy reporting requires the involvement and expertise of multiple stakeholders and functions in an organization, including management, regulatory and legal, financial reporting, accounting, and sustainability. It is important that responsibilities are properly allocated and that the right people within the organization take ownership. This is an exercise that should not be underestimated,” says Walter.

“It’s important that these stakeholders are well-informed, so that they can adapt their investment strategies in real-time to stay aligned with regulatory developments and ahead of competitors,” says Filippo. “Activities that can prove valuable in this area include conducting a gap analysis, analyzing eligible and alignment activities, drafting or reviewing your company’s disclosure statement – with a final check by an independent party prior to submission. For investment activities, this could also include conducting an analysis of a target company’s disclosures for due diligence or M&A purposes, for example.”

“The EU Taxonomy is the cornerstone of the regulatory framework on sustainable financial and non-financial reporting. By staying up-to-speed with compliance requirements, you can avoid costly surprises and more confidently make strategic decisions about sustainable investment choices and resource allocation,” says Walter.

Wondering which next steps your company needs to take to maximize your EU Taxonomy percentages or need assistance with your reporting? Contact our specialists – we’re here to help!