We present a guide to understand what the European Green Taxonomy is and how your organization should adapt to it from 2023.

The EU Taxonomy is a classification system that establishes a list of environmentally sustainable economic activities. The aim is to create more transparency around the sustainability of companies’ business activities.

Understanding Green Taxonomy

Given the many environmental challenges we face today, there is a clear need for a transition to a production model based on technologies and methods with low environmental impact.

The European Union has committed to leading this ecological transition with the European Green Deal, a comprehensive strategy that aims to achieve climate neutrality by 2050 and protect biodiversity and natural resources.

But to achieve these ambitious goals, public policies are not enough. The involvement of the private sector is also needed, especially companies and investors, as they have a key role in financing the green economy.

How can companies and investors know whether their activities or products are truly sustainable? What criteria should they follow to align their decisions with EU environmental objectives? How can they avoid the risk of falling prey to greenwashing?

To answer these questions, the EU has created the European Green Taxonomy, a classification system for economic activities that seeks to provide a clear and common definition of what is sustainable and what is not.

In short, it is a regulation that establishes the criteria to determine whether an economic activity (for example, cement production) and any investment product associated with it can or cannot be classified as environmentally sustainable.

To do this, the taxonomy is based on four principles:

1. The activity must contribute substantially to one or more of the six environmental objectives set by the EU:

• Climate change mitigation (through reducing greenhouse gas emissions)
• Adaptation to climate change (refurbishing certain infrastructures or activities to protect against the effects of climate change)
• Sustainable use and protection of water and marine resources
• The transition towards a circular economy
• Pollution prevention and control
• The protection and restoration of biodiversity and ecosystems

2. The activity must not cause significant harm to any of the other environmental objectives.

3. The activity must comply with minimum social safeguards, such as respect for human and labour rights.

4. The activity must follow the specific technical standards for each sector, which define the thresholds and indicators to measure environmental performance.

These criteria apply to more than 70 economic activities covering sectors such as agriculture, industry, transport, energy and construction.

The taxonomy regulations include annexes listing the eligible activities according to each environmental objective and the technical standards they must follow.

This taxonomy is based on the recommendations of experts and scientists and establishes technical criteria to determine whether an activity is sustainable or not; and provides for a periodic review of the taxonomy to adapt it to scientific and technological advances.

To whom does the Taxonomy regulation apply?

The European green taxonomy mainly affects two types of actors: financial institutions and large companies.

Financial institutions are those that offer financial products (investments, funds, bonds or loans). These entities must report the percentage of their income or expenses that come from or are allocated to sustainable activities according to the taxonomy. In this way, investors will be able to know the environmental impact of their investments and make more informed and responsible decisions.

Large companies, for their part, are required to publish non-financial information on their environmental, social and corporate governance impact (renamed Corporate Sustainability Reports). These companies must report in these reports the proportion of their income or expenses that come from or are allocated to sustainable activities according to the taxonomy.

Furthermore, the European Green Taxonomy also applies to the European Union and its Member States in terms of public funding through grants and subsidies. In this way, the EU will be able to ensure the coherence and effectiveness of its public policies in achieving its environmental objectives.

The European green taxonomy gradually came into force in January 2023, starting with the criteria relating to climate change (mitigation and adaptation) and has recently been extended to other environmental objectives (water and marine resources, circular economy, pollution and biodiversity). 

Process of applying the taxonomy in your organization

To apply the European green taxonomy to a company subject to reporting of its non-financial information statements, the following steps must be followed:

• Identify the economic activities carried out by the company and determine whether they are eligible within the European green taxonomy.
• Evaluate the degree of alignment of each eligible activity with the technical criteria established by the European green taxonomy.
• Calculate and report the percentage of income, expenses and assets associated with sustainable activities according to the European green taxonomy.

We explain each step in greater detail below.

Identification of activities

To find out whether an economic activity meets the criteria of the European green taxonomy, the quickest and most reliable method is to use the search engine for activities eligible for the EU taxonomy, which allows you to filter by sector, environmental objective and type of activity.

The taxonomy is based on the NACE nomenclature to identify each economic activity, so you can use it to determine whether or not your activity falls within the category eligible for the taxonomy.

Evaluate the degree of alignment with technical criteria

To comply with the European green taxonomy, it is not enough to identify the eligible economic activities according to the annex of the regulation. It is also necessary to check whether the technical selection criteria established for each activity and each environmental objective are met.

Technical selection criteria are specific standards that define thresholds and indicators for measuring the environmental performance of economic activities.

To check whether the technical selection criteria are met, the delegated act for each environmental objective must be consulted and check whether the economic activity complies with the established thresholds and indicators.

In addition, it must be ensured that the economic activity does not cause significant harm to any of the other environmental objectives, which implies meeting other thresholds and additional requirements. This criterion is related to the DNSH principle.

Report the degree of eligibility of our economic activities

Reporting the eligible proportion is one of the main obligations established by the European Green Taxonomy Regulation.

The eligible proportion is the percentage of operating income or expenses that comes from or is allocated to sustainable activities according to the taxonomy. This measure allows for the assessment of the degree of contribution of an entity or a financial product to the EU environmental objectives and facilitates the comparison between different investment options.

To report on the eligible proportion, the format and content established by the regulations must be followed, which are as follows:

• An overview of economic activity
• The environmental objective to which economic activity contributes
• The eligible proportion is expressed as a percentage. It must be reported for the following indicators:
  • % of eligible turnover
  • % of investment in eligible assets
  • % of operating expenses on eligible activities.
• An explanation of the methodology used to calculate the eligible proportion

The report must be clear, precise and verifiable. It must be based on reliable and up-to-date data and must faithfully reflect the reality of the entity. In addition, it must be updated periodically to incorporate changes that may affect the eligible proportion.

The next steps of the Green Taxonomy

The European Green Taxonomy is currently in a process of gradual development and implementation. As explained, the first delegated act on the EU climate taxonomy entered into force on 1 January 2022. However, this act only covers two of the six environmental objectives set out by the regulation: climate change mitigation and adaptation.

For the other four pending environmental objectives (water and marine resources, circular economy, pollution and biodiversity), the European Commission has published the drafts of its delegated acts, which are expected to be approved in the coming months of 2023.

In addition, the European green taxonomy provides for a periodic review to adapt to scientific and technological advances, as well as to new market needs and demands.

Companies and investors should therefore keep an eye on developments in the European green taxonomy and prepare to adapt to any changes that may affect them.

At the same time, they must take advantage of the opportunities offered by the taxonomy to improve their environmental performance, access new sources of financing, and increase their transparency and credibility.