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Worth knowing about EU’s climate law and taxonomy

On 21 April the European Union agreed on the new European Climate Law, which lays out the path for Europe to achieve climate neutrality by 2050. On the same day, an ambitious package of measures was also adopted for the first part of the EU taxonomy. What happens now? When does the taxonomy take effect, and who is affected? We take a look at these questions together with SEB’s experts.

The work with the taxonomy began in 2018 and SEB as a bank has a unique insight into the work, among other things based on participation in the EU's expert groups. Marie Baumgarts participated in the technical expert group that developed the taxonomy for the two first environmental goals and Karl-Oskar Olming is part of the expert group that is now continuing the work on the taxonomy's remaining four environmental goals and possible expansion.

The bank's experts also include Anne Kristin Kästner, who has developed a tool for taxonomy analysis in equity portfolios, and Åsa Knudsen Sterte, who has previously worked at the Ministry of Finance and negotiated the taxonomy regulation on behalf of Sweden.

What does the new Climate Law entail?

It means that the EU has introduced legally binding targets to reduce net greenhouse gas emissions to zero by 2050 along with an intermediate target to reduce net greenhouse gas emissions by at least 55% by 2030, compared to 1990 levels. These targets were previously included as plans and activities in the EU’s Green Deal, but they will now after the political agreement be codified into law, requiring the Member States to take necessary action to achieve the targets.

What is the taxonomy?

It is a green classification system that concretises the EU’s climate and environmental targets into a number of criteria that are required for an economic activity to be classified as environmentally green or sustainable. It establishes six environmental objectives, of which the two first now are defined, and for an activity to qualify as sustainable, it must make a significant contribution to the achievement of at least one of the targets – at the same time that it does not significantly infringe upon any of the other targets. In addition, certain minimum social requirements need to be met.

The aim of the classification is to give stakeholders as investors and companies guidance on how they can invest and develop their business models in a way that contributes to the climate transition.

The first part of the taxonomy, which is now being presented in the form of a delegated act, focuses on the climate. It sets threshold values for activities that are considered to significantly contribute to the goal of achieving net zero emissions by 2050 or that contribute to a countering of negative consequences of climate change. The taxonomy thus shows the path for how to achieve the goals of the Paris Agreement to stop Earth’s warming.

The EU is now continuing its work on creating a taxonomy for the other four environmental areas: protecting biodiversity, the transition to a circular economy, protecting oceans and water, and preventing pollution. These will be presented in separate delegated acts.

What does the continued process look like with respect to the first part of the taxonomy?

The European Parliament and Council of Ministers now have a maximum of six months to reject or adopt the delegated act in its entirety, parts of the act cannot be renegotiated. To reject a delegated act requires a simple majority in the European Parliament or a qualified majority in the Council of Ministers, which is, however, extremely unusual as Parliament and the Member States have delegated the authority to produce the act to the European Commission.

Who is required to report in accordance with the taxonomy’s delegated act on the climate?

It is mainly intended for all categories of institutional asset managers that offer green products, such as mutual funds or pension savings. The taxonomy reporting is also obligatory for all listed companies with more than 500 employees as well as banks and financial market companies (i.e. those covered by the EU Non-Financial Reporting Directive, NFRD. Over time the scope will be broadened to include more companies.

All companies have the option to report in accordance with the taxonomy on a volunteer basis, however.

How are companies to report according to the taxonomy?

For financial products, for example an equity fund, it must be stated how much has been invested in taxonomy-aligned activities. The companies covered must report how large percentage of their economic activity is aligned with the taxonomy. This means that they are to report how large a share of their operations make a substantial contribution to achieving the targets without having any other significant adverse environmental impact.

The taxonomy’s first delegated act on the climate is estimated to cover the economic activity of roughly 40 per cent of listed companies in the sectors that account for 80 per cent of direct greenhouse gas emissions in the EU.  

When are companies required to report in accordance with the taxonomy?

The companies subject to the requirement are to report starting with the 2021 financial year, i.e., in connection with publication of their 2021 annual reports. 

What happens with companies whose activities are not aligned with the taxonomy? Will they have more costly financing, or perhaps none at all?

The aim of taxonomy is to contribute to the climate transition by serving as guidance for investors and other stakeholders. There are no formal requirements for a company to be taxonomy-aligned, nor any prohibition for investors to invest in companies that are not taxonomy-aligned.

Since the taxonomy shows the path to achieving the Paris Agreement’s targets, you could say that the more a company’s operations are taxonomy-aligned, the more future-proofed its business is from a climate perspective.

Companies whose operations are not taxonomy-aligned today but which can show a credible transition plan will have an advantage in attracting investors. The opposite applies for companies that do not have a credible transition plan.

According to an analysis conducted with the help of SEB’s Impact Metric Tool, an analysis tool for investment portfolios, at present only around 3 per cent of the largest listed companies’ revenues are aligned with the taxonomy (Developed Market Index). So, there is great need for transition to measure up to the Climate Law’s objectives of decreasing the emissions with 55 percent to 2030.

A number of areas in the taxonomy are the subject of political debate. Which parts have been excluded from the delegated act that has now been presented?

As a result of political discussions, certain parts have been pushed back in order to be dealt with in separate processes. For the delegated act for agriculture, they want to wait for ongoing negotiations of the EU’s agriculture policy to gain better concordance. Nuclear power, which was not included in the original proposal – due to the requirement that operations may not potentially cause significant adverse environmental impact – will be addressed in a separate process to give the EU’s Member States and the European Parliament an opportunity to be involved. At the same time, maritime shipping and restoration of wetlands (which can serve as carbon sinks) have now been included in the taxonomy.

A lot has been discussed regarding forests, bioenergy, buildings and more. What is the status in these areas?

With regard to forestry and bioenergy, several countries, including Sweden, have worked to ensure that the sustainability criteria are in line with the EU directive on renewable energy. This has been obeyed compared to the first draft, but to what extent it depends a bit on who you ask.

In forestry, companies are required to provide forestry plans and climate benefit analyses in order for their operations to be classified as taxonomy aligned. On this issue EU has been open to allowing this at the group level, but it is too early to say what this might entail in practice. Forestlands smaller than 13 hectares are exempted from the requirement for a climate benefit analysis.

Production of bioenergy now seems to be generally classified as taxonomy-aligned if is conducted in accordance with the EU Renewable Energy Directive.

As for buildings, certain changes have also been made to the original proposal. What applies now is that buildings with an energy classification a “A” and the 15 per cent most energy efficient buildings in each country are classified as taxonomy aligned. It is still not clear exactly how the calculation of the 15 per cent will be performed.

Generally speaking, it is still too early to say how the rules surrounding the taxonomy will be applied in practice. This will be chiseled out in the continued work. Practice will become clearer as companies and banks begin reporting in accordance with the taxonomy.

Looking forward, work is underway on a possible expansion of the taxonomy, what happens there?

SEB is part of the Platform for Sustainable Finance, which works with recommendations for a possible expansion of the taxonomy. The areas that are considered are social goals and activities that can cause significant harm, as well as activities with little, or insignificant, impact.

Will we hear more about that work and how do I get in touch with the bank's experts?

We will continuously communicate about future developments and how it affects our customers and society at large. You are welcome to contact the bank via your regular channels for more information.