28 September 2021
In order to achieve the goals of the Paris Climate Agreement and the European Green Deal - climate neutrality by 2050 - significant CO2 reductions in specific, especially emission-intensive sectors and related massive investments are essential in the coming decades. The EU Taxonomy Regulation 2020/852, which entered into force on 12 July 2020, in conjunction with the EU Sustainable Finance Disclosure Regulation 2019/2088 (SFDR), is intended to redirect capital flows in a way that favours sustainably operating companies. To this end, the Taxonomy Regulation establishes a classification system for environmentally sustainable economic activities and specifies the information to be reported in this regard. On 21 April 2021, the European Commission's delegated act on EU climate taxonomy ("Climate Act") entered into force, which sets out specific technical screening criteria for two environmental objectives of the EU taxonomy, climate change mitigation and adaptation.
Why the already high demand for projects and investments in CO2 avoidance and reduction, especially for large-volume renewable energy projects such as the construction of offshore wind farms, will increase further as a result of the EU taxonomy and why many key industries will not succeed in classifying their sales under the EU taxonomy without concluding Power Purchase Agreements (PPAs) for green electricity and using green hydrogen.
The starting point for classifying an economic activity under the EU taxonomy is whether it is "environmentally sustainable" within the meaning of the Taxonomy Regulation. An economic activity is considered "environmentally sustainable" if it contributes substantially to one or more of the six environmental objectives set out in the Taxonomy Regulation, does not significantly harm any other environmental objective and meets certain minimum social standards, including the International Bill of Human Rights or international labour protection provisions (Minimum Safeguards). The six environmental objectives are:
The purest form of taxonomy-aligned activity supports an environmental objective itself and directly. Furthermore, the Taxonomy Regulation classifies two additional types of economic activities as environmentally sustainable. In relation to climate change mitigation, these activities support the transition to a climate-neutral economy in the sense of the Paris Climate Agreement (so-called transition activities). Furthermore, for all environmental objectives - i.e. not only in relation to climate change mitigation - these are so-called enabling activities which must contribute to other activities being carried out, which in turn contribute significantly to one or more of the above mentioned six environmental objectives.
Within the framework of the Taxonomy Regulation, the European Commission was mandated to issue so-called "delegated acts" with screening criteria under which certain economic activities qualify as environmentally sustainable. For the first two environmental objectives "climate change mitigation" and "climate change adaption", the Climate Act is such a delegated act for individual sectors. The Climate Act should cover the economic activities of about 40 percent of listed companies in those sectors that account for about 80 percent of direct greenhouse gas emissions in Europe. These sectors include energy, forestry, manufacturing, transport and buildings. The Climate Act is dynamic and is regularly adapted to new developments and technological progress. This is to ensure that new sectors and activities, including those that support the transition to a climate-neutral economy or enable other activities, can be included under its scope. Another delegated act for agriculture and for some sectors of the energy industry not yet included in the Climate Act will be adopted towards the end of 2021.
Article 8 of the Taxonomy Regulation requires undertakings subject to the Non-Financial Reporting Directive (NFRD)) to disclose in their non-financial statement or consolidated non-financial statement information on how and to what extent their activities are associated with environmentally sustainable economic activities as defined in the Taxonomy Regulation. Paragraph 2 of Article 8 specifies that in particular non-financial undertakings shall disclose the proportion of their turnover, capital expenditures and operational expenditures associated with activities included in the EU taxonomy. The companies concerned must therefore review their entire business activities, whereby the EU taxonomy does not provide for any restriction of the comply-or-explain rule of the NFRD.
Companies that are currently subject to the NFRD are thus directly affected by the reporting obligations. More specifically, these are capital market-oriented companies and financial service providers with more than 500 employees. However, the range of affected companies will get wider: In a package of Sustainable Finance measures in April 2021, the European Commission published a proposal for the so-called Corporate Sustainability Reporting Directive (CSRD), which is to replace the NFRD and is expected to apply from the 2023 reporting year. If these plans are implemented, small and medium-sized capital market-oriented companies and large non-capital market-oriented companies will be affected as well (if they each exceed at least two of the following three size criteria: Balance sheet total: EUR 20 million, net sales: EUR 40 million, average number of employees during a business year: 250).
Indirectly, the reporting obligations of the EU taxonomy already have an impact on small and medium-sized companies. This is because many financial market participants and large companies are already asking their customers, suppliers and subcontractors for sustainability data (and in some cases obliging them to disclose it) in order to be able to fulfil their legal reporting obligations. In addition, companies that want to determine and reduce the overall carbon footprint of their products are significantly dependent on the corresponding data from their business partners.
In addition, the Taxonomy Regulation also refers to the Disclosure Regulation, according to which financial market participants (within the meaning of the Disclosure Regulation) must publish information on sustainability risks of financial products on their websites and in pre-contractual information. For financial products based on sustainable investments within the meaning of the Disclosure Regulation, in addition to the obligations of the Disclosure Regulation, the intended EU environmental objective, the type and scope of the taxonomy-aligned economic activities in which the product is invested, and the percentage share of the taxonomy-aligned activities in the overall portfolio must be presented, as well as a list of the shares of enabling activities and transitional activities. For financial products of financial market participants that have investments with environmental characteristics and are advertised as such but are not considered environmentally sustainable, the disclosure requirements for environmentally sustainable investments shall apply accordingly. In addition, blanket statements are to be included in the pre-contractual and regular reporting that no Do No Significant Harm test was carried out for the corresponding underlying invested economic activities and that these do not comply with the EU taxonomy. With regard to other financial products, a declaration will be required in future that the information underlying the financial product does not take into account the criteria of the EU taxonomy.
The Member States are obliged by the Taxonomy Regulation to adopt rules on measures and penalties for breaches of the product-related disclosure obligations. These measures and penalties should be dissuasive, effective and proportionate. What exactly sanctions will look like in national law is still pending.
With regard to company-related disclosure obligations, the Taxonomy Regulation does not contain any provisions on the regulation of penalties by the Member States. With regard to Germany, a violation of the non-financial reporting obligation has so far been sanctioned differently in the HGB (from fines to even prison sentences of up to three years for the body authorised to represent the company or the supervisory board). With the adoption of the CSRD, however, a fundamental revision of the regulations on non-financial reporting is to be expected.
In this respect, the reporting obligations will force a large number of companies to deal with the sustainability criteria of the EU taxonomy in order to be able to make a classification at all. This will have to be accompanied by the creation of corresponding know-how, capacities and new internal processes.
The Taxonomy Regulation itself explicitly does not contain any obligation to invest in sustainable activities. Rather, it is intended (see above) in conjunction with the Disclosure Regulation to redirect financial flows on the capital market in such a way that sustainably operating companies are favoured and in this respect creates the basis for a large number of sustainable finance measures. Through the EU taxonomy, the EU and its Member States commit to taking the criteria of the EU taxonomy into account in all specifications for financial products and corporate bonds, provided that these are marketed as ecologically sustainable. This is the basis for the requirement that so-called standards for environmentally sustainable financial products (e.g. EU Green Bonds, EU Eco Label) must be based on the EU taxonomy. The Commission is planning various financing support concepts based on the EU taxonomy, such as the promotion of EU Green Bonds or the consideration of the environmental balance in financial products (EU Eco-Label). On 6 July 2021, the Commission already published a draft EU Green Bond Standard (EU GBS).
Other decision-makers, especially banks, will also include the criteria of the EU taxonomy in many decisions on the granting and conditions of loans and bonds, if only to improve their own reporting. KfW also supports medium-sized companies with "investments in ambitious climate protection measures that are based on the technical criteria of the EU taxonomy" with favourable loans. In this respect, it can be assumed that raising capital for non-sustainable investments within the meaning of the Taxonomy Regulation will be made considerably more difficult, which in turn will effectively force companies to at least consider the point of sustainability in every investment decision.
The EU taxonomy is accompanied by the expectation that the transparency and certainty created for customers and promoters should counteract "greenwashing" and thus trigger a greater willingness to invest in green or sustainable products. The EU taxonomy does not classify any activity as explicitly green or non-sustainable, but rather distinguishes between taxonomy-aligned and non- taxonomy-aligned activities. Nevertheless, there is a risk that an activity that is not classified as "green" in the sense of the EU taxonomy is automatically perceived as unsustainable. In this respect, the EU taxonomy and the resulting reporting obligation will become a decisive factor for the external perception of companies. Market participants who make insufficient efforts to be classified run the risk of losing their competitiveness in relation to customers and investors in the long term. Suppliers have already recognised this as a risk - or, in other words, as an opportunity - and are creating additional competitive advantages for themselves by proactively supporting their customers in their efforts to reduce CO2 emissions or by supplying green products themselves (e.g. products manufactured using purely green electricity).
Annex 1 of the Climate Act sets out, among other things, the technical screening criteria for the sectors listed therein, which are used to determine under which conditions an economic activity can be considered to make a significant contribution to climate change mitigation. According to these screening criteria, the following measures, for example, are potentially eligible for an improvement of the EU climate taxonomy:
The means for CO2 reduction are manifold and vary greatly depending on the sector concerned. For the manufacturing sector, it is generally argued that most companies would generate a large share of their CO2 emissions through energy supply, for example for process heat or lighting. CO2 emissions could therefore be reduced by reducing energy consumption, in particular by using more efficient technologies, and/or by switching to "green" electricity. In the steel industry, the use of hydrogen instead of carbon in the manufacturing process could significantly reduce CO2 emissions. For the chemical industry, there are also first developments towards lower CO2 emissions in the manufacturing process, for example by using green hydrogen for emission-free ammonia synthesis. However, a major hurdle for the use of CO2-neutral or -reduced processes in the steel and chemical industry is, apart from the considerable investments required, the demand for green electricity and sustainably produced hydrogen or the far from sufficient supply. Many industrial companies are thus pushing for an accelerated expansion of renewable energies. In July 2021 the Federal Ministry of Economics and Technology (BMWi), based on a Prognos AG study it had commissioned, announced that an adjustment of the analyses on electricity consumption in 2030 is necessary. It announced further that the forecast electricity consumption is between 645-665 terawatt hours, i.e. significantly higher than the value of about 590 terawatt hours forecast at the beginning of 2020. In the process, the BWMi has also raised the forecast electricity demand for the production of green hydrogen from 20 to 30 TWh. A detailed forecast is to follow in autumn 2021.
A further or additional way for a company to improve its classification under the EU taxonomy may be to redirect its capital and operational expenditures towards environmentally sustainable economic activities as defined by the EU taxonomy. This can be a crucial aspect for the external perception of the company and the corresponding financing. A variety of measures are conceivable here that can fall under the EU taxonomy if certain criteria are met such as the development of climate-friendly production processes to reduce CO2 emissions from selected energy-intensive processes, investments in "green" IT such as data-driven solutions to reduce CO2 emissions, conversion of the vehicle fleet for goods and passenger transport to zero- or low-emissionvehicles or the renovation of existing buildings to reduce primary energy demand.
With regard to reporting obligations under the EU taxonomy or reporting obligations of suppliers, customers, clients, etc., a large number of companies will now have to deal with the question of whether their economic activities are to be classified as "environmentally sustainable" in the sense of the EU taxonomy or how to improve classification or help business partners in this respect. The resulting demand for the most diverse projects, investments and other measures to avoid or reduce CO2 will continue to rise. The Pressure on demand for green energy is already increasing significantly in the market. In particular, the demand for direct supplies of green electricity (unsubsidised under the Renewable Energy Sources Act!) through Power Purchase Agreements will also increase. This pressure will in turn further fuel the development of large-scale green power projects - if the framework conditions are created (areas for onshore wind and solar PV; further offshore wind areas and - not to be forgotten - grid expansion, both for electricity and gas). Finally, not only will projects and investments in renewable energies (in the broadest sense, i.e. including innovative CO2-reducing technologies, e.g. for more efficient storage and distribution of green electricity) increase, but an increase in M&A transactions in this area is also to be expected, for example among technology providers or in the area of venture capital, because the tasks set also entail the need for innovations. Thus, the corresponding financing is not only privileged by the state or by institutions such as the KfW, it is also to be expected that lenders will give preferential treatment to sustainable transactions with a view to their own reporting.