EU Taxonomy and implications for business

Climate change adaptation is one six core objectives of the EU Taxonomy regulation that is set to change the way business and industry operates. The new regulation is aimed at altering behaviour, systems and ways of life to protect the environment from the impacts of climate change caused by human activity. What is business and industry doing to adapt their commercial activities, operations and objectives to comply with the new EU taxonomy? And if it hasn’t already started, what can a company do to make the required adaptations?

The EU taxonomy, and closely-aligned UK Taxonomy, formalises a legal framework for the processes of climate change adaptation that business and industry will increasingly be required to adhere to. It is an important new framework for assessing the sustainability of different activities and investments across the European Union and sets the world standard for labelling green investments. The regulation will have an impact on many businesses especially those in the financial and environmental sectors.

“The EU taxonomy both for mitigation and adaptation is a new way of assessing business and investor contribution to climate related impacts,” says Jose Maria Ortiz, MD of impact investment and business growth at Palladium. “Whilst some leaders are making an effort to understand and contribute, not many organisations have actually adapted their business models or investment portfolios.”

EU Taxonomy regulation

EU Taxonomy applies to companies subject to non-financial reporting (NFRD). Based on current rules, large listed companies will have to disclose to what extent the activities they carry out meet the criteria. This applies to companies with more than 500 employees during the financial year.

The six environmental objectives of the Taxonomy are: climate change mitigation, climate change adaptation, sustainable use and protection of water and marine resources, transition to a circular economy, pollution prevention and control, and protection and restoration of biodiversity. The criteria are developed for economic activities in sectors such as agriculture, manufacturing, electricity, transportation, buildings and communications.

To date, there is no mandatory assurance of Taxonomy-related reporting under Article 8 in most EU jurisdictions. This will change with the introduction of the Corporate Sustainability Reporting Directive (CSRD) in 2024, which will require, at a minimum, limited assurance across the EU.

Companies seeking finance and investment will increasingly be required to meet the requirements of the EU Taxonomy that is designed to help investors choose green investments and make sure that they are getting the maximum sustainability benefits from their investments. For example, a company might be categorised as a low carbon investment if it demonstrates that it is taking steps to reduce its carbon footprint. This information can be used to inform investors about the environmental impact of their investments.

Financial services companies will need to review their investment portfolios to ensure that they are meeting the requirements of the Taxonomy. This could involve shifting investments away from high-carbon activities and towards those that meet the new regulatory requirements. This shift could also involve providing financial products and services that are designed to support the transition to a low-carbon economy.

“Only plans that are aligned with the Taxonomy will be allowed to be financed by green bonds or green loans, and we see a huge appetite in the market to deploy capital through these two instruments,” Ortiz says. “As access to credit dries in the current cycle, organisations with strong plans aligned to the taxonomy will have a relevant advantage against others when it comes to accessing finance.”

EU Taxonomy impact on companies

The EU Taxonomy will have an impact because companies will need to prove that their activities, products and services meet the requirements of the Taxonomy in order to be labelled as sustainable. Companies will need to review their operations and invest in strategies to ensure that their activities meet the requirements of the Taxonomy. This could include investing in renewable energy sources, using energy efficiency technologies, or switching to sustainable materials.

Some of the challenges businesses face in embracing the Taxonomy include a lack of awareness of the issue and its implications, lack of data and knowledge, difficulties in incorporating climate change into decision making, regulatory uncertainty, resource constraints and a lack of engagement from stakeholders.

Companies may find that regulations are difficult to interpret and may require significant resources in order to properly comply with the requirements. Additionally, the costs associated with compliance may be high, particularly for small businesses, and firms may struggle to stay on top of changes to the regulations and adjust their activities accordingly.

The cost of compliance

As part of the regulation, companies must assess and disclose how their activities are aligned with the EU Taxonomy and what costs are associated with this process. The costs associated with complying with the EU Taxonomy can vary depending on the complexity of the business activities and the scope of the assessment. Generally speaking, businesses can expect to hire external experts to review their operations and provide recommendations on how to align their activities with the Taxonomy. Additionally, firms may need to invest in software or other technology solutions to monitor and track their progress.

Though the compliance costs may be significant for some businesses, there are some strategies that can be employed to reduce costs. One way is to review operations and identify areas of improvement that can be made in order to better align activities with the EU Taxonomy. Additionally, businesses may want to look into technology solutions that can help to automate certain aspects of the process and reduce the amount of manual work that needs to be done.

There may be costs associated with compliance but there are also potential benefits such as increased access to sustainable finance and improved brand recognition. In order to reduce costs, businesses can look into using internal expertise and technology solutions to help streamline the process.

How can businesses embrace the EU Taxonomy?

There are a number of measures businesses can take to adapt to the demands of the Taxonomy, including identifying and managing physical risks, reviewing and strengthening supply chains, factor climate change into decision making, developing policies and procedures, increasing transparency and communication and engaging with stakeholders.

“More and more organisations are committing publicly to net zero by 2050 which highlights how leadership teams and boards are increasingly committed to climate mitigation and adaptation measures,” Ortiz says. “As these commitments become public, we see organisations moving into the implementation stage looking for solutions to transform their value chains to comply with the adaptation and mitigation contribution.

“Energy efficiency is another of the big investments we’re seeing across Europe (much more than in other regions) as well as the rediscovery of their supply chains to ensure they source from organisations aligned with their objectives.

“Organisations that have not yet started this journey should be familiarising themselves with the taxonomy and assessing the organisation’s assets against them,” Ortiz urges. “An interesting exercise would be for them to assess their investment plans against the criteria, as the advantage of having an investment plan that complies is massive, not only in the competitive advantage that can bring to the organisation, but also to the cost of capital to finance it.”

The benefits of EU Taxonomy compliance

Environmental businesses that provide services or technologies that help companies meet the requirements of the Taxonomy can benefit from increased demand for their services. In addition, companies that focus solely on providing environmental products or services can also benefit. These companies can label their products and services according to the Taxonomy and take advantage of the growing demand for green investments.

Though there are costs associated with compliance with the EU Taxonomy, there are also potential benefits. The process of climate change adaptation can bring a number of benefits for business, including: improved resilience to climate change impacts, reduced costs, improved competitiveness, enhanced reputation and improved social and environmental outcomes.

Companies that comply with the regulation could benefit from increased access to certain types of sustainable finance, such as green bonds or other instruments. Additionally, companies may find that they are able to attract more investors who are looking for sustainable investments. Lastly, compliance could provide brand recognition and a competitive edge over other firms that are not compliant.

“Innovation in products with a low emission profile is a growth area with new products around concrete, construction and industrial materials, fashion and cosmetics and the food industry,” Ortiz concludes. “The pressure coming from the boards downwards is noticeable, and the taxonomy will help those boards to hold executives accountable through comparable measurement to peers in their sector.”