ESG: the Commission publishes FAQs to clarify the Taxonomy Regulation

On 29 November 2024, the European Commission published a draft Commission Notice. This sets out a series of Q&As (the November FAQs), which provide technical clarifications on the application the EU taxonomy, in particular on

• the technical screening criteria for new activities included in the Taxonomy Climate and Environmental Delegated Acts

• the generic 'do no significant harm' (DNSH) criteria and

• the related reporting obligations.

This Note first sets out the legislative background to the EU Taxonomy and then examines the key aspects of the November FAQs. To go direct to the section on the November FAQs, click here.

For more information, see our online resource, "Sustainable Financing and ESG Investment"

A. The legislative background

The Taxonomy Regulation was published on 22 June 2020 and was designed with two issues in mind

• the lack of a harmonised EU-wide definition of environmental sustainability and

• the fact that the EU Member States do not themselves have the resources to meet the EU's climate commitments, and that therefore private capital must be directed towards environmentally sustainable activities.

The Taxonomy deals with these two issues by

• setting out a uniform test for environmental sustainability and

• requiring certain entities based on their size to report their level of alignment with environmentally sustainable activities. 

Together, these measures allow EU investors to compare the sustainability of different undertakings across the EU and to make investment decisions based on this comparison. 

(i) Environmental Sustainability and the taxonomy

The Taxonomy requires that, for an economic activity to be environmentally sustainable, it must:

• make a substantial contribution to one of six defined environmental objectives;

• do no significant harm (DNSH) to any of the other environmental objectives;

• comply with a series of minimum social safeguards; and

• comply with the requirements of the detailed technical screening criteria (TSC) (see below).

When drafting the Taxonomy, the EU concentrated on those economic activities which could make the largest contribution to one of the environmental objectives.  In the language of the Taxonomy, these are eligible economic activities.  An eligible economic activity which passes the four-step test set out above is then said to be aligned;

The Taxonomy's six environmental objectives are:

• climate change mitigation

• climate change adaptation

• sustainable use and protection of water and marine resources

• the transition to a circular economy

• pollution prevention and control and

• the protection and restoration of biodiversity and ecosystems.

These objectives were introduced on a phased basis, with the more easily quantifiable climate change objectives coming first, although all six are now in force.

The TSC for each eligible economic objective are set out in a series of delegated acts, described below. 

(ii) What entities are in scope?

The Taxonomy does not itself contain the rules for determining whether or not an undertaking is in scope, but instead refers to the Accounting Directive - in particular, to Articles 19a and 29a, which are themselves inserted in the Accounting Directive via the Corporate Sustainability Reporting Directive (CSRD)  Briefly, Article 19a brings large undertakings in scope, whereas Article 29a brings the parent undertakings of large groups in scope.

The Taxonomy entered into force on a phased basis but, from 1 January 2025, will apply to all large undertakings and parent undertakings of large groups (the previous requirements to be a Public Interest Entity with 500 or more employees will cease to apply at that date).

(iii) Disclosures under the taxonomy Regulation

Article 8 of the Taxonomy Regulation provides that an in-scope undertaking will disclose information on how and to what extent the undertaking's activities are associated with economic activities that qualify as environmentally sustainable under the Taxonomy. 

The Taxonomy specifies the Key Performance Indicators (KPIs) to be used by a non-financial undertaking, namely

• the proportion of its turnover derived from products or services associated with environmentally sustainable economic activities; and

• the proportion of its CapEx and the proportion of its OpEx related to assets or processes associated with environmentally sustainable economic activities.

The KPIs to be used by financial undertakings (as well as further details on the KPIs set out above) are contained in the Disclosures Delegated Act (see below). 

In addition, the KPIs for both non- financial undertakings and financial undertakings were subject to various phase-ins, for example initially the requirement was initially to report eligibility only, as opposed to alignment.

(iv) Level 2 measures under the Taxonomy Regulation

As with most EU regulations, the details of how an undertaking can comply with its disclosure obligations under the Taxonomy Regulation are set out in a series of underlying Level 2 measures. These include:

• the Disclosures Delegated Act - this sets out the details of the KPIs to be used by undertakings within scope of the Taxonomy, as well as the templates to be used when reporting these KPIs

• the Climate Delegated Act - this contains the TSC for the first two environmental objectives of climate change mitigation and climate change adaptation.  The Climate Delegated Act was subsequently amended to include additional economic activities

• the Complementary Climate Delegated Act - this (not without controversy) added specific nuclear and natural gas activities to the list of eligible economic activities and

• the Environmental Delegated Act - this sets out the TSC for the remaining environmental objectives of the sustainable use and protection of water and marine resources; the transition to a circular economy; pollution prevention and control; and the protection and restoration of biodiversity and ecosystems.

B. The November FAQs

As well as the Taxonomy and the delegated acts set out above, the Commission has published various sets of FAQs to support in-scope entities with the implementation of the EU taxonomy.

The most recent of these, the November FAQs, were published on 29 November 2024, which are organised as follows

• Section I contains general questions

• Sections II to VII contain questions on specific economic activities as they relate to the different environmental objectives - for example Section III which relates to climate change adaptation contains a Question 71 on desalination and in particular the specific method of calculating the GHG intensity of electricity used in this activity.

• Section VIII contains questions related to the generic DNSH criteria, which again address specific economic activities and

• Section IX contains questions related to the Disclosures Delegated Act.

Note: as the questions in sections II to VIII are not of general application, we have not summarised them further. We would, though, note that they are a valuable aid to the interpretation of the TSCs

Looking at the key questions in Sections I and IX in more detail:

(i) Section I - General Questions

The General Questions section of the November FAQs provides clarification on a number of points, including:

• where TSC refer to specific requirements of another piece of EU environmental law, if the TSC are worded in a way that allows the use of exemptions, these exemptions are applicable, whereas if the wording does not allow the use of exemptions, those exemptions are not applicable;

• although the general rule under the Taxonomy is the references to NACE codes in TSC are indicative only and should not prevail over the specific description of an economic activity, activities in the services sector are an exception.  Here, the references to NACE codes are included in the specific description of the activity, as the services relate to products manufactured by economic activities classified under specific NACE codes, and therefore the NACE codes are not merely indicative;

• on the question of whether or not the DNSH criteria set out in the TSC are more detailed than the requirements of the ESRS (European Standards for Sustainability Reporting which will be used for reporting under the CSRD), and if the ESRS disclosures can be used to show compliance with the DNSH criteria, the November FAQs clarify that compliance with the Taxonomy's DNSH criteria set out in the Taxonomy Delegated Acts is a separate issue from the thematic reporting requirements stemming from the ESRS.  Reporting under the CSRD is intended to ensure transparency regarding the undertaking's impacts on sustainability matters, and regarding how sustainability matters affect the undertaking's development, performance and position (i.e., double materiality). The absence of specific performance thresholds under the CSRD can be compared with the Taxonomy, which requires both a significant contribution to one environmental objective as well as DNSH to any of the other five, and on this basis referring to ESRS disclosures cannot be sufficient to demonstrate compliance with the DNSH criteria, although the data used in ESRS reporting will be useful for the assessment of compliance with the DNSH criteria; and

• on the question of frequency of third party verification, the November FAQs draw a distinction between the third-party assurance of Taxonomy disclosures (as required by the CSRD) and the verification of compliance with specific TSC requirements.  In short, the former is required to be an annual process, whereas the frequency of the latter will be set out in the relevant TSC.

(ii) Section IX - Questions related to the Disclosures Delegated Act

As we mention above, the Disclosures Delegated Act contains the details of the KPIs that in-scope entities should use when reporting under the Taxonomy.  Some of the questions covered by this part of the November FAQs are:

• the November FAQs contain a useful table setting out the timeframe for reporting under the Environmental Delegated Act and the activities added to the Climate Delegated Act.  In summary this timeline will be:

  • from 1 January 2025, non-financial undertakings report their Taxonomy-alignment with the economic activities covered by the Environmental Delegated Act and the amended Climate Delegated Act;

  • from 1 January 2024 to 31 December 2025, financial undertakings report the Taxonomy-eligibility of the economic activities covered by the Environmental Delegated Act and the amended Climate Delegated Act; and

  • from 1 January 2026, financial undertakings report their Taxonomy-alignment with the economic activities covered by the Environmental Delegated Act and the amended Climate Delegated Act.

• a listed SME which opts-out of sustainability reporting until 2028 under the CSRD does not have to include Article 8 Taxonomy disclosures in its management report;

• an undertaking reporting Taxonomy disclosures for the first time in a given reporting year (N) does not need to include comparative information for the preceding financial year (N-1);

• the modified reporting templates included in the Environmental Delegated Act replace the templates in the Disclosures Delegated Act. The new templates allow reporting in relation to all six environmental objectives;

• where an activity is Taxonomy-aligned, but is eligible to contribute to more than one objective:

  • a non-financial undertaking should assess whether or not the activity is aligned with each eligible objective and report the outcome accordingly in the reporting template; and

  • there is a specific method applicable to financial undertakings for calculating KPIs per environmental objective.

• where a business combination occurs close to the year-end, meaning that it is not practically possible to assess the year-end alignment of the acquired activities, the November FAQs state that undertakings should use all available information when assessing the Taxonomy-alignment of their activities, including those acquired through business combinations, in order to make accurate Taxonomy disclosures. Activities acquired through business combinations during a reporting period should be included in the reporting, based on

  • the post-acquisition Taxonomy-assessment of those acquired activities and
  • information gained during pre-acquisition due diligence.

• information gained during pre-acquisition due diligence.