December 24, 2020
Sustainable finance and EU Taxonomy: An overview
The EU Taxonomy written by the Technical Expert Group on Sustainable Finance defines the mandatory reporting designed to align sustainable investment with EU-based companies contributing toward climate change mitigation and adaption. The ultimate objective is to support the EU’s target of being net zero in carbon emissions by 2050. It will be a new requirement for large companies (above 500 employees) with entities in the EU from 2022, which means collecting data in 2021. UL is a leading provider of ESG software and advisory services, here we discuss some of the operational challenge’s companies are facing in reporting and the solutions they are applying.
EU Taxonomy reporting focuses on the most material greenhouse (GHG) emitting sectors, e.g., energy production covering sectors accounting for 93.5% of total EU emissions. The reporting focuses on examining GHG emissions at an activity level, e.g., emissions from rail transport, aluminum production etc. It requires companies from 2022, to show the proportion of their revenue, capital expenditure (capex) and operating expenditure (opex) tied to these activities that meet specific GHG activity criteria, e.g., zero tons of carbon dioxide equivalent produce per gigawatt hour of energy produced (for energy companies) in their annual reporting.
In addition to company reporting, investors selling funds marketed as sustainable in the EU must start reporting this for these funds in 2021, which means they are already reaching out to firms for data. The U.K. as part of the Brexit process is not subject to the detailed thresholds but the UK government has indicated its willingness to adopt a variation for U.K. company reporting. Taken together the EU Taxonomy will drive a great deal of additional data collection and reporting for firms and investors going forward.
How EU Taxonomy drives sustainability to front and center
The EU Taxonomy reinforces the positive trend toward bringing the sustainability function front and center in driving corporate strategy. As the Taskforce for Climate-related Financial Disclosures (TCFD) is a driver for the integration of the sustainability function with the enterprise risk management (among others); the EU Taxonomy drives integration of sustainability with group finance. As a result, many companies we work with across our advisory and software solutions have set up cross functional taskforces within their organizations to understand what is required to report to the taxonomy.
Approach and challenges to a sustainable finance taxonomy
The job of the internal corporate taskforce typically starts with identifying which company activities e.g. aluminum production are included in the taxonomy activity list and what the associated thresholds or criteria are. Next, the team completes a data mapping exercise to determine at what level financial data such as revenue, capex and opex (often at the site/facility level linked to taxonomy activities) is mirrored by non-financial/sustainability data and can be effectively matched. This compound data can then be rolled up to enterprise level ready for external reporting.
Based on our work, we have isolated some of the most common operational challenges companies face in completing this important work. These are in addition to methodological issues with the Taxonomy previously raised by others such as it being a binary assessment versus a graduated scale. We also recognize that the methodology will continue to evolve as more scientific research is completed and implementation challenges are understood.
What we see as four (4) key challenges with the sustainable finance EU Taxonomy:
- For many companies’ sustainability and finance data reporting structures, e.g., site vs. region vs. business line are significantly different and this disparity gets worse as you go down the organizational hierarchy
- Taxonomy and non-taxonomy sustainability activity data is combined and can’t be effectively separated, for example plants producing multiple products some of which qualify for reporting and some which do not, making it difficult to determine if thresholds have been met for specific activities
- Where financial and sustainability data can be effectively matched there is significant manual work to align data for external reporting that can introduce errors
- External assurance of taxonomy disclosures is not currently required; however companies have expressed concern over independent assurance of estimation methods and what evidence and process would be required
Solutions for a sustainable finance future
In the first round of company reporting in 2022, we expect to see a high degree of estimation as companies report their Taxonomy alignment for the first time. As time passes and investors benchmark companies’ Taxonomy performance within industries and analyze time series data, companies will need to increase reporting granularity to drive sustainability performance improvement in order to be included in sustainable investor portfolios.
This will drive greater alignment between financial and non-financial data and in turn between sustainability and finance teams. To address these challenges, UL customers are collecting activity level sustainability data using our Software-as-a-Service (SaaS) solutions and then combining this data with financial data, either through integrations or outside of relevant systems. UL is evolving its solutions to support our clients, for example by building capabilities to improve the alignment with financial data and automate Taxonomy calculations. This will enable firms to clearly demonstrate their sustainability performance to investors and contribute to driving the EU toward its net zero goal.
About UL: UL helps companies measure and report their ESG data to a variety of frameworks including the UN SDGs, CDP, GRI, SASB and others. For more information and to arrange a demo of our solutions visit UL.com/360.
Article written by
ESG Advisory and Solutions Lead