The evolution of the EU taxonomy

Bloomberg’s Rokhsana Saddighzadeh discusses the challenges of EU Taxonomy reporting as regulatory requirements develop. This piece first appeared in Responsible Investor’s ESG Data & Disclosure Report 2023.

Firms have begun to get to grips with disclosure requirements under the EU Taxonomy over the past year. We sat down with Rokhsana Saddighzadeh, Bloomberg’s global product manager for sustainable finance regulation, to find out how EU Taxonomy reporting requirements are evolving and how firms can set themselves up for success.

What did EU Taxonomy corporate reporting look like in 2022?

Ultimately, we saw the EU Taxonomy take shape in 2022 with companies required to report on the share of their activities that are taxonomy eligible – in other words, whether their activities are covered by the taxonomy. While firms are still finding their feet, under the scope of the Non-Financial Reporting Directive (NFRD) approximately 2,000 EU firms are expected to report EU Taxonomy metrics.

At Bloomberg, we monitor a broader universe of approximately 15,000 companies, enabling us to also capture any voluntary reporting. Within this scope, close to 1,300 companies reported their eligibility for fiscal year 2021. Approximately half of those firms have also reported whether or not they align to the taxonomy objectives, a more stringent aspect of the EU Taxonomy that took effect for non-financial firms earlier this year.

However, the format of that reporting presents a usability challenge – it’s very complex. We are seeing few companies adhering to the required templates, which offer a structure to help standardize the variety of data firms need to provide to demonstrate taxonomy alignment or eligibility.

Instead, firms use their own approach, which can create challenges around the consistency of the data. The good news is that the European Commission has recently launched a Taxonomy Navigator. We think this will really help address these usability problems.

How have these consistency challenges impacted financial firms’ EU Taxonomy reporting?

Financial firms rely on high-quality corporate reporting to accurately demonstrate the sustainability profile of their lending and investment activities under the EU Taxonomy at both entity and product levels.

There are a lot of complexities to entity-level reporting for financials by way of the Green Asset Ratio for banks and the Green Investment Ratio for investment firms. Given this and the consistency challenges, we have seen 130 financial firms report their eligibility but in varying formats.

When it comes to fund-level Taxonomy reporting for green funds under pre-contractual disclosures, which took effect January 2023, few are displaying alignment with the EU Taxonomy. In fact, according to Bloomberg data collected via the industry adopted European ESG Template, just under half of 9,000 green funds Bloomberg reviewed in March 2023 do not include EU Taxonomy aligned investments.

How do the EU Taxonomy and the SFDR interact?

The Sustainable Finance Disclosure Regulation and EU Taxonomy converge in joint fund-level reporting for Article 8 ‘light green’ and Article 9 ‘dark green’ funds. But there are several foundational discrepancies between the two regulations. They both include the concepts of ‘sustainable investment’, ‘do no significant harm’, and ‘good governance’, but the approach behind these concepts is different under each regulation. These deviations do cause implementation challenges for market participants in regulatory implementation.

How can the gaps in EU Taxonomy disclosures be remedied?

I see three key solution areas to bridging this gap. The first is adherence to templates. The EU Taxonomy pro-vides specific templates for disclosures, yet their use is sporadic. Greater up take of the templates mandated from January 2023 will bring greater consistency and increased confidence in that data.

Second, estimates are permitted under the EU Taxonomy product-level reporting. Guidance from supervisory bodies states that only company-reported ESG data should be used as inputs for these estimates. This has always been the philosophy at Bloomberg when modelling and estimating data for EU Taxonomy reporting to reflect company behavior more accurately and encourage transparency to underlying sources. As one of the only solution providers who do this, firms that use our data know that they can confidently use estimates to comply.

The final area is the general improvement around corporate disclosure of ESG metrics. One silver lining is the replacement of NFRD by the Corporate Sustainability Reporting Directive. This new directive modernizes and strengthens the rules about the ESG information that companies have to report. A broader set of large companies, as well as listed SMEs, will now need to report on sustainability – about 50,000 companies in total.

How is the EU Taxonomy likely to evolve?

The key development on the horizon is that under the Taxonomy, there are currently only technical screening criteria for two of the environmental objectives – climate change mitigation and adaptation. We expect the criteria will expand this year to cover the remaining four environmental objectives, which are biodiversity, circular economy, water and pollution. This is currently being consulted on by the European Commission with 33 new company activities and two existing ones under review.

This is in addition to potential amendments and additions of company activities to the existing climate change mitigation and adaptation environmental objectives. We should also expect to see consultations and reviews materialize for key SFDR concepts including the ‘Principal Adverse Impacts’, the notion of a ‘Sustainable Investment’, and more.

How will global taxonomies function alongside the EU Taxonomy?

Taxonomies are proliferating globally. There are almost 30, but they vary in scope and in whether they contain mandatory or voluntary disclosures. They are at various levels of development; some are under discussion, some are still being proposed and some are in effect.

The market hopes for alignment to achieve a single, consistent language for green investment activities.

However, we are seeing deviation in practice. For instance, Singapore’s taxonomy traffic light approach includes amber and red categories for activities that are considered transitional or harmful respectively. If there is significant deviation, the question of interoperability between these regulations will come to the fore. It would be a challenge for a global firm with global investments to adhere to the various requirements if taxonomies deviate substantially.

Is the EU Taxonomy achieving its ultimate objective of mobilizing capital for sustainable activities?

It’s easy to lose sight of the overall objectives behind these requirements in the day-to-day implementation. These pioneering regulations under the EU action plan on sustainable finance are integral to creating transparency in what has otherwise been a rather opaque domain. Since these regulations are the first of their kind, it is understandable they are evolving to account for new information and practices to ensure they are mobilizing capital towards sustainable activities.