Since 1 January 2022 Financial Markets Participants will have to make additional (‘Level 1’ compliant) SFDR disclosures on the taxonomy-alignment of a financial product. In addition, Large Public-Interest Entities must include in their non-financial report a disclosure on the proportion of taxonomy-eligible economic activities in relation to certain KPIs.

For SFDR or NFRD in-scope companies the additional disclosures will be mandatory but to underline their ESG efforts the disclosure can also be applied voluntary by other market participant.

The EU Taxonomy

The EU Taxonomy Regulation introduces a classification system, establishing a list of environmentally sustainable economic activities. In order to qualify as environmentally sustainable an economic activity has to meet all of the following four overarching conditions:

  1. Substantially contributing to at least one of the following six environmental objectives: (i) climate change mitigation, (ii) climate change adaptation, (iii) the sustainable use and protection of water and marine resources, (iv) the transition to a circular economy, (v) pollution prevention and control, (vi) the protection and restoration of biodiversity and ecosystems.
  2. Not significantly harming any of the other environmental objectives listed under 1.
  3. Complying with certain minimum social and governance safeguards such as the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights.
  4. Complying with the scientifically based Technical Screening Criteria (‘TSC’) established by the EU Commission. These TSCs will be developed over time by Delegated Acts supplementing the Taxonomy Regulation. Firstly, the TSC for activities substantially contributing to climate mitigation and climate adaptation will be developed, followed by TSCs for the other four remaining environmental objectives listed under 1. In addition the Platform for Sustainable Finance is also preparing an advice on the expansion of the EU taxonomy to social objectives, which would also require the development of appropriate TSCs.

In December 2021 the long awaited first Climate Delegated Act has been published in the EU’s Official Journal. This Climate Delegated Act covers the TSCs in relation to climate mitigation and climate adaptation for approximately 102 activities within different sectors such as among others transport, construction and real estate, manufacturing and energy.

However, natural gas and nuclear-energy activities are currently not included. In a recent advice, the Sustainable Finance Platform recommended that nuclear energy should not be considered as taxonomy aligned since the current TSC do not ensure ‘do not significantly harm’ (DNSH) and therefore do not meet the requirements of the Taxonomy Regulation. Despite that critical advice issued by the Sustainable Finance Platform, the EU Commission has presented its draft for the first Taxonomy Complementary Climate Delegated Act which includes amongst others TSCs for specific gas and nuclear activities that qualify as transitional activities. Once translated into all official EU languages, the Taxonomy Complementary Delegated Act will be formally transmitted to the EU Parliament and EU Council which will have six months to scrutinise the document. If not objected within this period, the draft Complementary Delegated Act is scheduled to enter into force and apply as of 1 January 2023. To ensure transparency, the taxonomy alignment of certain gas and nuclear activities would come with additional NFRD disclosure requirements (see more below).

For a practical overview of the activities currently covered and the corresponding conditions under which they could substantially contribute to either climate mitigation or climate adaptation, the EU Commission has developed the useful tool of the EU Taxonomy Compass, available online.

For an extensive overview of the EU Taxonomy Regulation, see here.

Additional SFDR disclosures on taxonomy-alignment

Besides establishing a classification system, the EU Taxonomy Regulation also amends the disclosure requirements in place under the Sustainable Finance Disclosure Regulation (‘SFDR’) and the Non-Financial Reporting Directive (‘NFRD’).

Since 10 March 2021 Financial Market Participants offering financial products within the EU are subject to different mandatory ESG disclosure obligations, both on entity- and on product-level. For an overview of the different disclosure obligations applicable since March 2021, read more here.

With the publications of the first Taxonomy TSCs these disclosure obligations are expanded with additional disclosure obligations which are different depending on whether the financial product aims to be dark green (article 9 products), green (article 8 products) or not at all green (article 6 products). Financial products that are market as being dark green (article 9 products) or green (article 8 products) require additional pre-contractual disclosures and periodic reporting. These disclosure obligations amongst others include information on how and to what extent the investment underlying the financial product are in taxonomy-aligned economic activities. The latter also includes the disclosure of the proportion of investments in environmentally sustainable economic activities selected for the financial products.

For green products (article 8), the Taxonomy Regulation requires the following additional statement to highlight that within the portion of investments not linked to taxonomy aligned economic activities, certain of these activities may significantly harm one of the Taxonomy Regulation’s environmental objectives: ‘The “do no significant harm” principle applies only to those investments underlying the financial product that take into account the EU criteria for environmentally sustainable economic activities. The investments underlying the remaining portion of this financial product do not take into account the EU criteria for environmentally sustainable economic activities.’

Products which are not promoting any ESG characteristics or not sustainable investment (article 6 products) must disclosure in the pre-contractual documentation or periodic reports the following statement: ‘The investments underlying this financial product do not take into account the EU criteria for environmentally sustainable economic activities.’.

Where the Level 1 SFDR disclosures already apply since 1 March 2021, the entering into application of the SFDR Regulatory Technical Standards or ‘Level 2’ disclosures which include more detailed guidelines on how to report (such as templates) have been extended until 1 January 2023.

As the EU Commission aims to create a “single rulebook” which merges the SFDR and Taxonomy-related product disclosures, the European Supervisory Authorities have updated their Final Report for a single rulebook product disclosures.

Since 1 January 2022 companies must thus have to make ‘Level 1’ compliant Taxonomy alignment disclosure. From 1 January 2023 these disclosures will have to be ‘Level 2’ compliant. Where already possible, it is however recommended to align current disclosures with the future Level 2 standards (RTS SFDR) to prepare for its future entering into application as of 1 January 2023.

Additional NFRD disclosures on taxonomy-aligned and taxonomy-eligible activities

The Non-Financial Reporting Directive (NFRD) requires large public interest entities to include non-financial statements as an integral part of their annual public reporting obligations.

At present, the NFRD applies to “large public-interest entities” (‘PIEs’). Are considered being an “PIE”: (i) EU entities that have transferable securities admitted to trading on an EU regulated market; (ii) EU credit institutions; (iii) EU insurance undertakings; and (iv) EU entities that are designated by Member States as public-interest entities. “Large” here refers to a PIE with more than 500 employees and that have either a balance sheet total of more than EUR 20 million or a net turnover of more than EUR 40 million. 

However it is the EU’s ambition to generally revise and extend the reporting requirements and scope of NFRD by introducing a proposal for a Corporate Sustainability reporting Directive (CSDR) (see our earlier contribution here) with the aim to expand the scope from large PIE to all large companies (listed or not).

Following the Taxonomy Regulation, the mandatory non-financial statement must include information on how and to what extent the companies’ activities are associated with economic activities that qualify as environmentally sustainable under the Taxonomy Regulation. In particular, the non-financial companies must disclose the following key performance indicators (KPIs): (i) the proportion of their turnover derived from products or services associated with taxonomy aligned economic activities; (ii) the proportion of their capital expenditure (CapEx) and (iii) the proportion of their operating expenditure (OpEx) related to assets or processes associated with taxonomy aligned economic.

In December 2021 the EU Commission’s Delegated Act and Annexes setting out the content, methodology and presentation of information to be disclosed by undertakings concerning the proportion of environmentally sustainable economic activities in their business, investments or lending activities was published in the Official Journal (‘Disclosure Delegated Act’).

From the financial year (FY) 2022, the Disclosure Delegated Act will apply for non-financial undertakings with first reporting obligations on taxonomy-alignment as from 1 January 2023. For financial institution the Disclosure Delegated Act provides an extension, as they will only have to render a first report from 1 January 2024 for FY 2023. However, as from 1 January 2022 until 31 December 2022 (or 2023 for financial institutions), undertakings must only disclose on the taxonomy eligibility of their activities.

With its proposal to also include gas and nuclear activities as transitional taxonomy aligned activities (see more above), the EU Commission also introduces additional NFRD (or future CSDR) disclosures. To provide a high degree of market transparency, financial and non-financial companies should present specific disclosure requirements to show the percentage of their gas and nuclear taxonomy aligned energy activities.