By Silvia De Iacovo

The EU taxonomy has received quite a bit of attention in recent weeks. But what exactly is it? How does it work? And how will it contribute to the EU’s objective of climate neutrality in the energy sector?

What is the EU’s sustainable finance framework?

Since 2018, the EU has started to build a sustainable finance framework that would channel more private investments into sustainable economic activities. The framework consists of three building blocks: (i) a classification system, or ‘taxonomy’, of sustainable activities, (ii) a disclosure framework for non-financial and financial companies, and (iii) investment tools, including benchmarks, standards and labels. With the launch of the flagship initiative of the European Green Deal, the financial and economic sectors have a fundamental role to play in the transition towards the EU’s 2030 and 2050 climate and environmental objectives. To reflect this, in July 2021, the Commission adopted a Strategy for financing the transition to a sustainable economy.

What is the EU taxonomy and what is its role in the financial sector?

The EU taxonomy is a science-based classification system that allows financial and non-financial companies to share a common definition of sustainability, when determining their investment choices. It translates the European Green Deal objectives by defining and classifying what is in line with a net zero trajectory by 2050, based on a rigorous methodology. It is not a mandatory list of activities in which investors have to invest. Rather it creates a common language for investors and companies, thereby helping connect finance to the transition efforts happening in the real economy.

The benefits are numerous: it offers concrete criteria per sector and economic activity, which in turn help companies plan and engage in the transition, but also position themselves for the market to assess their actions. Furthermore, the EU taxonomy provides clarity to investors and helps incentivise investments towards where they are most needed. It also strives to boost transparency, with a view to guiding and encouraging the market to make investment choices that are fully consistent with the EU’s climate and environmental objectives.

How can activities qualify under the EU taxonomy?

The Taxonomy Regulation includes six climate and environmental objectives, namely: (i) climate change mitigation, (ii) climate change adaptation, (iii) sustainable use and protection of water and marine resources, (iv) transition to a circular economy, (v) pollution prevention and control, (vi) protection and restoration of biodiversity and ecosystems. It also sets out four overarching conditions that an economic activity has to meet in order to qualify as environmentally sustainable. According to these, an economic activity should contribute substantially to one or more of the climate and environmental objectives, it should not significantly harm any of the other objectives, and it has to be carried out in compliance with minimum social safeguards, which are defined in the regulation. Finally, it has to comply with technical screening criteria established through delegated acts by the Commission, who is empowered to draft the actual list of environmentally sustainable activities. These criteria are based on the input of external experts, namely the Technical Expert Group on Sustainable Finance and the Platform on Sustainable Finance. To stay current, the criteria for activities will be updated as technology evolves, in order to take into account the latest scientific and technological developments, and therefore mobilise private investment towards ever-cleaner energy solutions.

How does the EU taxonomy contribute to the EU’s objective of climate neutrality in the energy sector?

The objective of the EU taxonomy is to shift from more polluting activities – such as coal generation – towards a climate-neutral future, mostly based on renewable energy sources. Renewables have priority in the EU taxonomy and they are already included in a climate delegated act defining technical screening criteria for economic activities that substantially contribute to the first two climate objectives. The delegated act has been applicable since January 2022.

However, Member States’ paths to climate neutrality start from very different positions. Some parts of Europe are still heavily reliant on high carbon-emitting coal. Extensive discussions have taken place on how the EU taxonomy can further help guide private investment to those activities that are needed to reach climate neutrality. Therefore, on 2 February 2022, the Commission presented a complementary delegated act covering certain gas and nuclear activities for their potential contribution to climate change mitigation and adaptation.

Taking into account scientific advice and current technological progress, the complementary delegated act recognises the role for certain gas and nuclear related activities, but only for a defined period of time and insofar as they contribute to the transition to climate neutrality. The EU taxonomy is about accelerating the transition to a better, cleaner and safer future, and under its framework, only investments that commit to this acceleration will be recognised. Therefore, the inclusion of nuclear and natural gas comes with clear conditions associated with their use, in line with the EU’s climate targets, and with safeguards against significant environmental harm. Alongside these criteria, additional transparency requirements were also introduced, to help investors clearly recognise if investments include natural gas or nuclear activities and to what extent, so they can make an informed choice.

How can the EU taxonomy accelerate the transition?

The EU taxonomy recognises the different realities in Member States, while contributing to the transition towards the EU’s climate and environmental goals. Ultimately, what matters is that all Member States and the EU as a whole deliver on our collective climate ambition. Member States remain fully responsible for deciding their own energy mix and for striking the appropriate balance, in terms of energy security, energy price stability and, especially, in terms of their commitment to decarbonisation and climate neutrality.

Finally, the taxonomy is not an instrument of EU energy policy, but a tool to increase transparency in financial markets for sustainable investments by the private sector. It does not mandate investments and does not prevent any economic sector from receiving investments. What the taxonomy does is to guide the market and help drive the transition towards climate neutrality.

Read more on the EU taxonomy

Silvia De Iacovo is a policy assistant in DG FISMA working in the Sustainable Finance Unit.