As the death knell sounds for mandatory disclosure, European investors still want to avoid data shortfall.
Proposed changes to the EU’s sustainability reporting rules could see well in excess of 80% of previously in-scope companies no longer having to report against the taxonomy.
This has disappointed many sustainability-focused investors who need to ensure their portfolios are aligned with Europe’s taxonomy for sustainable activities both for compliance reasons and to manage ESG risks and opportunities.
But they hope that there will be enough market-based incentives for firms to continue to report against the bloc’s pioneering classification system.
Proposed changes to the EU Taxonomy Regulation were unveiled on 26 February as part of the European Commission’s (EC) first omnibus package, which simplifies the bloc’s sustainability reporting rules. A consultation on the taxonomy revision ended on 26 March.
Under the intended simplification, only companies with more than 1,000 employees would be subject to the EU’s Corporate Sustainability Reporting Directive (CSRD), which the EC itself estimates would exempt 80% of currently in-scope companies.
On top of this, taxonomy reporting will only be mandatory for in-scope companies that have more than €450 million in revenue. Leo Donnachie, Senior Policy Manager – Sustainable Finance at the Institutional Investors Group on Climate Change (IIGCC), thinks this will force many more companies that would otherwise be submitting taxonomy-aligned reports out of scope.
“This is a significant rollback of reporting. The taxonomy is a fundamental cornerstone of the EU’s sustainable investing framework,” he said. “It’s hard to refute that the proposed changes won’t have an impact on data availability, even if the largest companies are going to remain in scope and mandatory reporting.”
Vedran Kordić, EU Taxonomy Coordinator at the World Wide Fund for Nature (WWF) EU, described the EC’s decision to scrap mandatory reporting for vast numbers of companies as “very frustrating”.
The WWF has just submitted a 14-page response to the EC’s consultation, emphasising how the EU’s taxonomy has been an inspiration to taxonomies around the world.
Last month, Nicole Yazbek-Martin, Head of Taxonomy and Natural Capital at the Australian Sustainable Finance Institute (ASFI), told ESG Investor that her team drew heavily on the European experience as they were developing Australia’s own classification regime.
“The EU has had this soft power, through the taxonomy, to influence financial flows to sustainable activities throughout the world,” said Kordić.
“Since the European taxonomy was the first such piece of legislation that has been implemented, many countries around the world started developing taxonomies because they knew that, at a certain point, companies would have to report against a taxonomy if they wanted to operate in the EU.”
The EU Taxonomy Regulation requires companies subject to the CSRD to disclose the proportion of their turnover, capital expenditure, and operating expenditure that are taxonomy-eligible and taxonomy-aligned.
Market incentives
Investors fear that, if the taxonomy becomes voluntary for all but the largest firms, many will simply stop using it to report data which can play a key role in investment decisions.
However, with many firms keen to attract sustainability investment flows, market forces will encourage some taxonomy-aligned reporting to take place.
“It is definitely going to be the case that there will be investor pressure and, indeed, a lot of incentives for companies that are looking to raise capital for their [green] transition efforts to continue reporting against the taxonomy, irrespective of whether they’re in scope,” said the IIGCC’s Donnachie.
The EU Green Bond Standard came into force at the end of 2024, setting out strict rules for those who want to issue green bonds, including forcing 85% of proceeds to be directed to activities that are eligible under the taxonomy.
Donnachie thinks that an intended revamp of the EU’s Sustainable Finance Disclosure Regulation (SFDR) later this year, which may see a simplification of green fund categories, could also keep the pressure and incentives on companies to continue to report.
“The taxonomy is a great way for companies to showcase what they are doing at an activity level. It’s an important forward-looking capex metric that allows companies to tell their transition story,” he said.
As the dust settles
Not all sustainability-focused investors are unhappy about the demise of the taxonomy-based reporting, however. On the contrary, some think it might be a net positive for the green transition.
“From an international investor perspective, the EU taxonomy was in very challenging waters before the revision,” said Sondre Myge at SKAGEN Funds, a Norwegian asset manager.
“For international investors, there are questions as to how a meaningful commitment to the EU taxonomy plays out on a global investment portfolio. The EU taxonomy only provides visibility on your European holdings, plus or minus a few global companies, if you are lucky.”
Myge’s confidence in the taxonomy has been further shaken by the “complex geopolitical environment” against which the taxonomy has been defined.
“It’s not certain that what is included today in the EU taxonomy will still be there in five years, or even in two years,” said Myge.
European politicians were heavily criticised when they amended the taxonomy to effectively label investments in the gas and nuclear sectors as sustainable.
While market forces may initially help keep focus on taxonomy-aligned reporting, Myge thinks the EU’s classification will ultimately have “diminishing value” over time, which he feels may not be a bad thing.
“I don’t think it has any negative impact,” he said. “I think that the companies that care about sustainability, can survive without it. These things will progress naturally, organically, through other means.”
Myge added that it should be up to international standard-setting bodies, rather than the EU, to champion sustainability best practice. This would help take the politics out of disclosure, he argued.
While Europe gained first mover advantage by rolling out its own taxonomy and reporting requirements, other jurisdictions have awaited consensus, rolling out the standards developed by the International Sustainability Standards Board (ISSB).
“The best toolkits we have at our disposal are the ones that give us the opportunity to apply them across our investment portfolio,” said Myge.
“So I’m not worried that the scaling down of the EU taxonomy will lead to diminished interest [in sustainable investment]. In fact, I believe that this might be necessary to rejuvenate investor interest in the topic.”
In a new report, the International Capital Markets Association has called on EU regulators not to restrict the assessment of sustainable investments solely to the EU Taxonomy to prevent a “dramatic narrowing” of the investable universe in sustainability. The trade body said Europe should remain open to other official and leading market taxonomies as well as established assessment tools and approaches.
