One of the key objectives of the EU Sustainable Finance Action Plan is to improve transparency on the sustainability performance of corporates and to reduce avenues for “greenwashing“. Therefore, the EU Taxonomy describes the “environmentally sustainable” economic activities and the financial metrics to quantify the performance of these taxonomy-aligned economic activities.
The Taxonomy Regulation requires European firms coming under the Non-Financial Reporting Directive (NFRD) and its successor, the Corporate Sustainability Reporting Directive (CSRD), to report the financial metrics or the Taxonomy Key Performance Indicators(KPIs) on an annual basis. In this article, we describe a 3-step process for Taxonomy Aligned Reporting that can be used by first-time reporting firms, focusing on non-financial undertakings.
In our earlier articles on EU Taxonomy Regulation, we provided an overview of the regulation (read here), the key differences between Taxonomy Eligibility and Taxonomy Alignment (read here), and the details about the Taxonomy KPIs for financial and non-financial undertakings (read here).
Reporting the Taxonomy KPIs not only contributes toward compliance with the EU disclosure regulations but also serves as a valuable tool for investors and other stakeholders to assess the sustainability performance and outlook of the reporting firm. Given how vital the disclosed information is, the reporting firm should invest time and effort to ensure high-quality reports that will help it shield itself from “greenwashing” accusations and attract responsible investors (RIs).
Critical requirements for ensuring high-quality reporting
EU Taxonomy reporting can be very complex and cumbersome for first-time reporters, especially for smaller firms that may have only limited resources at their disposal. Listed below are some crucial aspects that a reporting company must be mindful of before starting the process.
- The CSRD requires assurance of the reported information, which means reporting should have proper documentation for every process step to enable an audit trail.
- Data is critical. While this may sound a cliché, a reporting firm has to ensure that a reliable data gathering, data management and analysis system is in place to make the reporting process more accessible.
- For firms with multiple facilities spread in different geographies, many upfronts will be needed to ensure that standardised data is collected from all the locations and departments.
- The “moment of truth”, or the robustness of the reporting process, will be tested when financial data gets linked to the performance of the taxonomy-aligned sustainable economic activities.
- Taxonomy KPI definitions do not match precisely with the definitions of conventional accounting standards.
- The reporting process is a multi-department effort and will involve professionals from the reporting firm’s sustainability, legal/compliance and finance departments.
3 Steps to Taxonomy Aligned Reporting
At a high level, the reporting process involves the following steps.
- Eligibility assessment of economic activities
- Alignment assessment of economic activities
- Mapping financial performance to the aligned activities
The details of the above steps are as follows.
- Eligibility Assessment
As we explained in our previous article on the difference between taxonomy-eligibility and -alignment of economic activities (read here), eligibility is necessary, and alignment is sufficient. In other words, every taxonomy-aligned activity should first be a taxonomy-eligible activity.
To be eligible or to qualify as a sustainable activity, an economic activity should substantially contribute to at least one of the six environmental objectives of the Taxonomy below.
- Mitigation of climate change
- Adaptation to climate change
- Sustainable use and protection of water and marine resources
- Transition to the circular economy
- Pollution prevention and control
- Protection and restoration of biodiversity and ecosystems
Only activities that contribute to the first two environmental objectives – Climate Change Mitigation and Adaptation – have been formally adopted so far.
A reporting firm must first create an exhaustive list of all possible “sustainable” economic activities it engages in and map them to the “environmentally sustainable” activities under the EU taxonomy. This step can be very complex for a firm reporting for the first time under the Taxonomy Regulation as it involves precisely matching the “sustainable” economic activities with what is defined as “sustainable” within the EU Taxonomy Regulation.
As per the EU Taxonomy Compass, there are 88 activities in Climate Change Mitigation and 95 activities in Climate Change Adaptation, which an entity can choose from for reporting on Taxonomy alignment (as of July 2022). In addition, the Taxonomy Compass provides the NACE codes for these activities to make the matching process more accessible.
2. Alignment Assessment
After shortlisting all the taxonomy-eligible economic activities, a firm has to apply three criteria to select taxonomy-aligned activities. The three criteria are
- Substantially contribute to one of the six economic activities in line with the Technical Screening Criteria (TSC)
- Do-no-significant-harm (DNSH) in relation to the other environmental objectives
- Comply with Minimum Social Safeguards (MSS) as described in the Taxonomy Regulation.
It may be noted that the first criteria above would have already been applied in the previous step when shortlisting activities that are taxonomy-eligible.
- Mapping financial performance to the relevant Taxonomy aligned economic activities
In this stage, the reporting firm has to calculate the Taxonomy KPIs – the proportion of revenue (or turnover), capital expenditure (CapEx) and operational expenditure (OpEx). Then, the firm must calculate the KPIs for the individual activities to arrive at the Taxonomy KPIs.
Several firms report both the Taxonomy eligible KPIs and Taxonomy aligned KPIs. The example we shared in our earlier article on Taxonomy (read here) is reproduced below.
The summary of the Taxonomy KPIs reported by the German energy firm, E.On, for the year 2021 as given below.
|% Taxonomy eligible (of total)||% Taxonomy aligned (of total)|
The detailed report can be accessed here.
Reporting in line with EU Taxonomy Regulation is complex, specifically for the firms that are reporting for the first time. However, the complexity can be overcome if the reporting firm makes adequate preparations and executes the reporting process in a structured manner.
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