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EU-Taxonomy Extension – How a traffic light system will transform EU-Taxonomy classification
Today, there are debates about extending the current version of the EU-Taxonomy. The EU’s original Taxonomy was developed to provide insights on sustainable investments for investors, government and other organizations. The Taxonomy aims to provide a science-based classification system to use in financial decisions with the goal of increasingly directing investments in sustainable economic activities. While the EU-Taxonomy is still relatively new, it has attracted a large amount of critical feedback.
Why is the current version of the EU Taxonomy receiving criticism?
The current version is mainly focused on the performance levels of activities that are considered to make a substantial contribution to the EU´s environmental objectives, while also not making significant harm to one of those objectives. So, economic activities are considered sustainable if, on the one hand, they directly contribute to the fulfillment of EU environmental goals or support the achievement of at least one of the environmental goals, such as data services to optimize the management of renewable energy sources. In doing so, none of the other environmental goals may be significantly impaired.
Still, this classification shows some limitations. It leaves a wide variety of economic activities non-classified, either because they have no sustainable transition options or they are considered to not substantially contribute to the climate objectives. This non-classification is often misinterpreted as ”non-sustainable“. This implies that at some point, the investments for those activities will eventually dry up, although they are not actually unsustainable.
Traffic lights driving a broader understanding of sustainable activities
The latest proposal would introduce a traffic light system for classifying economic activities. This would entail that more activities are included in the EU-Taxonomy, showing the different degrees of sustainability.
This is to be seen in the visualization below.
In comparison to the existing Taxonomy, the new model shows a more complex classification system. Firstly, there are some activities, classed as red (Box 1), that cannot be reformed and will always be considered to do “Significant Harm“. Secondly, listed activities with an Amber status are considered as “intermediate performance“ (Box 2). Those are activities that are in the process of transitioning to a more climate compatible performance. Box 3 shows activities that are about to be included in the future. The ultimate goal is to eventually assess all the activities on an activity-by-activity basis. The last column (Box 4) shows the low environmental impact activities (LEnvI), which includes the activities that do not have significant environmental impact and should not be regarded as either red, amber or green. It could allow enterprises to show that their overall activities do not cause environmental or social harm, although not considered “green“.
Directly spoken, many EU-Taxonomy users could benefit from an extension of the Taxonomy framework to introduce other performance levels, since this would enhance transparency. Additionally, it would support a faster environmental transition within the whole economy with the goal of the “Red“ activities, transitioning to “Amber“ and to eventually eliminating the activities unable to transition.
What does that mean for companies?
The extension of the EU-Taxonomy aims to provide more transparency around the environmental impact of economic activities with the goal to incentivize investments in sustainable activities. Companies need to be aware of what this will mean for them. As investors increasingly focus on climate compatible activities, companies will need to adapt their strategy accordingly. Already today, companies are faced with the challenge of developing a climate relevant strategy in order to position themselves as a sustainable and climate compatible company.