EU Taxonomy eligibility: the ultimate guide for your business

The EU Taxonomy is the official EU classification system for sustainable economic activities.

It helps investors identify sustainable activities, and prevents greenwashing by employing a data-driven, scientific approach. Under the EU Taxonomy, an activity is considered environmentally sustainable - or "Aligned" with the EU Taxonomy - if it makes a substantial contribution to one of six environmental objectives, and if it does not significantly harm any of the others. Taxonomy-alignment is increasingly becoming one of the most important factors affecting a company’s ability to attract green investments.

However, any given economic activity can be assessed for alignment if and only if it's present in the EU Taxonomy in the first place - that is, if it's "Taxonomy-eligible".

Business activities are eligible for alignment assessment if they are listed in the EU Taxonomy. This means that specific, science-based criteria exist to evaluate their sustainability performance. However, it does not guarantee that the company has fulfilled the criteria laid out in the regulation.

In short, Taxonomy-eligibility is a necessary (but not sufficient) condition to prove Taxonomy-alignment.

As of January 1, 2022, companies falling under the scope of the Non Financial Reporting Directive (NFRD) have had to report the extent to which they perform Taxonomy-eligible activities, by disclosing the proportion of their Turnover, CapEx and OpEx KPIs associated with eligible activities. Companies that fall under the expanded scope of the Corporate Sustainability Reporting Directive (CSRD), the successor of the NFRD, will need to start doing this as well by 2025 at the latest.

‍Why is EU Taxonomy reporting challenging?

Because it requires companies to directly link their financial data to sustainability assessments for the first time, conducting a full eligibility assessment can constitute a great challenge for most companies.

We have broken down the process into a few actionable steps, listing both the main challenges faced by companies approaching their reporting requirements and the emerging best practices.

This piece benefits from the contributions of:

• ‍Lukas Simon, Sustainable Finance Solutions Manager at Frankfurt School - UNEP Collaborating Centre for Climate and Sustainable Energy Finance
• ‍Carmen Auer, Partner Sustainability Services at BDO Germany
• ‍Johann Weicht, Principal Consultant and EMEA Co-lead EU Green Deal and Taxonomy Services at ERM

STEP 1: Perform high-level eligibility-mapping

Even before diving into your financials, it is essential to have a solid understanding of your eligibility potential. This involves mapping all of your activities and matching them with the activities listed in the EU Taxonomy, a process that is often managed by the ESG or Sustainability department of your organization. ‍

‍Why is this challenging?

1) Eligible activities can be found beyond the company’s main business areas. A company’s investments into the construction of buildings, the production of its own electricity, or market research and RD&I can substantially increase its eligibility score.‍

2) Getting the “how” of eligibility mapping right can be surprisingly tough. A widespread approach is to map the company’s activity using NACE codes, which are number-tags for business activities in the EU. Yet, activities also have to match the precise descriptions laid out in the Taxonomy to be considered eligible. These descriptions do not always correspond precisely to the scope of each NACE code.‍

3) Eligibility mapping can be especially burdensome for companies with many, diverse activities. Examples include large companies with a wide range of suppliers and customers, as well as groups which report at the consolidated level.

Some best practices:

• Do not stop at the title: always check the activity description as well. Some of the activities defined in the Taxonomy have broad names, such as “Manufacture of other low-carbon technologies”. Companies may miss out on eligibility because they are misled by vague activity titles.
• Make sure to screen not only your main business area but also your capital and operation expenditures. These can substantially increase your final eligibility score.
• Based on projected eligibility, estimate the capacity required for full eligibility and alignment assessment over all business units. Factoring the necessary human resources and budget for data gathering and analysis at this early stage will avoid unpleasant surprises later on.
• Set up a dedicated team and appoint a general Taxonomy coordinator. They will be in charge of gathering input from different departments (e.g., finance/accountig, ESG, operations). A great example of this approach can be found in Aixtron’s 2021 Sustainability Report.

In general, eligibility assessments should not be underestimated.

Assessing eligibility can be as challenging as assessing alignment. While specific criteria and thresholds exist for alignment, with eligibility determining whether or not one of your activities falls into scope can be challenging at times.

_{Johann Weicht - Principal Consultant and EMEA Co-lead EU Green Deal and Taxonomy Services at ERM}

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Moreover, even before starting the assessents, Lukas Simon stressed the importance of having appropriate processes and structures already in place.

Companies really need to ask themselves whether they already have appropriate data structures and data management systems before they even start assessing Taxonomy-eligibility.

_{Lukas Simon - Manager Sustainable Finance Solutions, Frankfurt School-UNEP Collaborating Centre for Climate and Sustainable Energy Finance}‍

STEP 2: Linking financial data to eligible activities

Once eligible activities have been identified, it is time to determine the share of your Turnover, CapEx and OpEx that are associated with these activities. This is the brunt of the work, involving as many as five distinct phases, that can be summarized as follows:

Setting up a financial data structure and data management system which is suitable for the granularity of financial data required by Taxonomy assessments;

1. Conducting a robust eligibility screening across all business areas and sites;
2. Matching operational descriptions with Taxonomy descriptions
3. Matching the financial data associated with each eligible activity found.

For a thorough definition of accounting standards, see the Henkel 2021 Sustainability report.

‍Why is this challenging?

• The more eligible activities, the greater the amount of financial data that has to be collected and mapped to eligible activities.
• Collecting data about non-core activities can be especially taxing. This was the case for Airbus (as reported in their annual report), whose core business was not included in the Taxonomy: it could have reported higher eligibility in its 2021 Annual Report, had it not been for the lack of higher-resolution data.
• Taxonomy KPI definitions differ from conventional accounting standards. As an example, labor costs associated with eligible Operating Expenditures cannot be considered for taxonomy eligibility. Definitions for what is included in Turnover, CapEx and OpEx are set out in the Disclosure Delegated Act associated with the Taxonomy Regulation.

Some companies underestimate the fact that KPI denominators are not a given. Neither Turnover, nor CapEx, nor OpEx are the same for Taxonomy Reporting as they are for financial statements.

_{Carmen Auer, Sustainability Services Partner, BDO}

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Another big Taxonomy-related challenge is having financial data talking to sustainability data. The IT systems for financial and non-financial data don’t necessarily speak to each other out of the box.

_{Johann Weicht - Principal Consultant and EMEA Co-lead EU Green Deal and Taxonomy Services at ERM}

Some best practices:

Collect and compute financial data that is granular enough well ahead of time, also for non-core activities. To ensure that sufficient granularity is achieved, it can make sense to incorporate the controlling and financial data management team early on. One example can be the precise proportion of Turnover or OpEx associated with zero-emissions transport among a whole fleet of transportation vehicles.

STEP 3: Laying the groundwork for future reporting requirements

So far, European institutions have prioritized economic sectors with the greatest potential impact on carbon emissions reduction. These are the activities that are currently included in the Taxonomy. However, the fact that an activity is not currently included in the Taxonomy does not necessarily mean it is unsustainable.

The Regulation will soon be extended to many more environmental objectives and business sectors. Moreover, an “Extended Taxonomy” and a “Social Taxonomy” will likely enter into force by 2025*. These will substantially increase the number of high-eligibility sectors and companies.

*Update, August 2022: according to Bloomberg, the Social Taxonomy has been delayed indefinitely.

Why is this challenging?

The impending extension of the environmental Taxonomy alone will add over 110 new eligible activities to the current classification. This means that over 2500 new technical screening criteria could be added.

‍Some best practices:

• Always keep in mind that most companies very likely engage in at least some eligible activities. Even though your main business activity is not yet covered in the Taxonomy, those associated with your capital and operating expenditures might well be.
• Do not underestimate your CapEx and OpEx. An increased CapEx on Taxonomy eligible (and aligned) activities can substantially elevate your score.
• Don’t let future regulations take you by surprise! Having a dedicated team or solution can help you always keep an eye on the regulatory timeline.
• Analyze current low eligibility to bring yourself ahead. Having only a few eligible activities might leave some time and resources at your disposal for alignment assessment.

Starting to calculate the alignment score of your current eligible activities leaves your hands free for future alignment reporting on your main business area. However, keep in mind that alignment assessment comes with its own set of challenges and best practices to follow!

To sum up:

Eligibility assessment is the very first step to running a fully-fledged EU Taxonomy analysis. When done correctly, it can maximize your potential to attract green capital, and lay a nice foundation for the upcoming (and increasingly demanding) reporting requirements.

Eligibility screening also comes with several challenges, which can hinder your ability to deal with these requirements at speed. It is crucial to prepare ahead of time and to make sure to follow best practices, along with the EU guidelines. Would you like to learn more about this and other sustainable finance topics? Follow us on LinkedIn!

Want to start your EU Taxonomy journey today? Get in touch to explore how we can help.

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Disclaimer: The information provided in this content is for educational and informational purposes only and should not be construed as legal or investment advice. The content is not intended to be a substitute for professional advice. Always seek the advice of a qualified professional before making any investment or legal decisions. The author and publisher of this content are not responsible for any actions taken based on the information provided. Any reliance on the information in this content is solely at the reader's own risk.