EU taxonomy: progress, data and the road ahead

Progress is being made towards refining the EU Taxonomy, but perfecting a classification system this complex is an evolving process.

1. The recently launched EU Taxonomy User Guide is a valuable step towards overcoming some of the practical difficulties
2. It is important to recognise that companies are beginning to disclose their taxonomy alignment data, but the data gap remains wide
3. Refining the taxonomy is key to resolving the difficulties asset managers are having in defining sustainable investment

When it comes to the EU taxonomy, the devil is in the data. As a far-reaching classification system for economic activities and reporting that indicates the extent to which companies’ activities benefit or harm the environment, its introduction was never going to be an easy ride.

It’s to be welcomed then that in June the European Commission published not just its European Taxonomy Delegated Act, but also a European Taxonomy User Guide, seeking to tackle some of the practical issues that have arisen. June also saw the European Sustainability Reporting Standards which specify what sustainability data is expected to be reported under Corporate Sustainability Reporting Directive (CSRD).

The EU taxonomy sends a clear signal to the market about the definition of sustainable climate activities of investable assets, the expectation of greater transparency and the importance to minimise the risks of greenwashing. Yet it’s undeniable that investors struggle, among other things, with its lack of compatibility with the Sustainable Finance Disclosure Regulation (SFDR), as well as the data gaps and rigidity.

In our recent webinar, Pictet Asset Management’s Philippe Le Gall, a Senior ESG Engagement Specialist, explained his view. Le Gall highlighted the mismatch between the introduction of the SFDR with its requirements for asset managers and the beginning of corporate reporting under the taxonomy. SFDR was introduced in 2021, two years before Europe’s companies started to disclose data regarding the alignment of their activities with the taxonomy. This is key for asset managers in their own SFDR reporting requirements.

Le Gall is pleased, though, that matters are improving, as in the last few months companies have started to disclose their taxonomy alignments. “When I saw these first data disclosures from companies in a very codified manner, on how their revenues and capex and opex align with the taxonomy, I really sighed with relief,” he says.

Abrdn’s Craig Mackenzie, Head of Sustainability, Multi-Asset and Investment Solutions, has similar concerns. He believes that the regulators set out to make the taxonomy a framework for asset managers complying with the SFDR, but ran into practical difficulties. He points to gaps in the taxonomy’s coverage of activities – for instance it initially only included climate. What’s more, he thinks the European Commission should flexibly accept estimates of taxonomy compliance – rather than insisting companies attest to whether their activities are aligned with the taxonomy.

As a result, Mackenzie says, asset managers are turning to the SFDR’s Article 217 rule for defining sustainable investment, which he regards as too important. “If the EU taxonomy doesn’t work for me, what do I do? I have to make up my own rules and use the article 217 framework. Actually, I use FTSE Russell’s excellent [Green Revenues] taxonomy for qualifying my fund as article 9. But this is not a great outcome because it means every fund in the industry is going to have different ways of calculating sustainable investments.”

Just as with any ambitious, ground-breaking initiative, the EU taxonomy was always likely to encounter challenges. There are signs, though, that as companies start to disclose their alignment with the classification system these problems will gradually recede.

Even so, Lily Dai, our Senior Research Lead at FTSE Russell, an LSEG business, explains there is much to do. She notes that the quality of the early corporate taxonomy reporting is mixed – she may still have to drill down into more detail to discover the extent of their alignment. What’s more, she adds, the taxonomy often relates to EU legislation, making it hard for non-EU companies to report against.

Her conclusion? “I fully agree that disclosure is improving, but we still have a long journey to travel,” she says.

Taxonomy data currently can primarily be used for reporting rather than capital allocation purposes because only a very small number of companies are fully aligned with the EU taxonomy – for instance, analysing data in LSEG’s recently launched enhanced EU Taxonomy Solutions, only about 0.5% of the FTSE All Share Index. What’s more, about a third of the $7 trillion green economy companies are based in emerging markets and so are unlikely to disclose their EU taxonomy alignment.

What are the solutions for accelerating the process of overcoming the taxonomy’s challenges? Le Gall would like to see the European Commission put forward a pragmatic proposal for estimating whether the activities of companies such as those in emerging markets are aligned with the taxonomy.

Mackenzie’s wish list includes interoperability between the world’s 47 different taxonomies and a desire to “think outside the box” when fixing the lack of compatibility between the SFDR and the taxonomy. “The great thing is that the EU has a solution; it has a taxonomy that it is making progress on and learning to fix.”

The fact that so many other jurisdictions have imitated the EU taxonomy shows the wisdom of this initiative. It’s encouraging that the Commission recognises where the problems lie and is working to overcome them. To put this into context, it took decades to get financial accounting right and the taxonomy is on the right path after just three years.

Navigating the EU taxonomy is proving challenging. Listen to our recent webinar and hear industry experts discussing the structure and complexity of the regulation, implementation and usability challenges and the importance of data and transparency.

Our recently launched enhanced EU Taxonomy data solution combines multiple market leading data sources to analyse eligibility and alignment for companies that are not reporting the data across a broad universe. With the solution, we are helping customers to navigate requirements and fulfil their compliance obligations.