What is the law/regulation?

The European Council and the European Parliament in December 2019 reached political agreement on the text of a proposed Regulation on the Establishment of a Framework to Facilitate Sustainable Investment – the so-called "Taxonomy Regulation.”¹ On 15 April 2020, the European Council adopted, at first reading, the proposed Taxonomy Regulation and published the adopted text.² The Taxonomy Regulation needs to be adopted by the European Parliament at second reading before it can be published in the Official Journal of the EU (“OJ”). It will enter into force 20 days following publication in the OJ.

What is its scope and impact?

The proposed Taxonomy Regulation establishes an EU-wide classification system or ‘framework’ intended to provide businesses and investors with a common language to identify to what degree economic activities can be considered environmentally sustainable. It aims to “provide clarity and transparency on environmental sustainability to investors, financial institutions, companies and issuers thereby enabling informed decision-making in order to foster investments in environmentally sustainable activities.”³

It is important to note that while the majority of the Taxonomy Regulation will impact asset managers who make available a “financial product” which either (a) has environmental sustainability as its objective or (b) promotes environmental characteristics, the Taxonomy Regulation also states that where financial market participants⁴ do not take into account the criteria for environmentally sustainable investments they should provide a statement to this end, meaning that all asset managers are, effectively, in scope.

In defining “financial product,” the Taxonomy Regulation refers to the definitions embedded in the Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability‐related disclosures in the financial services sector (the Disclosure Regulation):

• a portfolio managed in accordance with Article 4(1) of Directive 2014/65/EU (MiFID II);
• an alternative investment fund (AIF);
• an Insurance-based Investment Product;
• a pension product;
• a pension scheme;
• a UCITS fund; or
• a Pan-European Personal Pension Product.

The Taxonomy Regulation provides a definition of “environmentally sustainable” economic activities. An economic activity is environmentally sustainable if:

• It makes a “Substantial contribution” to one of the following six specified environmental objectives;⁵

1. climate change mitigation;
2. climate change adaptation;
3. sustainable use and protection of water and marine resources;
4. transition to a circular economy;
5. pollution prevention and control; and
6. protection and restoration of biodiversity and ecosystems.

• It does “no significant harm” to any of those six environmental objectives (i.e., avoids adverse environmental impacts).
• It avoids violation of minimum “social safeguards” (i.e., avoids adverse social impacts).
• It complies with “technical screening criteria,”⁶ which will be developed using delegated legislation in due course. (The Commission is required to establish a platform on sustainable finance, consisting of experts who will advise on the technical screening criteria).⁷

The Taxonomy Regulation together with the Disclosure Regulation will require firms to disclose the degree of environmental sustainability of funds and pension products that are promoted as environmentally friendly, and include disclaimers where they do not (articles 8 and 9 of the Disclosure Regulation). In addition, firms which are subject to the Non-Financial Reporting Directive (NFRD)⁸ will be required to provide certain information in relation to the Taxonomy Regulation in their related filings.

The Taxonomy Regulation contemplates that asset managers will use the technical screening criteria to assess a company’s economic activities and determine whether each activity does or does not meet the taxonomy criteria – then aggregate the percentage of taxonomy alignment at investment and product level.⁹ The Taxonomy Regulation will be supplemented by delegated acts that will contain detailed technical screening criteria for determining when an economic activity can be considered sustainable, and hence can be considered Taxonomy-aligned. The percentages of taxonomy alignment will help firms explain their strategies in a way that is consistent and easily comparable for investors.

What is the timeline?

The Taxonomy Regulation is not yet in force. Political agreement on the final compromise text of the Taxonomy Regulation was reached in December 2019, and the EU Parliament is expected to adopt it at some point during 2020.

The Taxonomy Regulation states that to give sufficient time to the relevant actors to familiarise themselves with the criteria for environmentally sustainable economic activities¹⁰ set out in the Regulation and to prepare for their application, the obligations set out in this Regulation should become applicable, for each environmental objective, 12 months after the relevant technical screening criteria have been adopted.

Currently the Taxonomy Regulation contemplates a phased implementation, with certain rules set to apply from different dates:¹¹

• 1 July 2020, for the climate change mitigation and climate change adaptation objectives.
• 31 December 2021, for the circular economy and pollution prevention and control objectives.
• 31 December 2022, for the water and healthy ecosystem objectives.

What are the Key Considerations for Asset Managers?

The overarching aim of the Taxonomy Regulation is to provide a common language to identify which activities and financial instruments can be considered as environmentally sustainable to be used by investors, financial institutions, companies and issuers.

As a piece of EU legislation, its impact will be felt in the EU by entities such as AIFMs, UCITS management companies, investment firms authorized under MiFID II that provide portfolio management or investment advice, and these entities will need to ensure that they use the ‘framework’ taxonomy when making disclosures (including, but not limited to, in prospectuses, portfolio management agreements, annual reports, non-financial statements, and on websites). The need to conform investment practices to these disclosures means that the taxonomy also could influence the way that many investment firms incorporate ESG into their investment processes. While the Taxonomy Regulation is a piece of EU legislation establishing an EU-wide classification system, it will also impact non-European asset managers offering ‘financial products’ into the EU. For example, (i) a non-EU manager that has a structure that incorporates a UCITS may need to assist the UCITS ManCo with making disclosures by providing the ManCo with certain information relating to environmental sustainability, and some of these disclosures will need to consider the framework taxonomy or (ii) a non-EU manager marketing its funds in the EEA under Article 23 of AIFMD will need to consider the framework taxonomy when making the requisite disclosures. Given the size of the EU market, and because the taxonomy is the most comprehensive attempt yet to set regulatory standards for ESG, the taxonomy may also influence ESG disclosures and practices outside of the EU.

Footnotes

1) Regulation of the European Parliament and Council for the establishment of a framework to facilitate sustainable investment, and amending Regulation 2019/2088 on sustainability-related disclosures in the financial services sector.

2) For the adopted text of the Taxonomy Regulation, click here.
3) https://ec.europa.eu/info/sites/info/files/business_economy_euro/banking_and_finance/documents/sustainable-finance-taxonomy-spotlight_en.pdf
4) The Taxonomy Regulation refers to the definition in Article 2 (1) of the Disclosure Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability‐related disclosures in the financial services sector. Click here.
“‘financial market participant’ means: (a) an insurance undertaking which makes available an insurance‐based investment product (IBIP); (b) an investment firm which provides portfolio management; (c) an institution for occupational retirement provision (IORP); (d) a manufacturer of a pension product; (e) an alternative investment fund manager (AIFM); (f) a pan‐European personal pension product (PEPP) provider; (g) a manager of a qualifying venture capital fund registered in accordance with Article 14 of Regulation (EU) No 345/2013; (h) a manager of a qualifying social entrepreneurship fund registered in accordance with Article 15 of Regulation (EU) No 346/2013; (i) a management company of an undertaking for collective investment in transferable securities (UCITS management company); or (j) a credit institution which provides portfolio management”.
5) Taxonomy Regulation, Article 5 “Environmental objectives”.
6)Taxonomy Regulation, Article 14 “Requirements for technical screening criteria”.
7) Taxonomy Regulation, Article 15 “Platform on Sustainable Finance”.
8) Non-Financial Reporting Directive 2014 (2014/95/EU).
9) The Final report of the Technical Expert Group on Sustainable Finance published in March 2020 contains a full list of revised or additional technical screening criteria for economic activities which can substantially contribute to climate change mitigation or adaptation. Click here.
10) Taxonomy Regulation, Recital 34.
11) Taxonomy Regulation, Article 18 “Entry into force and application”.