The impact of the EU taxonomy on SMEs (and other rules about sustainability)
‘In order to meet the EU’s climate and energy targets for 2030 and reach the objectives of the European green deal,
it is vital that we direct investments towards sustainable projects and activities.’
This is the first sentence you can read on the European Commission’s EU taxonomy page. Indeed, we have a long way to go to meet our environmental impact targets. What is the EU taxonomy exactly? Who is affected by it, and how? Why are companies so concerned about it, after all it is not the first time we are hit by new legislation from the EU commission in terms of sustainability, right? In this article we will explain how small and medium sized companies will be affected by the EU taxonomy (and other EU legislation).
In 2014, the EU introduced the Non-Financial Reporting Directive (NFRD), which regulates how the main actors of the EU economy should report on their corporate social responsibility work. This is a call for bigger companies to be more transparent on how their activities impact the society. Shortly after that, in 2015, the United Nations adopted the Agenda 2030 for Sustainable Development, and the EU committed to the Paris Agreement (long-term goal of keeping the increase in global average temperature to well below 2°C above pre-industrial levels). Since December 2019, the Green Deal keeps the EU active with multiple projects, strategies and action plans to become the first climate-neutral continent.
However, there was a missing part in this puzzle: how do we redirect the investments towards sustainability? Since 2018, the EU Commission has been working on a new sustainable finance strategy. First things first, we need to harmonize the reporting methods used by economic actors - for more transparency, consistency and comparability. That is the objective of the EU taxonomy.
Sustainability reporting obligations
The NFRD regulates sustainability reporting obligations in the EU and covers both social and environmental aspects of sustainability reporting. As of today, the sustainability reporting obligation set by the NFRD only applies to large companies in the EU. Though some countries have transposed the EU regulation into national laws, such as France or Sweden, there are still a number of EU countries that rely solely on the EU directive NFRD.
In Sweden, companies that meet two or all three of the following conditions, during both of the last two financial years, must prepare a sustainability report:
The average number of employees has been more than 250 people.
The reported total assets have been more than SEK 175 million.
The reported net sales have been more than SEK 350 million.
The EU taxonomy in brief
The EU taxonomy is a classification system, establishing a list of environmentally sustainable economic activities. (...) The EU taxonomy would provide companies, investors and policymakers with appropriate definitions for which economic activities can be considered environmentally sustainable. In this way, it should create security for investors, protect private investors from greenwashing, help companies to become more climate-friendly, mitigate market fragmentation and help shift investments where they are most needed.
Source: EU Commission
The EU taxonomy focuses on environmental impact, and aims to establish a common understanding of green economic activities that make a substantial contribution to EU environmental goals, by providing consistent, objective criteria. For covered economic activities, reportees will have to disclose:
Which activities make a substantial contribution to the related environmental objectives
Whether or not these activities do significant harm to the other environmental objectives
The obligation is applicable for all companies that fall under the scope of the NFRD, as well as financial market participants. This includes private equity, SME loan funds or even venture capital funds.
1 January 2022: Applicability of the regulation on:
Climate change mitigation
Climate change adaptation
1 January 2023: Applicability of the regulation on:
Sustainable use and protection of water and marine resources
Transition to a circular economy
Pollution prevention and control
Protection and restoration of biodiversity and ecosystems
1 January 2025: Financial institutions to report on financial undertakings
CSRD and other coming legislation in the EU
In parallel to the EU taxonomy come changes in the sustainability reporting obligations. A study conducted in 2020 shows that the impact of the NFRD is limited, mainly due to the flexibility of the notion of materiality and the possibility for companies to choose among different existing reporting frameworks.
In that regard, the EU Commission adopted a Proposal for a Corporate Sustainability Reporting Directive (CSRD) in April 2021. The proposal amends the reporting obligations of the NFRD by extending its scope and providing more details on the reporting practices. In October 2022, the EU Commission will adopt a set of EU sustainability reporting standards. 2022 is also the first year for financial institutions to report in compliance with the SFDR (sustainability‐related disclosures in the financial services sector), passed in November 2019.
Impact on SMEs
Though there is no obligation to align with the EU Taxonomy, disclosing harm done to the listed environmental objectives will damage the reputation as well as push investors away from the organization. Taxonomy-aligned activities will also benefit from institutional investments and attract funds allocated to green investments. Because it is the piece of the puzzle that drives future investment opportunities in the EU, it will affect the decisions made by investors and the direction of the EU economy in the coming years.
SMEs represent 99% of the activity in the EU. According to the final report on proposals for a relevant and dynamic EU sustainability reporting standard-setting, SMEs must be involved in an inclusive manner since they are a major part of the economy and since they are also confronted with sustainability-related risks and opportunities, and because they impact society and the environment. Though non-listed SMEs are exempt from disclosure and reporting obligations in the EU today, it is clear that the opportunities in our economy will be shaped by the coming regulation in our countries. The EU’s plan is to invest in green projects, and they have planned to release €1 trillion to support sustainable investments as part of the Green Deal. The EU Taxonomy lays the ground for identifying which activities will be prioritized in the coming investment opportunities.
How to prepare
Get ready for investors to ask more questions. Adapt your investment pitch or your IPO to the trends on the market. Be prepared, transparent and honest.
Amongst all the recent and coming regulations on sustainability in the EU market, the EU taxonomy is the one indicating which actions will be prioritized in the coming years. Venture capitals, banks and other financial institutions will allocate resources to the transition towards a green market. More and more is done to avoid greenwashing, and SMEs will have to be included if the EU wants to meet its target from the Green Deal and the Paris Agreement.
Precisely because SMEs do not have the resources to dedicate administrative time to sustainability reporting, the EU has exempted them from the scope. However, larger companies will request data from SMEs when they are part of their supply chain. Whether it is CO2e calculation, LCA of your product or gender equality ratios in your organizations, as an SME there is a strong interest from your investors, business owners and customers to access impact related data.
Our advice to SMEs in Sweden:
Start tracking your impact data as soon as possible, make it a habit
Check if your main activity falls under the scope of the EU taxonomy and if yes, if you are aligned (EU Taxonomy compass)
Keep in mind the 6 areas of the EU taxonomy
Make sure to follow up on the EU sustainability reporting standards (2022)
Engage with your main stakeholders to understand their expectations and meet their needs
Contact CSC Consulting for more info on sustainability management!