EU Taxonomy alignment assessments: A 5-step guide for your business

As the EU sustainable finance regulatory framework enters into force, a growing number of companies will have to report their EU Taxonomy eligibility and alignment scores. If you are ready to assess your alignment, you should already know the ins and outs of eligibility reporting. If this is not the case, we have you covered.

The alignment score is arguably the most crucial part of an EU Taxonomy report, for four main reasons:

1. Investors, customers, and prospective hires will increasingly rely on your alignment score as a means of assessing the overall sustainability performance of your company.
2. Your alignment score is an indicator of your company’s potential to attract green capital from private and institutional investors and within the framework of SFDR Article 9 funds.
3. The alignment score of portfolio companies will be adopted by credit institutions to calculate their Green Asset Ratio (GAR).
4. By benchmarking your alignment scores against those of your competitors, you can get a clearer idea of your industry’s sustainability best practices.

What is EU Taxonomy alignment?

Economic activities are aligned with the EU Taxonomy when they:

1. Make a Substantial Contribution (SC) to one of the EU Taxonomy’s six environmental objectives
2. Do No Significant Harm to any of the other five objectives
3. Are conducted in compliance with the Minimum Social Safeguards

Alignment assessment is a long and time-consuming process that grows in complexity depending on the number of eligible activities a company (or its suppliers and buyers) are engaged in.

How does alignment assessment work in practice?

The EU Taxonomy lists Technical Screening Criteria for each of the eligible activities. If an activity meets all of the Technical Screening Criteria for Substantial Contribution and DNSH, and if the Minimum Social Safeguards are complied with at company-level, the eligible activity can be considered aligned.

In short:

1) Technical Screening Criteria are defined for each economic activity listed in the Taxonomy Regulation.

2) These define the thresholds by which economic activities can be considered as substantially contributing to one of the six environmental objectives, and are paired with criteria ensuring activities do no significant harm (DNSH) to any of the other five

3) Technical Screening Criteria are also based on state-of-the-art science evaluating the environmental impact of economic activities; and

4) Technical Screening Criteria can be quantitative or qualitative.

Once compliance with the Technical Screening Criteria has been established, Turnover, CapEx, and OpEx KPIs have to be mapped to those aligned activities. The percentage of eligible and aligned KPIs represents your business’ final EU Taxonomy score.

Because of the amount of evidence, analyses, and documentation needed for alignment assessment, solid organization is critical. This piece will guide you through the main challenges faced by companies in this space, as well as the best practices associated with them.

This piece benefits from the contributions of:

• Joshua Brunert, Global Head of ESG Product at Apex Group LTD
• 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: Identify alignment criteria for each eligible activity

Why is this challenging?

1) Alignment analyses come with varying degrees of difficulty, depending on the specific activity performed. For instance, substantial contribution criteria for afforestation span over four pages. On the other end of the spectrum, the simple fact that electricity generation with solar PV panels is conducted is sufficient to prove a substantial contribution to climate change mitigation.

2) Do No Significant Harm is typically harder to prove than Substantial Contribution. This is in part because Do No Significant Harm criteria already cover all six environmental objectives, while only two (climate change mitigation and adaptation) are currently in scope for Substantial Contribution.

3) Do No Significant Harm criteria often require several complex technical assessments to be conducted. This may be necessary at the activity level, but can also be required at the individual site or business unit level. Some examples are:

1. ‍Climate Risk and Vulnerability Assessment: This criteria’s goal is to scope out the risks that the economic activity poses to the climate, and the potential impacts of climate change on the activity itself. Often, they require the use of climate projections and scenarios.‍
2. Environmental Impact Assessment: This criterion is focused on the impact of the activity on nature, natural resources, biodiversity, and ecosystems. In some cases, it includes an assessment of the impact of the activity on water and water use.
3. You may also need to conduct assessments on recycling possibilities, or so-called cross-media effects. These occur when polluting agents move from one environmental medium to another, e.g. from water to land or from land to air.

4) Some Technical Screening Criteria can be hard to interpret. For example, climate projections for physical risk assessment must be at the ‘smallest appropriate scale’ based on the activity concerned – though no definition or benchmark for the meaning of ‘appropriate’ is provided in the legal text.

Some best practices:

Think Strategically About The Criteria Against Which You Will Assess Your Activities.

To prove Substantial Contribution, you will need to select one of the six environmental objectives. For now, the choice is restricted to climate change mitigation and adaptation. Depending on the objective you choose to substantially contribute to, you will need to show that the activity does not significantly harm any of the other five objectives that are defined for the chosen economic activity. It can be useful to think strategically about the objective you choose for substantial contribution, as some combinations of Substantial Contribution and DNSH criteria might be easier to prove than others for your specific activity or company.

Make Sure That Your Appointed Taxonomy Coordinator Or Team Oversees The Whole Project.

Have them scope out the Taxonomy clauses, and ask them to provide a rough estimate of the efforts that will be required even before starting the actual assessments.

As Lukas Simon and Johann Weicht stressed:

Companies must conduct status quo assessments before checking alignment: that way, they will already know which of their activities are regulated and subject to standards, which will earn them a lot of time and resources ahead of assessment.

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

When a company wants to operationalize Taxonomy alignment, a whole set of questions arises. For instance: is it enough that you have a corporate policy addressing the Minimum Social Safeguards or the compliance aspects within the Do No Significant Harm criteria? Or do you need to build a program around that to ensure that you are cascading the criteria to all relevant parts of the organization?

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

‍

STEP 2: Organize the collection of evidence across different teams

To prove alignment, you will have to gather compliance evidence for each eligible activity regarding its Technical Screening Criteria. ‍

Important: as the final report must be audited, it is necessary to create a solid audit trail. This can only be achieved by gathering a great volume of supporting evidence, including reports, assessments, and compliance documents.

Why is this challenging?

1. Sustainability departments cannot gather all the necessary evidence on their own. Collaboration between different teams and functions (e.g. finance and controlling) is inevitable and should be accounted for early on.
2. Multiple departments must work on a company’s single Taxonomy report, and cross-departmental collaboration is often required even for individual assessments.  

Some best practices:

1. Make sure that all evidence is stored by a central Taxonomy coordinator or coordination center.
2. Create a cross-departmental Taxonomy working group as early as possible. This will help get everyone involved in the planning and understanding process at an early stage, and prevent misalignments.

However, according to Carmen Auer, it's important to keep in mind that not all companies might be able to set up these structures and processes.

While some companies have very strong management systems or in-house information databases, or some other ‘single sources of truth’ they can rely on, for others the data gathering process might be more challenging. This is why it's important to set up data structures and databases in advance, in order not to end up doing this manually every time.

_{Carmen Auer, Sustainability Services Partner, BDO}

STEP 3: Identify missing evidence, and make up for it

Some TSC compliance evidence may already exist within the company’s data storage systems and be readily available for inclusion in reports. However, this is not always the case. New documents might need to be created through thorough assessments at the level of the activity, business unit, or location. Understanding which documents are missing in advance can help structure the reporting process, including the budget and human capital required.

Why is this challenging?

1. Documents such as reports and certifications of compliance can be stored within different departments of the organization. Again, finding and listing them requires considerable coordination efforts.
2. It might be difficult to determine exactly at which level the assessments must be conducted, as this depends on the requirements connected with specific activities. For example, environmental impact and water impact assessments can require the collection of evidence at individual sites or locations.
3. Big European groups face an additional struggle. Potential subsidiaries or daughter companies based outside of the EU have never dealt with European Union standards before. This is especially true for the many instances in which the Taxonomy regulation references Directives, Recommendations, and the national law of EU Member States.

Some best practices:

• Prepare in advance a checklist of the assessments that are missing for full compliance. If working with a consultant or software solution for your Taxonomy reporting, make sure to receive a detailed document list before beginning your planning and execution.
• Based on the number of assessments that need to be conducted, decide on whether to outsource a portion of the assessment to consultants or specialized firms. Once the necessary evidence has been gathered, forward it to the Taxonomy team for a final check.
• For foreign subsidiaries or daughter companies, consider asking for support from external experts.

But how to even get started? For Camer Auer, it's all a matter of asking the right questions.

When companies realize that they are missing some crucial information, the main question they need to be asking is: how quickly can I get this information, so that I can report on alignment this year already? Or would I need to change my processes to get there?

_{Carmen Auer, Sustainability Services Partner, BDO}

Sustainability data still comes from many different functions and departments. It’s a data gathering exercise, and it helps to understand: what is it exactly that you are looking for?

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

STEP 4: Check Minimum Social Safeguards

While compliance with Substantial Contribution and DNSH criteria must be checked at the activity level, compliance with Minimum Social Safeguards can be assessed at the level of the whole company.

For example, for the "Production of Iron and Steel" to be aligned, the CO2 emissions of this specific activity must be below a certain threshold. Meanwhile, to check for compliance with the MSS, due diligence on the enforcement of human and labor rights can be checked at the entity level of the steel-producing company.

Some best practices:

1. In addition to the company-level assessment, consider including site and activity-specific analyses. Even if they are not mandatory, they will enable you to show that risks and potential adverse impacts of the activities on the enforcement of human and labor rights are taken seriously by your firm, and contribute to the robustness of the assessment.
2. For example, if your company has production sites outside of the EU, due diligence should be conducted to make sure that the same human and labor rights standards and policies as the EU sites are in force there.

STEP 5: Match financial data with aligned activities

Once compliance with the TSCs has been proven, companies must match each aligned activity with the related financial KPIs. This process does not differ significantly from the one involved in the eligibility assessment.

If you are not familiar with the process of mapping your financial data to Taxonomy eligible activities, we have published an article on this topic in the context of an eligibility assessment.

Summing up:

Your business' final alignment score gives you a reliable, scientifically accurate indication of how “green” your organization is. However, Taxonomy alignment assessment is a complex, time-consuming, and cost-intensive process. You will need to identify the correct alignment criteria that apply to your activities, collect existing evidence, perform assessments, and link sustainability data to your CapEx, OpEx, and Turnover to a novel degree of granularity.

To take full advantage of the benefits of EU Taxonomy reporting, you and your organization should prepare well ahead of time. But it's also important not to be overwhelmed.

Alignment is challenging for most companies, given how novel these requirements are; people are learning on the go, and a lot of education and training around this topic is needed.

_{Joshua Brunert, Global Head of ESG Product, Apex Group Ltd}

‍

At Briink, we leverage AI to digitize and automate your EU Taxonomy reporting process. This ensures that your organization reaches its full alignment potential at ease - leaving your hands free for the strategic planning that maximizes your taxonomy score and positive sustainability impacts. Reach out to learn more!

‍

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.