EU Taxonomy
July 11, 2022

EU Taxonomy eligibility assessment: 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 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.

An economic activity is eligible if it is one of the 100+ business activities listed in the EU Taxonomy. This means that specific, science-based criteria exist to evaluate its sustainability performance. However, it does not guarantee that these criteria have necessarily been met (or proven to be met) by the company conducting the reporting.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 this 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.

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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:

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?

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:

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.