The Winning Strategy of Eligibility Analysis: A Case Study in Taxonomy Assessments
The EU Taxonomy is a complex regulation, and even seasoned financial market participants sometimes struggle with its cumbersome requirements. In this case study, we examine how different paths to eligibility analysis can considerably affect its strategic outcome, and how technology can streamline the whole reporting process - and mitigate investors’ uncertainty.
Feb 16, 2023
Framing the Problem: Even the Starting Line is Blurry
The EU Taxonomy is a complex regulation that requires a deep understanding of ESG frameworks, sustainability lexicon and interconnected regulation. Market participants, both investors and corporates, have been vexed attempting to navigate this constellation of requirements.
The pervasive sense of confusion is felt broadly across the regulation, beginning with the very first step in the Taxonomy analysis, identifying eligible activities within a firm.
Taxonomy-eligibility is key, as it is the defining factor that determines the unique Technical Screening Criteria (TSC), the specific requirements to prove a given activity is sustainable. Classifying a company’s activities under the Taxonomy framework has been a primary pain point for many users, as many firms simply do not classify their operations in the same way as the regulation, creating a deep misalignment. This can impact the opportunity for corporates and investors to effectively and accurately demonstrate their eligibility and alignment KPIs to regulators and other stakeholders.
Further operability issues around eligibility include the case of firms whose activities are simply not included in the regulation (yet).
As the Taxonomy only includes 102 activities covering less than 20 sectors, many firms, despite their inherent sustainability credentials, are simply not able to comply with the framework.
This will change overtime as the regulation evolves, including implementation of four additional environmental objectives and accompanying economic activities, in addition to a social impact focused Taxonomy. While certain activities in the regulation are sector (and NACE code) based, others cut across industries and refer to operations in ways that most companies are not familiar with. Examples including “manufacturing of other low-carbon technologies”, “close to market research, development and innovation”, etc., stand out as opportunities for firms otherwise not covered by the Taxonomy to demonstrate alignment.
A key factor to keep in mind, even if a firm’s revenues can technically be classified under multiple Taxonomy eligible activities, the regulation does not allow for double counting - a given revenue can only be aligned once under one activity. This underscores the importance of understanding the different ways a firm’s revenues can be defined under the taxonomy, as the difference between TSC in each eligible activity will deeply impact alignment potential.
We will now take a closer look at a live case study to illustrate the issues raised above around eligible activity selection and its ramifications. Before moving on, however, it is important to stress that this can be complicated if performed by your in-house team. So consider engaging with a specialist advisor and/or scoping out different technology solutions to empower your in-house team.
We often find that the best value comes from combining these two strategies, which is why we created a 60-day program that does exactly this. You can find more information at the end of this article, or at this link.
But enough with the introductory remarks. Let’s dive in.
Deep Dive: A Case Study on Eligible Activity Selection
This case study presents the Taxonomy eligibility analysis for a firm in the gas and chemical manufacturing industry. As a start-up (six years in business) focused on sustainability, the company creates novel chemicals and gasses that have a lower carbon footprint than the leading market alternatives.
The focus for the analysis was to identify Taxonomy eligible and aligned turnover. We deployed a prototype version of Briink’s AI-powered ESG Documents Analyzer (you can ask for a demo here to learn more), which we combined with specific Taxonomy advisory, to conduct a full corporate taxonomy eligibility assessment. The final results are highlighted in the tables below.
The model identified five eligible activities and presented a pathway assessment on alignment by displaying the relevant TSC for each activity and objective. As the Taxonomy activities related to the other four environmental objectives are in draft form, the output analysis included an indication of eligible activities in the regulatory pipeline, but did not include the TSC for those as they have not been finalized.
The reported NACE code for the firm was C20.1.1, "Manufacture of industrial gasses", which is not included in the current version of the Taxonomy.
Additionally, this NACE code did not capture the full scope of the firm’s activities, which also included products eligible under the activity “manufacture of basic organic chemicals.” The Briink tool identified this activity in company documentation, ensuring that all eligible activities were captured.
The tool also identified that many of the product lines (namely those that had a lower GhG emissions profile than market alternatives) could qualify for sector agnostic activities including “Manufacture of other low carbon technologies” and “Close to market research, development and innovation”. The potential to achieve KPI alignment through two additional pathways created substantial flexibility to the firm and increased their likelihood of alignment, as highlighted below in Tables 2, 3, and 4.
The tables below (2,3,4) represent the unique TSC under the three possible economic activities identified for the firm - all under the Climate Change Mitigation objective (though note that two of the activities could contribute to the Climate Change Adaptation objective). By examining the criteria under each of the activities we can better understand what is required from the firm to demonstrate alignment. Moreover, to improve usability of the regulation, which is complex and written in legalese that is not approachable to non ESG domain experts, we have simplified the text in our tool to create easy to understand action items.
By examining the tables below we can observe a few interesting Taxonomy takeaways. The first is that there are clear differences and similarities in the TSC that would influence whether a firm could qualify for the Taxonomy. For example, we see that the DNSH requirements under the “Manufacture of basic chemicals” activity are more cumbersome than under the other activities.
Additionally, a look through analysis to the specific GHG clauses highlights that the thresholds for emissions under the “Manufacture of basic organic chemicals” activity (Table 4) are much more stringent than under the other two (Table 2, Table 3), which have a more flexible approach to measuring impact.
We can also see that a Life Cycle Assessment is required to approve alignment in each of these cases, though the specifics of how that report needs to be compiled differ across activities, further underscoring the importance of looking through different eligibility pathways.
Wrapping up - Some Key Takeaways
Many private companies and investors are struggling to get up the learning curve on ESG topics and implement mandatory regulatory reporting. For SMEs and start-ups there are simply too many pressing daily operational issues to set aside limited time or resources to focus on developing required policies and data collection systems.
This has made the Taxonomy an ultra complex piece of regulation, very difficult for the market to adopt.
Portfolio companies need support in completing Taxonomy assessments because it is a non intuitive way of defining economic activity
A good Taxonomy assessment starts with a firm understanding of eligibility, which influences all of the requirements for proving sustainable economic activities
Taxonomy reporters who leverage technology solutions will be in a better place to maximize KPIs and cut down on administrative burden.
Some best practices:
Don’t just take a NACE code approach. This could easily miss the full spectrum of Taxonomy eligible activities in a firm, and limit the opportunity to report KPIs. Understand the core economic activities of the firm and align those to the EU Taxonomy activities included in the regulation.
Understand the different pathways a certain business revenue has towards alignment with the Taxonomy - knowing that how you define the activity under the regulation will impact the process for alignment.
Keep an eye on the evolving regulatory landscape - the Taxonomy is a work in progress and new economic activities will be added in the coming years.
Do not underestimate your CapEx and OpEx. An increased CapEx on Taxonomy eligible (and aligned) activities can substantially elevate your score.
Don’t let future regulations take you by surprise! Having a dedicated team or solution can help you always keep an eye on the regulatory timeline.
Analyze eligibility to bring yourself ahead. Using a combination of tailored advisory and reporting solutions can give you a head start into this process, by helping you better understand pathways towards Taxonomy alignment can save you time and resources.
To sum up:
Eligibility assessment is the very first step to running a fully-fledged EU Taxonomy analysis, and it isn't always a straightforward exercise. When done correctly, it can maximize your potential to attract green capital, and better tell the firm’s sustainability story.
Eligibility screening comes with several challenges, which can hinder your ability to deal with these requirements at speed.
Of course, it is still crucial to prepare ahead of time and to make sure to follow best practices, along with the EU guidelines. For this purpose, it might be best to invest in specialized ESG advisory and/or training and upskilling for your in-house team.
If you want to pair this up with technology solutions - like the Briink Taxonomy and SFDR Reporting Platform and the upcoming Briink’s AI-powered ESG Document Analyzer - that can help increase efficiency and scale your reporting, we have recently put together an all-inclusive 60 days plan to EU Taxonomy and SFDR reporting.
The plan includes over 5 hours of personalized advisory, as well as unlimited access to the Briink Reporting Platform, and is designed to walk you through the reporting process from start to finish - while keeping costs low.
Want to start your EU Taxonomy journey today, but you are yet not sure of what might work best for you? Get in touch to explore how we can help.
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.