Streamlining Sustainability: EU Platform's Blueprint for a More Practical and Manageable Taxonomy

The EU Platform on Sustainable Finance (the "Platform") has published last Wednesday a report with practical recommendations on how to simplify the EU Taxonomy (the "Report"). In this blog post we delve deeply into the five core proposals made by the Platform, providing detailed insights and analysis. The EU Taxonomy is the European Union's classification system for environmentally sustainable activities. It establishes a "common language" for investors, enabling "like-for-like" comparisons between companies and investments by translating environmental performance into financial metrics. This innovative approach explains both its success and complexity. The Platform has been established as advisory body to the European Commission on sustainable finance matters and consists of a panel of sustainability experts from diverse public and private sector stakeholders.

The Report contains concrete suggestions on how EU Taxonomy can be made simpler and more efficient, based on two years of market insights and stakeholder engagement on the usability of the framework. It is issued just in time for the European Commission's expected "simplification shock" to the EU sustainable finance framework. The respective Omnibus simplification package (covered in our earlier blog post) aimed at simplifying and reducing regulatory burdens is currently announced for 26 February 2025 but may be delayed into March.

The Report's proposed simplifications involve reviewing and updating the Disclosures Delegated Act dealing with company's reporting on EU Taxonomy and the Climate and Environmental Delegated Acts containing the criteria for assessing economic activities (see our blog on the Platform's earlier call for feedback on its preliminary recommendations for the review of the Climate Delegated Act). According to the Platform, the proposed revisions could potentially cut companies' reporting load by over a third and simplify processes for financial institutions significantly. In this context, it is important to note that the Taxonomy is not meant to be static; it must be regularly revised to incorporate the latest scientific research and industrial innovations. Also, to fully realize its potential it must be continuously improved and simplified.

In the Report, five core proposals are made to the European Commission concerning the main changes needed to make the EU Taxonomy framework more accessible and simpler: 

Proposal 1: Refine the Do No Significant Harm ("DNSH") assessment and related reporting obligations 

The Platform noted that the so-called "DNSH" assessment has led to challenges for EU Taxonomy users. This assessment is based on defined technical screening criteria which relate to topics such as physical climate risks, environmental impacts, use of chemicals and recyclability of materials. While these criteria are well-suited for new projects or investments, they pose difficulties for companies attempting to measure revenues from Taxonomy-aligned activities when retrospectively assessing compliance with DNSH criteria.
To address these challenges, the Platform recommends several general and user-specific (i.e. distinguishing between non-financial and financial companies) actions:

• Improve usability of DNSH criteria: Undertake a comprehensive review of the DNSH criteria currently set out in the Climate and Environmental Delegated Acts with a view to making them clear and unambiguous with parameters that enable pass/fail outcomes that are verifiable through objective means such as documents, tests, and third-party verifications. For instance, subjective terms like "minimize" or "reduce" should be clarified with quantifiable values.
• Address different use cases and consistency: Make sure that the DNSH criteria distinguish between different users (non‑financial vs. financial companies) and KPIs used (turnover vs. capital expenditure ("CapEx")).

Non-financial companies

• Differentiate between turnover and CapEx: The review of the DNSH criteria should clearly distinguish between the two main KPIs used to measure Taxonomy alignment, being turnover and CapEx, to enhance their applicability and implementation. Flexibility in turnover alignment for DNSH compliance should be temporarily allowed on a comply-or-explain basis until a comprehensive review of the DNSH criteria is completed: 
  • Comply-or-explain would apply to backward-looking criteria for decisions made before the criteria entered into force, for which compliance can't be achieved in current operations. For those criteria, it should be enough to show these decisions met legal requirements at the time and continue to comply with all related legal obligations.
  • Comply-or-explain would not apply to criteria that can be met based on current operations (e.g. GHG emission thresholds, process criteria applicable to current operations, e.g. ensuring good status of water bodies), and any criteria where non-compliance still causes significant harm, like activity sites in protected areas or adaptation measures that adversely affect adaptation efforts of others.
• Ensure international applicability: Make DNSH criteria globally relevant by converting references to European legislation into quantitative or process-based requirements or by using widely adopted international standards and reporting guidelines as the baseline instead of European directives. This approach will help EU companies with non-EU operations and international companies reporting under the EU framework to model their business practices to these requirements.
• Control over verified outcomes: Currently, some DNSH criteria are based on permits or provisions from third parties or EU Member States or refer to directives that are still developing or not fully mature. As a result, some elements are not within the control of the company, making it difficult for companies to claim compliance. The European Commission should ensure that meeting DNSH criteria is under the control of the relevant company and does not depend on external factors or entities, except where robust criteria design is otherwise impossible.

Financial companies

• Use of Proceeds ("UoP") Debt or CapEx Assessments: For these assessments, DNSH criteria apply at the project's maturity. Predicting future compliance with DNSH criteria is challenging when these criteria depend on observed outcomes. In UoP or CapEx financing assessments, compliance is based on a commitment rather than actual outcomes. Therefore, for large projects, DNSH-related testing criteria should allow for DNSH-related contractual conditions to be defined at the approval of financing and monitored during implementation to verify compliance over time. Minimum reporting requirements before verification should also be indicated.
• Permit automatic compliance for EU legislation: Financial companies should not need to conduct further due diligence for DNSH criteria that refer to EU legislation for UoP instruments. The European Commission should clarify which criteria are aligned with existing EU legislation and exempt financial institutions from verifying compliance with these criteria. For criteria not aligned with EU legislation, the European Commission should specify the necessary documentation for verification, e.g., in the EU Taxonomy Compass. This could be detailed in supplementary guidance or as part of the Disclosures Delegated Act review.
• Turnover and CapEx reporting: No further due diligence required by the financial company if it is exposed to a company in scope of the Corporate Sustainability Reporting Directive ("CSRD") that reports compliance with all applicable DNSH criteria in its Taxonomy reporting. 
• Use of estimates and proxies: Allow the use of estimates and proxies to assess DNSH compliance (see also Proposal 4) in (i) Turnover and CapEx reporting, especially where retrospective assessment is challenging; (ii) for non-EU and non-CSRD exposures of financial entities that do not voluntarily report against the EU Taxonomy. 
• Retail market instruments: Credit institutions must ensure DNSH compliance for retail financial instruments (e.g., car loans), but they often lack the necessary data on the underlying activities and assets, and further efforts are required to ensure they are provided with this information. In the meantime, the Platform recommends temporarily relieving credit institutions from verifying DNSH compliance for retail market instruments until relevant information is systematically accessible, and the Climate and Environmental Delegated Acts have been reviewed.

Proposal 2: Introduce materiality thresholds for non-financial KPIs and improve usability of the OpEx KPI

The Platform notes that for companies with very low eligibility under the EU Taxonomy, preparing Taxonomy reporting represents a cost with limited relevance for strategy-setting or analysis by external stakeholders. To address this, the Platform makes the following recommendations: 

• Introduce materiality threshold: Implement a materiality threshold for the Taxonomy KPIs to reduce the reporting burden for companies with very limited exposure to Taxonomy activities. This threshold should be based on cumulative exposure rather than individual economic activities. Under this approach, non-financial companies assess if their activities correspond to the descriptions in the Climate or Environmental Delegated Acts. If activities are below the materiality threshold set by the European Commission, they report these as immaterial with a brief rationale and may choose not to report on alignment. For example, if a health services company operates residential care facilities as a minor part of its activities, it should disclose that this activity is relevant under the EU Taxonomy but considered immaterial to its overall business and expenditures. Therefore, alignment would not be assessed. Similarly, it is proposed that financial institutions operating multiple business segments (e.g., banking, insurance, asset management, etc.), which are expected to disclose a Combined KPI (a single, aggregated metric that combines the individual Taxonomy KPIs calculated for each of these segments), can exclude business segments considered as immaterial from a financial perspective in its calculation of the Combined KPI.
• Guidance on thresholds: Clearly define materiality thresholds so that these do not vary across geographies (as is currently the case). Thresholds should:
  • Consider the cumulative exposure to Taxonomy eligible activities considered for exemption (e.g. if a company's small business segments are relevant to the EU Taxonomy's environmental goals, the company shouldn't be able to exclude all these activities from the alignment assessment). 
  • Set an absolute limit in terms of turnover above which an activity could not be exempted from alignment assessment (regardless of its relevance for the individual company). 
  • Be reviewed over time as the coverage of Taxonomy activities increases.
  • Reporting of specific nuclear and fossil gas energy activities included in the Climate Delegated Act should be exempt from the materiality threshold application.
• Alignment with financial reporting: Ensure the approach to materiality thresholds aligns with existing financial reporting regulations. Particularly, the way companies break down business segments when reporting turnover under existing financial reporting should be aligned with the segment breakdowns for reporting the Turnover KPI under the EU Taxonomy. 
• Improving the usability of the OpEx KPI: Feedback from Taxonomy users demonstrates that the OpEx KPI is seen as particularly important to capture activities reflected in the Taxonomy that are not captured by Turnover or CapEx, such as R&D or maintenance. However, the definition of the OpEx KPI is not aligned with the one used in financial reporting standards and guidance on the materiality exemption mechanism (Annex I, paragraph 1.1.3.2 of the Disclosures Delegated Act) is unclear. The Platform proposes making the OpEx KPI mandatory only for R&D expenses and voluntary for other operational expenses, with clear definitions linked to accounting standards and sector-specific guidance to simplify computation and reduce reporting complexity.

Proposal 3: Allow proxies and estimates for the Green Asset Ratio ("GAR") 

The Platform has identified several limitations in the current GAR reporting, making it non-comparable and ineffective for credit institutions to showcase their efforts to green their portfolios. For instance, some assets in the denominator of the GAR cannot be assessed against the technical screening criteria due to their nature (e.g., cash, goodwill, intangibles), while the denominator includes assets not reflected in the numerator (e.g., non-EU exposures), creating a distortion in the ratio computation. The Report provides recommendations to better align GAR with its intended purpose and address these limitations:

• Address asymmetry of the numerator and denominator: Exclude assets that cannot be measured against the Taxonomy from both the numerator and denominator, such as cash, goodwill, intangibles and interbank loans.
• Use of estimates: Allow estimates and proxies (see also Proposal 4) in the numerator for non-CSRD exposures, including non-EU and retail exposures. Ensure the methodology used and share of alignment estimated are publicly disclosed by credit institutions to indicate the percentage of estimated data included in the GAR, and provide clear, harmonized principles for estimation methods and common proxies to prevent greenwashing.
• Third-Country and non-EU exposures: Include non-EU large corporates in the numerator by allowing for the use of estimates and proxies for determining alignment. Develop international principles for non-EU exposures and reporting interoperability.
• Use of Proceeds ("UoP") loans to sovereigns and supranational issuers: Include exposures to sovereigns and supranational issuers in both the numerator and denominator and allow estimates and proxies for these exposures.
• Minimum Safeguards ("MS") assessment for retail exposures: Clarify that credit institutions do not have to check MS compliance on retail exposures, e.g. by clarifying that MS checks are only applicable to direct corporate clients. 

Proposal 4: Provide clear guidelines on estimates 

The Platform recognised that when investee companies or counterparties lack Taxonomy data, financial institutions may need to use estimates, particularly for non-CSRD companies. To ensure consistency, the Platform has set detailed criteria and guidance for using estimates and proxies on eligibility, Substantial Contribution ("SC"), DNSH, and MS for companies not subject to reporting obligations under the CSRD related to the Taxonomy Regulation. However, this summary does not cover the specific recommendations for each of these criteria. By way of overarching comments, the Platform has recommended that: 

• Prioritizing reported data: Reported data from companies should always be prioritised, and if estimates are used, estimation methods must be consistently applied to both SC and DNSH criteria.
• Guidance for auditors: Any guidance on appropriate estimation methods should be targeted to auditors to ensure equal treatment and acceptance of practices across stakeholders, including financial institutions, data vendors, and companies.
• A balanced approach: If the framework assumes that activities fail the Taxonomy test if there is not enough data, this limits EU Taxonomy alignment and reduces investment opportunities, affecting climate-focused funding. On the other hand, if the framework assumes that activities pass the Taxonomy test without reliable data this could lead to overstating alignment leading to greenwashing. The Platform therefore calls for a balanced approach between these extremes.
• Estimation models: Companies must develop estimation models that maintain proper levels of governance, traceability, transparency, input coverage, and input quality. These models should only be used when investee companies or counterparties lack Taxonomy data.

Proposal 5: Voluntary, simplified reporting approaches for small and medium-sized enterprises ("SMEs"), banks and investors

The Platform recognised that SMEs are to be facilitated access to sustainable finance, and developed two tailored approaches to be used by credit institutions or other financing providers to classify the loans or other type of financing they provide to SMEs as sustainable (green or transition) finance and to simplify related reporting:

• Simplified Approach for listed SMEs (green finance) 
  • Develop an online tool with detailed guidance, assessment methodologies, and a database of necessary data points. Include training and capacity-building programs for listed SMEs.
  • Consider reducing the reporting burden for listed SMEs by requiring DNSH assessments only on main activities or expenditures being financed and by limiting the MS assessment to non-violation of applicable laws and having in place and reporting on due diligence processes under the (upcoming) reporting standards for listed SMEs under the CSRD (LSME standards), as developed by EFRAG.
• Streamlined Approach for unlisted SMEs (transition finance)
  • Provide a framework focused on climate change mitigation and adaptation objectives which goes beyond the activities listed in the Climate Delegated Act, allowing unlisted SMEs to demonstrate the climate-related efforts of their activities, investments or enterprise.
  • Where activities are listed in the EU Taxonomy, make these more accessible to unlisted SMEs, by grouping similar activities, clarifying references to EU legislation and other sections of the Taxonomy and simplifying lice-cycle assessment requirements. 
  • Limit the Minimum Safeguards ("MS") assessment of the unlisted SME to compliance with applicable laws, no financing for sectors excluded from Paris-Aligned Benchmarks as defined under the EU Benchmarks Regulation Framework and allowing reporting on indicators related to human rights due diligence under the voluntary reporting standards for unlisted SMEs (VSME standards), as developed by EFRAG.

In addition to these proposals related to content, the Platform also reviewed reporting templates for Taxonomy KPIs in the Disclosures Delegated Act to identify usability concerns and made recommendations to simplify templates by reducing or combining fields to focus on relevant company information and eliminate redundant data that don't aid decision-making.

What are next steps for EU Taxonomy?

Although the Proposal does not formally bind the European Commission, it often follows the main recommendations made by the Platform whose role it is to officially advise the Commission on usability and improvements to the Taxonomy framework. However, it is unclear if this will happen this time, given the context of the expected Omnibus simplification package and that some of the proposals are highly technical and may not be suited for a "quick-fix" solution to be published in two or three weeks (if the European Commission sticks to its timetable for the Omnibus simplification package). 

Any amendments to the Taxonomy framework will take time. There are rumours that the European Commission will re-open the CSRD and the Corporate Sustainability Due Diligence Directive ("CSDDD") at Level 1. While the Platform's recommendations do not specifically request a re-opening of the Taxonomy at Level 1, they do request amendments at the technical level (Level 2), such as the Disclosure, Climate, and Environmental Delegated Acts. The legislative procedure, involving the European Council and European Parliament, must run its course before the Omnibus simplification legislation can be finalized and take effect. The duration of this process will depend on factors like the complexity of the proposed amendments and political unity. By way of example, the relatively minor amendments to the EU Deforestation Regulation entered into force on 26 December 2024, within three months of the European Commission’s proposal.

Innovative initiatives like the EU Taxonomy require substantial investment, and it is important to recognize that success may not be immediate. This Report is a valuable acknowledgment of both the current challenges and successes. The Platform's overall assessment, supported by the existence or development of over 50 taxonomies worldwide, is that the EU Taxonomy is able to effectively direct investments towards net zero and sustainability. However, to achieve this efficiently and without imposing a significant reporting burden, the Taxonomy must become more practical and manageable. The Platform's detailed recommendations to the European Commission are a crucial step in this direction.