The EU Taxonomy is a framework to help provide transparency around sustainable economic activities in the European Union (EU). This taxonomy builds a clear definition and defines metrics to show how a company is operating in a sustainable way and also sets a definition of what a sustainable economic activity is.
A Sustainable economic activity as defined by Article 3 of the regulation is: An economic activity can be classified as a sustainable activity if it substantially contributes to one or more of the six objectives and does not harm the others, is carried out in compliance with minimum safeguards, and complies with detailed technical screening criteria (TSC).
Keeping investments aligned to the EU Taxonomy can be difficult and complex as the taxonomy is dense and nuanced across each environmental target. A five step approach can be taken to assess if an investment is contributing towards the objectives stated above and to understand overall alignment with the regulation.
1. Identification: Identify the relevant activities of the company or investment product across one or more of the environmental objectives.
2.Technical Screening: Check whether the company or investment product meets the relevant criteria for the environmental objective.
3. DNSH Criteria: Confirm that the "do no significant harm" (DNSH) criteria is met. This is mainly a due diligence process to verify this criteria.
4. Review for any negative impact on minimum safeguards: This review process looks to focus on if there is any negative impact on the minimum safeguard as described in the EU Taxonomy. Again, utilizing a tailored, comprehensive due diligence approach is recommended.
5. Calculate alignment to the Taxonomy: The assessment of how a portfolio is aligned to the EU Taxonomy to aid in disclosures at the product level, this process can be rigorous but impactful to understand how investments and revenue flow into sustainable economic activities.