European Commission refuses to let the dust settle on the EU Taxonomy

On 5 April 2023, the Commission launched a consultation on its draft of the long-awaited technical screening criteria ("TSC") for the four remaining Taxonomy objectives, sometimes known as "TAXO4"¹. The TAXO4 TSC were initially intended to be in place by 1 January 2023, a year after the TSC for the first two environmental objectives, but have been significantly delayed. Therefore, the draft's publication finally provides a fuller picture of the Taxonomy and gives those with ambition to align to the remaining environmental objectives an idea of the scale of that task.

At the same time, the Commission consulted on a draft amendment to the existing TSC for the first two environmental objectives, namely climate change mitigation and climate change adaptation. The fact that the TSC, which many entities are still only starting to get to grips with, are already being amended will not necessarily be welcome news. However, the Commission's proposed amendments highlight that the Taxonomy's TSC will be required to adjust to "developments, as well as to the European economy's actual progress towards its sustainability objectives"².

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Amendment to existing TSC

The draft amendments to the existing TSC on climate change mitigation and adaptation cover for the first time, or amend existing, criteria for economic activities, and in particular, activities with a strong focus on the transition to sustainable transport. This includes, for example, manufacture of components for low carbon transport, or the conversion of transport to lower carbon alternatives.

It is interesting that the Commission emphasises in its commentary that newly included activities may not only be those with the most substantial contribution, or the least harm to the other environmental objectives; this paves the way for certain activities, where there is presently no technologically or economically feasible low-carbon alternative, to be considered Taxonomy eligible or aligned. This is consistent with recommendations from the advisory body, the Platform on Sustainable Finance ("PSF"), which highlights the need for the Taxonomy to be a "dynamic tool"³ which can develop over time with technological and scientific development.

A good example of this is the inclusion of aircraft manufacturing, which includes upgrading and retrofitting for compliance with the strict TSC. The rationale behind the inclusion of such transitional activities is not difficult to discern; demand for aviation services cannot realistically be expected to cease entirely, even if environmentally conscious consumers decrease their carbon footprint by flying less. Therefore, it is beneficial to ensure that the remaining demand for flights is met by aircraft causing as little environmental impact as technically feasible. This inclusion is, however, already proving to be controversial, as critics argue that rail and zero-emission aircraft should be encouraged over traditional aircraft with only minimal environmental improvement, and that allowing aircraft to qualify with only marginal reduction of emissions will lock in carbon-intensive assets for many years.

The amendments to the existing TSC are planned to apply from 1 January 2024, with entities required to start reporting from 2024.

TAXO4 TSC

The newly proposed delegated act sets out the TSC for the four remaining environmental objectives, namely sustainable use of water and marine resources; transition to a circular economy; pollution prevention and control; and protection and restoration of biodiversity and ecosystems.

Each of the proposed annexes covers the TSC for activities contributing substantially to each TAXO4 objective:

Annex I establishes the TSC for sustainable use and protection of water and marine resources, covering activities such as manufacture of and services related to leakage control technologies, water supply, sustainable drainage systems and nature-based solutions for flood and drought risk.
Annex II establishes the TSC for transition to circular economy, covering various product-related activities aimed at reducing reliance on raw materials and new products (eg. repair and remanufacturing, sale of second-hand goods, and product as a service), waste management and remediation activities, construction and real estate activities.
Annex III establishes the TSC for pollution prevention and control, covering a smaller range of activities, namely manufacture of pharmaceutical products, ingredients and drug substances, collection / transport / treatment of hazardous waste, remediation of illegal / abandoned / non-compliant landfills and remediation of contaminated sites.
Annex IV establishes the TSC for protection and restoration of biodiversity and ecosystems; these TSC cover only conservation including restoration of habitats, ecosystems and species, and hotels / holiday accommodation and campsites.

The annexes set out the criteria for 35 newly eligible activities – just half of those recommended by the PSF last year. In particular, the proposed delegated act does not cover the agriculture, food or textiles sectors, which, given their significant impact on the environmental areas covered by TAXO4, is surprising.

It is expected that the TAXO4 TSC will apply from 1 January 2024, with reporting on eligibility from 2024 on FY2023 reporting, and on alignment from 2025 on FY2024 reporting. This timetable presents some issues for financial institutions in particular who will be reliant on non-financial disclosures by its investee companies to disclose Taxonomy eligibility. Given the different timetables, the PSF has recommended that the Commission clarifies that Article 8 Taxonomy reporting for CSRD-scope entities should apply on the same transitional timetable as indicated in CSRD.

The Commission has made it clear that it separately plans to introduce a Stakeholder Request Mechanism, which will facilitate stakeholders making suggestions based on scientific evidence for the amendment of existing or addition of new TSC, highlighting again that the Taxonomy will be constantly evolving.

Deep dive: Manufacturing of Electrical and Electronic Equipment

By way of example, we outline below a partial analysis of the TSC "Manufacturing of electrical and electronic equipment" economic activity, under Annex II (substantial contribution to a circular economy). This activity is particularly broad, given it can apply to any electrical and electronic equipment (from toys to X-ray machines) for industrial, commercial or consumer use. This represents a shift from the activities in the existing TSC, which are typically very sector-specific.

Where the economic activity manufactures equipment which qualifies for an EU Ecolabel, and the manufacturer provides verifiable proof of compliance with all criteria, a substantial contribution is assumed. Currently, the only type of electrical and electronic equipment that can obtain an EU Ecolabel is electronic displays.

Where no Ecolabel applies, technical screening criteria must also be met relating to:

designing for: (a) a long lifetime; (b) repair and guarantee; (c) reuse and remanufacturing; (d) dismantling; (e) recyclability,
the proactive substitution of hazardous substances,
information to customers,
producer responsibility.

The PSF has highlighted the following challenges faced by companies trying to align their economic activity to these TSC:

Lack of definition – the TSC contains requirements relating to components "rich in critical raw materials", however there is no minimum threshold for a component to be considered "rich" in a raw material. Additionally, there are no suggested methods for companies to adopt to demonstrate that the product has "superior recyclability" – it is not clear whether all or some of the criteria pointing to recyclability in (a) to (h) of Section 2.5 of the TSC (e.g. single polymer or recyclable polymer blends, non-moulded plastic enclosures) should be viewed as indicating superior recyclability. This lack of clarity impacts companies' ability to apply the TSC in a standardised way.
Lack of applicability – criteria for long-life products imply that only products containing updatable software or batteries are Taxonomy eligible, as no other product can comply with either of the two criteria on design for long lifetime. This TSC is simply inapplicable to other electrical products, and therefore these products cannot be Taxonomy-aligned.
Lack of data – in relation to the requirement to proactively substitute hazardous substances in products, not all of the substances listed or referred to in the TSC are included in the REACH / RoHS lists, and therefore data to determine whether products contain those substances is unlikely to be available.

Initial feedback on the consultations

On 3 May 2023, following the closure of the consultation period, the PSF published its response to the call for feedback on the proposed delegated act and amendments to the existing TSC⁴.

In general, it was noted that the publication of the amendments and TAXO4 TSC was welcomed and that both drafts were important in expanding the scope of the Taxonomy. However, both drafts were also criticised for lacking clarity, consistency, applicability (meaning some activities can never achieve Taxonomy alignment), for allowing companies too much discretion in applying the criteria, and, importantly, for an ambition level that is inconsistent with the Taxonomy regulation.

In addition, the Taxonomy specifies that non-financial companies should choose one of the six environmental objectives when reporting on alignment, even where they contribute to more than one, in order to avoid double-counting. The PSF have highlighted that the preferred option for companies will likely be climate mitigation, due to market interest in decarbonisation, leaving other objectives to fall by the wayside and lose investment. The need to report on only one objective may also discourage companies from seeking to align with a variety of objectives. To mitigate this, the PSF has proposed a disclosure template which would allow companies to report on revenue and expenditure contributions on all relevant objectives, rather than just one, whilst still reporting a single financial value.

Next Steps

The PSF made further suggested amendments for each of the points it raised and challenges it identified, however given that the European Commission opted for a different approach in response to the PSF's first report, it does not seem particularly likely that these will be adopted.

Both consultations closed on 3 May 2023 with 508 comments having been submitted. The final texts for both the draft delegated act and the draft amendment to the existing TSC are expected in June 2023, though further delays would not be too surprising.

Footnotes