The EU sustainable finance classification system, or taxonomy, creates a set of criteria for sustainable business. It is intended to promote practical and ambitious criteria also to improve the sustainability of construction. The effects will most likely extend to the industry's business financing and its availability. When directing funding to support the green transition, the criteria emphasize emission reductions, energy efficiency, and the circular economy.
The European Union's classification system for sustainable finance, or taxonomy in short, harnesses corporate finance as a catalyst for emission reduction goals for the first time. The goal is a mechanism by which the availability or price of money is tied to how climate-friendly the investment target is.
The EU taxonomy is a legal classification system that lists environmentally sustainable economic activities. Linking the financing of companies and the implementation of climate goals will revolutionize Europe's entire financial system.
In the future, companies will probably be obliged to produce a kind of "environmental accounting" alongside the financial statements, with which they will report on the effects of their operations on climate and biodiversity, among other things. In the future, the project's financeability will therefore not only depend on financial indicators, but investors' attention should also be drawn to sustainability-related risks. Financiers and investors can compare the environmental impact and responsibility of different investment targets.
The big ones have to be alert right away, but SMEs also need to be prepared
The taxonomy regulation entered into force in July 2020. Reporting according to it began to be applied from the beginning of 2022 with regard to taxonomy eligibility, i.e., in practice, to assess how much of the business falls within the scope of the taxonomy, such as, for example, new construction.
In the first phase, the regulation affects listed companies, banks and insurance companies employing more than 500 people, guiding the investments directed at them in the capital market. In the future, we want to include other actors in the business world even more widely within the scope of the taxonomy.
At the same time, a reform is being prepared that obliges banks and financial institutions to publish information about the sustainability of their loan portfolios and investments. This has ripple effects on all companies receiving funding, including SMEs. In the future, more and more companies applying for bank financing must be prepared to answer the lender's questions about sustainability.
The real estate and construction sector is listed as a significant industry within the scope of the taxonomy from the point of view of CO2 emissions, in the same way as energy production, transport or the production of primary raw materials such as steel and cement. In construction, the taxonomy criteria emphasize energy efficiency and low carbon. The circular economy – reducing the amount of waste, recycling, using recycled materials and extending the life cycle of the built environment – also plays a significant role, without forgetting the diversity of nature.
Environmental goals and criteria as a basis for impact assessments
In the taxonomy, the environmental effects of economic activity are assessed from the perspective of six objectives:
- mitigation of climate change,
- adaptation to climate change,
- sustainable use and protection of water resources and the natural resources offered by the seas,
- transition to a circular economy,
- preventing and reducing environmental pollution and
- protection and restoration of natural diversity and ecosystems.
In order for economic activity to be sustainable, it must contribute significantly to at least one environmental goal. The operation must not hinder any other of the aforementioned environmental goals. The principle of avoiding significant harm is described by the term "Do-No-Significant-Harm" (DNSH).
The taxonomy also includes the exact criteria for meeting the environmental goals. The first delegated regulation of environmental goals "Technical assessment criteria for mitigating and adapting to climate change", the so-called climate package, was adopted in December 2021. It is to be applied to demonstrate compliance with the taxonomy of economic activities from the beginning of 2023. The next supplementary regulation is expected in the next few years.
In addition to environmental goals and related criteria, the taxonomy includes a minimum protection review for social responsibility. It means that sustainable operations must not, for example, be against human rights. The minimum requirements derive from the OECD's guidelines for multinational companies, the UN's principles on business and human rights, the International Labor Organization's declaration on basic principles and rights at work, and the international human rights document.
There is plenty of room for improvement in the criteria
The report published by the Platform on Sustainable Finance on March 30.3.2022, XNUMX contains a proposal for technical criteria for the other environmental goals of the EU taxonomy. The publication of the proposed criteria is the first step towards the second delegated regulation of the EU Commission.
According to the view of the construction industry, the proposals prepared under heavy schedule pressure do not yet meet the needs of the market and industry. The criteria of the final draft regulation must be thoroughly revised in order for the classification system to work in practice.
We have emphasized that, especially in the circular economy, usable criteria can speed up the creation of a market for recycled raw materials and reusable construction components. Unrealistic goals can have the opposite effect. A moderate approach, based on gradually tightening goals, is surest to bite in the field where the taxonomy is applied.
The classification criteria must also be based on facts and figures obtained from practical business operations. The criteria must be simple, measurable and connected to the everyday life of companies. You have to know how to limit them to the most impressive ones.
These key elements are essentially missing from the construction-related criteria proposals that have been published now. Despite the shortcomings, the real estate and construction sector is committed to developing usable criteria to support the green transition of the sector. Together with Rakli, we are partly working out the twists and turns of the national interpretation of difficult criteria, and we are piloting the climate package's criteria to detect technical problems and gather information. Investigations are also underway to clarify taxonomy-related reporting.
Now we need a comb with a suitable few bristles and a brush thick enough to make the complex models of the financial sages face the reality of the real economy in a clever way. By working together and actively bringing out the voice of companies, we have a good chance of success.
Pekka Vuorinen
The author is the environmental and energy director of Rakennusteollisuus RT and the contractor organization FIEC's representative in the Platform on Sustainable Finance group of the EU Commission.
The classification criteria really need to be clarified. A good and extensive summary from Peka.