Why the EU Taxonomy could be a game-changer for green investments

In this special ESG episode of The Better Finance podcast, join Brian Tomlinson, Evan Tylenda and Nadia Humphreys as they discuss how EU Taxonomy is helping the fight against greenwashing.

Key takeaways:

The EU Sustainable Taxonomy provides a set of standards to identify and promote sustainable economic activities, aiming to combat greenwashing and drive investments toward sustainable practices.
To date, the taxonomy has primarily focused on two areas: climate change mitigation and adaptation, but it has now been expanded to cover four more environmental objectives, including pollution and circular economy.
Taxonomy is quickly becoming a market standard for defining “green” in a stock market context. This is seen by the increasing adoption of taxonomy reporting from companies outside the EU, demonstrating the tool's global relevance.

For your convenience, full text transcript of this podcast is also available.

Nadia Humphreys

"Taxonomy is not just a European tool and instrument, that it is a critically important instrument for you to be able to assess your business, for you to be able to measure your transition, and for you to be able to communicate with your investors about your plans to become more environmentally sustainable. And it is a beautiful opportunity for companies outside of Europe to see how much they align.”

Myles Corson

That was Nadia Humphreys, Head of Sustainable Finance Data Solutions at Bloomberg. I’m Myles Corson from Ernst & Young, host of The EY Better Finance podcast, a series that explores the changing dynamics of the business world, and what it means to the finance leaders of today and tomorrow. I’m delighted to share this special episode as part of our ongoing ESG series. Brian Tomlinson, an EY Managing Director focused on ESG reporting, spoke to Nadia and Evan Tylenda, Head of EMEA GS Sustain from Goldman Sachs, to discuss the EU Sustainable Taxonomy and its intended role in defining “green” economic activities. Listen as they explore its potential in reshaping the sustainable finance landscape by helping companies transition into more sustainable practices, while also combating greenwashing.

Brian Tomlinson

Hello, everyone. My name is Brian Tomlinson. I'm a Managing Director at EY in the Financial Accounting Advisory Services practice. Welcome to this Think ESG [Environmental, social and governance] episode of the Better Finance podcast. Today, we're going to be talking about the EU [European Union] Sustainable Taxonomy. It's the second podcast of the Better Finance series where we've done this, and I want to give you some background on the taxonomy itself. As many of you will know, the EU has a broad set of policy packages called the Green Deal. Those have some economy-wide sustainability objectives — things like net zero by 2050, 90% reduction in economy-wide carbon emissions by 2040, 55% reduction in GhG [greenhouse gas] emissions by 2030. To support achieving those broad sustainability goals, the EU has a very broad set of public policy in place. One of those is the Sustainability Taxonomy. What the taxonomy is partly doing is creating this construct of green by law, an activity is green not because a company says it's green, but because it is green by reference to an objective, largely science-based set of criteria that have been developed by the platform on sustainable finance. It's also partly an anti-greenwash device, which is to essentially surface underlying strategies in relation to sustainability to identify whether or not a company is really doing activities in a green way, particularly relevant where companies are indicating that the activities that they do are considered to be sustainable. Taxonomy is also potentially helping to drive investments in sustainability and can be part of a company's description of its transition plan and understanding of the speed of its transition to more sustainable footing. At its core, the taxonomy is asking companies two questions. It's asking them, are they doing any activities that can contribute to the EU sustainability objectives? That's the notion of eligibility and then, are they doing that activity in a sustainable way, which is the notion of alignment? Full of novel concepts for companies, a real challenge to respond to. One of the reasons so many companies are thinking about the taxonomy is as a result of the Corporate Sustainability Reporting Directive [CSRD], and it is through that very large number of companies, including companies not headquartered in the EU, will be scoped into reporting against the taxonomy. Important to note that taxonomy disclosures will also be subject to assurance. So, not only is this a ground up build for many companies, but it's also getting to a level of rigor in terms of reporting now which presents certain challenges. We've had a couple of years of taxonomy reporting from the largest EU companies and we'll delve into some of the learnings from that. But who better to talk to about what we've learned from the first two years of taxonomy reporting and what we might learn from the future years of taxonomy reporting than my panelists today. I'm joined by Evan Tylenda from Goldman Sachs and I'm joined by Nadia Humphreys from Bloomberg. Delighted to have you with us today. I wanted to get both of you to provide some initial reactions to that overview of the taxonomy — and perhaps start with you, Nadia, you served on the technical expert group in relation to the taxonomy. Can you talk a little bit about some of the objectives that you all had in mind when you were designing the taxonomy instrument?

Humphreys

Thank you so much, Brian, for inviting me today to your podcast. I'm really excited for the three of us to talk about what is arguably one of my favorite ESG topics. I appreciate that and well done to you for summarizing the entire layout of the taxonomy in a short opener. That was incredibly impressive.
As you quite rightly pointed out, so the technical expert group was established quite a while ago now, and actually, if we go back, and allow me to lament a little on the history, we were really hoping to speak a common language and I think you pointed this out in the introduction. In the old days, if I, as a company, wanted to claim that I was sustainable in some way, largely I would look at a peer comparison and I would say environmental metric, like carbon or water or waste, is best in class relative to peers that operate within my sector or within my geography. And that would then be my definition of me being sustainable and investors would be attracted to me. Now, when you start to establish climate goals, this sense of best performer is no longer good enough, so you don't necessarily achieve the environmental goal. And ultimately, what we were saying in the technical expert group is if we want the real economy to truly align under Europe's goal, but broader than Europe's goal, if we want to limit warming well below 1-1/2 degrees [centigrade], then what we need are simple, clear, actionable benchmarks that — whether I am a cement company or an energy company, I understand what good looks like and I'm able to report against it and that was very much our ambition back in the day. That is easier said than done and I think, if I could borrow just one small anecdote from a fellow platform member because I love it, is when you go into your first electric vehicle, you press the start button and it goes and that feels like a simple process, but there are years of engineering and technical know-how that go into building that vehicle and what definitely in Europe we're witnessing at the moment is still an evolution of that vehicle. So, the taxonomy is still in design mode, but once fully established and bedded down, we in the technical expert group very much hoped that you get into the taxonomy vehicle and press the start button and it all works. And I think, for me, maybe that's the opening on a reflection of where we wanted to be.

Tomlinson

That’s terrific commentary, I appreciate that, and it is one of the features of the taxonomy, which is that it is a progressive instrument. It will expand over time. It'll cover more activities over time and indeed the criteria for what is sustainable will also tighten over time, potentially. Evan, do you have any additional insights to offer on the taxonomy?

Evan Tylenda

Yeah, first I want to thank you, Brian, and it's a pleasure to participate here. I mean we've been following the taxonomy on the investor side for quite some time since late 2019. And I will say that has been a fairly lonely road during that period, but now we are seeing the potential of the taxonomy as it gets up and running and the way that I frame kind of what the intention of this is trying to do, as you mentioned and Nadia mentioned, is it is trying to serve as the basis for green by law, which right now in the sustainable investing space. We do not really have consistent standards. And I like to frame this environment that we're operating in similar to the 1920s and 1930s, with financial information which was not consistently reported. There were limited standards. We're effectively in that period now for sustainability accounting information. And so, we're watching these standards being developed real time and with that there's going to be a lot of confusion, a lot of challenges for interpretation that will work its way through. But the ultimate goal and purpose here, I think, is right in trying to provide more information and transparency to what companies are doing and saying in terms of what is green, what is not, and then ultimately, as well for investors to claim what they're investing in is green or not, and we ultimately see the taxonomy building into becoming that market standard of what's green over time.

Tomlinson

That's great. It feels like in many ways the taxonomy is addressing some of those core meta conceptual issues that we've had with the ESG space, right. So we've had a lack of standardization. We've often had a lack of context. How do you relate a company's sustainability performance to a real-world metric of environmental impact? And also, connected to both those problems is then the related concept of greenwash, and it feels like the taxonomy is to some extent dealing with all of those at the same time. I wanted to move to talk about our learnings from the first two years of taxonomy reporting. Just for context, so we have had two years of taxonomy reporting by the largest EU companies that have been scoped into the Nonfinancial Reporting Directive. The first year of that reporting was against the two environmental objectives of climate change mitigation and climate change adaptation in relation to eligibility. The second year was eligibility and alignment in relation to those first two environmental objectives. Nadia, I know the platform of sustainable finance has done a lot of work to look at the way in which those two first years of reporting have gone and how companies have wrestled with the taxonomy instrument. Wanted to see if you could provide us with some thoughts on how corporates have handled that and perhaps some of the capital markets implications of those first two years of reporting.

Humphreys

Yeah, Brian, absolutely. And just kind of maybe for the benefit of any listener who's unaware of what the platform is, in terms of supporting the implementation of the taxonomy, the European Commission formally appointed a group of technical experts onto something called the platform. And every two years, that platform reappoints its members and the mandate of this platform, which is actually the second one since the taxonomy came into legislation, have got three main things. So, the first is enhancing usability and ultimately growing the scope of the taxonomy, also consistency and credibility. The hot word at the moment is transition. So, how can the taxonomy support companies going through their transition? And then there's another third piece which is monitoring flows. Can we actually see the taxonomy be successful? Can we see that financial flows are supporting the overall ambition? And as you rightly point out, one of the very recent reports is something called a compendium of market practices and that's come out of the usability subgroup, and what that is, is it's seven stakeholder groups and I think there are 37 market practices in that report. So, it's a pretty lengthy report and it goes through different user types, and it says what can we see those user types have done with the taxonomy and also what can we see are peer-to-peer reflections. If I, as a corporate, wanted Brian to speak to you as a corporate and give you some advice, what would be the top pieces of advice? If anybody has not read the compendium, I strongly recommend it. I will not do it justice in your podcast, but I'm very happy to tell you what my personal takeaways were, particularly for the corporate community. On the corporates, what did we hear them say? The corporates were really talking about well, we use the taxonomy now as target setting, as Evan rightly pointed out, nobody really understood what good looks like. Now we do. We need to try and achieve that. What's also been really interesting is that it has given some strategic guidance on transition planning and what you can also see is in the Corporate Sustainability Reporting Directive [CSRD], in the reporting requirements there — it talks about the transition plan. It also talks about the taxonomy as an enabler, looking at things like capital expenditure. And that came out really strongly in the corporate feedback during the compendium. They use the taxonomy within their narrative to back up claims of sustainability performance and it also allows them to improve this comparability relative to peer group. What has been really interesting here is the scope of distributing European investment products. While they go into a European end asset owner, they're actually built and manufactured in America or in Asia, for example, and so you will have American and Asian asset management companies who are distributing their product to European end investors who are interested in the taxonomy alignment of the companies they choose to invest in. That global feature of the taxonomy came up quite a lot and what they also talked about is engagement. They have definitely felt that investors are now engaging them on not only their current taxonomy performance, but the plans to improve that over time. As Evan rightly pointed out, this concept of common narrative has been really useful, and I think that was something when I was reading the compendium that came across quite strongly to me in that chapter.

Tomlinson

That's terrific and that makes so much sense and I wanted to just pick up that point about the interaction effects between, say, the Corporate Sustainability Reporting Directive and taxonomy, because I think there are significant interlocking elements. Many companies going through gap assessments in relation to the ESRS [European Sustainability Reporting Standards] standards. We'll see that there are taxonomy elements listed throughout the ESRS standards. Many companies going through a double materiality assessment need to note that in the Efrag [European Financial Reporting Advisory Group] implementation guidance, they do reference to taxonomy as being an input to the double materiality assessment. So, you want your double materiality assessment and your taxonomy outputs to be best friends to relate to each other and to that transition plan point as well, if you are making those transition plan disclosures in your ESRS standards, part of the support for that transition plan will be in some of those CapEx [capital expenditure] and OpEx [operating expense] figures from your taxonomy disclosure. So, interesting to see the way these things all interact. Evan, I know you've seen two years of taxonomy reporting now in your capacity as an investor and wanted to get a sense of what some of those key findings that you've gleaned from those first two years might be.

Humphreys

What have we learned on the investor side? Well, first is looking at the scope of coverage. We're now getting a lot more information. We identified nearly 1,400 companies representing over €10 trillion in market cap, reporting some form of taxonomy alignment data. Within that, we find actually over 500 companies, reporting some form of green revenue or CapEx aligned to the taxonomy, which represents a cumulative €566 billion in green revenue exposure and over €166 billion in green CapEx spending. Now, some of the key observations we made is that first, the green revenue and green CapEx data we now get from companies is extremely helpful for promoting discovery value of companies with exposure to these secular growth themes and clean tech, and also helping identify where companies may be exposed to say green subsidies in either the US or Europe at a national level, but second is this point that you've been mentioning. We think this is one of the most underappreciated points of the taxonomy. It is an extremely helpful tool for identifying companies in transition, particularly where they're reporting higher green CapEx over green revenue and we argue this can start to help demystify companies’ decarbonization targets, where you can now see where they're putting hard dollars into the ground today into low-carbon technologies. And so going into maybe a few examples here, there are many high-carbon-emitting companies in the utility space that have fairly low exposure to renewables today, but significantly higher CapEx going into renewables. One example, one electric utility company shows only 12% taxonomy-aligned revenue exposed to renewables, but over 83% taxonomy-aligned CapEx and you can see that's going into wind, solar, hydrogen, flexible generation. Similarly, you see actually many traditional energy companies now able to claim credit for their green investment. They can now get credit for investment into renewables, biofuels, production of low-carbon chemicals, hydrogen production, as well as looking at cement, which is a very traditionally high-carbon-emitting industry. One company there is showing 0.8% green revenue, but 22.3% green CapEx going into largely carbon capture and decarbonization of cement. Those are some of kind of the positives. Now, with that said, one of the other big learnings is that the taxonomy is not without its challenges. There is definitely a lot of complexity and room for interpretation and a lot of areas that corporates and investors need to digest the information and as a result, I think, one of the other outcomes we've seen is there's many conservative figures that have been reported by corporates initially where we would have expected much higher revenue or CapEx aligned figures, but we do expect this to actually improve this year. So, going into kind of the second full year of alignment reporting with 2023 figures that we will get in annual reports in March and April. The Commission has issued a lot of guidance around this. They've expanded the number of activities covering categories, like auto parts going into EVs [electric vehicles], intermediate electrical components and cables, that now should give a lot more credit and a boost to capital goods companies as well. So, we're also expecting a lot higher-quality figures this year that we will get in March and April.

Tomlinson

And those “room for interpretation” points, I think, are so important, as we're starting to talk many US-headquartered clients through their first taxonomy assessments. Just the sheer volume of those judgment calls about how you apply your business to the eligibility criteria and then once you've got the eligibility criteria, how you then apply the relevant technical screening criteria and just the sheer volume of judgment calls there are throughout the taxonomy instrument — I think it's important to be prepared for. I did want to highlight that point that you make about taxonomy and the forward story. We’re seeing many companies that may have extremely low levels of green revenue today, but that have a plus-ed up CapEx plan, which is really going to indicate the extent to which they are moving from a business which is maybe high emitting today, but which is intending to be much lower emitting in the future. Using it as kind of part of the equity narrative around transition and so on, and I did just want to dig into some of those figures, Evan, and talk to you about those companies that have either advanced transition plans or excellent taxonomy disclosures. Are you seeing any correlation between their performance in stock market terms and taxonomy?

Tylenda

The short answer is yes. In some of our latest work, we created two indexes, tracking the performance of one taxonomy leaders, which is looking at those with high green revenue versus their peers, but then also transition companies where they have high green CapEx ratio ahead of their green revenue. And we’ve actually found, over the last five years, both categories leaders and transition companies have outperformed the broader MSCI ACWI [All Country World Index] stock 600 since 2019. While in more recent periods, transition companies have actually outperformed all categories and benchmarks since 2022. Now, within that category, you get more of those higher-carbon-emitting, more energy-focused companies. One of the things that will be interesting to track here going forward is a lot of the leaders are these high-growth, pure-play, long-duration companies that tend to suffer a bit in a rising rate environment and so we've seen some pullback in their performance late last year, but if rates have topped out will be interesting to see how those start to perform potentially in the future.

Humphreys

And if I can just back Evan up because one of the products that Bloomberg has been working on is a taxonomy-tilted version of a very popular European investment grade index and we mirror exactly the same performance. If you just tilt on having some greater than zero value of alignment, be it on revenue or on capital expenditure and back test, you will show out performance with very similar duration profiles to the main parent index. If you're looking at a tool to give you some kind of advanced return or alpha, then the taxonomy is actually proving to be quite a useful indicator to financial markets as well. And also, Brian, maybe just one thing to pick up on with the advice that you're giving to the US firms, I will definitely say they are not alone. We've observed about 1,800 companies reporting under the taxonomy, and as Evan rightly points out, about 1,500 of those are kind of European companies that are obliged to do so, but that's about 300 companies that have no obligation to report under the taxonomy but are choosing to do so already.

Tomlinson

Nadia, I wanted to ask you to provide any more examples you may have about how you're integrating this huge amount of data that derives from taxonomy disclosures into some of your Bloomberg's data analytics?

Humphreys

Before I answer your question, just one thing that you both made me incredibly happy was bringing up the transition topic. For a long period of time, I would sit on panels, talking about how I felt the taxonomy was a really useful tool for transition and so frequently, the narrative was taxonomy only rewards the best performers. It's like the deepest green and therefore, it's going to be the singular useless numbers that just celebrates what we already know that renewables are good and anything else is bad. To actually hear you both talk about it as a transition topic, has definitely given me a kind of warm fuzzy feeling inside. Your question was, Nadia, as a data vendor, what are you doing? There's two things. One, where a company reports, we collect and make that available and what has been very interesting for us, we cover an international scope. We're about 93% to 94% of global market cap and so, we are seeing taxonomy reporting from more than just European companies. As Evan rightly points out, taxonomy disclosure for European companies is around the 1,500 mark. When we start to look internationally, we see about 300 additional companies that have chosen to report under the taxonomy who don't have any direct obligation to do so. We make that data available. The second piece that I'll talk about is estimates. We have a large pool of capital that are on European ESG-flavored products whom are investing in companies outside of Europe and therefore not obliged to report under the taxonomy. But those financial products can claim taxonomy alignment using an estimate model. And just to speak very briefly into how we think through that, when you look at eligibility, as you rightly pointed out in the introduction, we're looking at the segment revenue of a company. A company under its current accounting standards will tell you segmented revenue values. If those are mapped then to the taxonomy, you can say what proportion of what they're doing is eligible, i.e., can be tested so it doesn't mean green, but just eligible and what is not. So, that's the first estimate that you would typically get from a data vendor. The second is then a much easier estimate to make. Something like substantial contribution normally has threshold metrics. It'll look at the carbon intensity of a given production unit, like cement in Evan’s earlier example. We would be able to see an international company reporting their carbon intensity of cement relative to the thresholds in the taxonomy, and we'd be able to tell you whether the performance of that company is in line or not. The third phase is do no harm and that is technically much harder to estimate. For any of you really familiar with the delegated acts, quite a lot of them point at existing European legislation, and those pieces of legislation don't necessarily have a direct translation internationally. What you can see in estimate models could be things like as long as the company doesn't have an environmental fine, it passes do no harm. Now that's not actually good enough, because certain emerging markets with very weak environmental legislation would automatically pass because there are no such things as environmental fines or they do not need to get permits or licenses to operate in a particular way. You, therefore, need to proxy do no harm to behavioral characteristics and those need to be seen in the way that the company is reporting its own corporate sustainability information. So, a good proxy to do no harm would be some form of mapping of the technical screening criteria or proxies to those technical screening criteria relative to what you see a company self-reporting in its own ESG disclosures. And then the final step is looking at minimum safeguards where you would apply things like an OECD [Organization for Economic Co-operation and Development] or UN Global Compact view of a company to check that there are no social issues, but also that you can see key policies exist in the way that the company is operating from a social perspective. And all of that data together will then give a proxy to whether or not we think a company is considered to be taxonomy-aligned or not. Now that is much easier on the revenue side. For capital expenditure, we see much weaker segmented reporting and therefore it makes it much harder under capital expenditure to do a decent estimate model.

Tomlinson

That's terrific commentary and I did just want to again emphasize that point that you both made about companies choosing to report voluntarily in relation to the taxonomy even where they haven't had an obligation to do so because of the need to get that story out to the capital markets in terms of their transition plan. Also noting the different degrees of difficulty within applying the taxonomy instrument to the relevant sets of KPIs. We certainly see that there's a spectrum of difficulty that runs from revenue through CapEx to OpEx getting exponentially more difficult in terms of tracing taxonomy figures through people's financial systems. I just want to pick up the impact, Evan, of the taxonomy on the existing sustainable finance landscape. You have things like green bonds, sustainability-linked loans, a whole sustainable finance ecosystem that's come about, but now you also have this taxonomy instrument which is intending to create “one standard to rule them all” in relation to what counts as green and what doesn't count as green. How do you see the taxonomy affecting the sustainable finance landscape?

Tylenda

Good question. I'll start kind of on the investor side and really to track the adoption that you tax something, you really have to start with another regulation known as SFDR, which stands for the Sustainable Finance Disclosure Regulation, which is effectively requiring any investment or financial product marketed into Europe to designate whether it's a sustainable fund or not. And what we've witnessed over the last few years is that essentially almost every fund marketed into Europe was becoming a sustainable fund under what's called Article 8, Article 9 of SFDR. And these Article 8, Article 9 products, if we're looking at equity, translate to roughly 60% of all AUM [assets under management] in European equities — nearly US$3 trillion in AUM. And these funds actually are obligated to report on their ownership of companies with green revenue and green CapEx and so, eventually, as we do see the taxonomy increasingly becoming that market standard for credentialing fund is green, given that's what it was designed to do, that will become much more influential once the data becomes available and we're now starting to see signs of investor adoption and understanding and awareness of that, on top of just the disclosure obligation. And we do see actually many companies highly aligned to the taxonomy, over 300% overweight in sustainable funds versus their weight in the benchmark. There is already some recognition given to those companies that are highly aligned today. Now on the corporate side, we are also seeing many companies starting to adopt the taxonomy alignment figures within their green financing programs for sustainably-linked bonds, linked loans and also recently, Europe just finalized the green bond standard, which will require at least 85% of the use of proceeds of those bonds to go to taxonomy-aligned activities. And so, to any extent a company wants to get that stamp of approval, they will have to comply with the taxonomy. So, do expect that to start to feature a lot more in investor corporate communication and financial products as, again, the data becomes more mature, and we get better information.

Tomlinson

It's useful to think about the way in which these different EU regulations interact with each other and where you may be scoped into one, you're likely scoped into other. In the final few minutes, I did want to talk about the forward story in relation to the development of the taxonomy. As we know, we've had two years of taxonomy reporting against those first two objectives, which were climate change mitigation and climate change adaptation. Over the last few months, the European Commission has finalized the next four set of objectives under the taxonomy, which cover things like pollution and circular economy. All of those objectives will be in place to report on eligibility and alignment by the time that first batch of US-headquartered companies are scoped into CSRD [Corporate Sustainability Reporting Directive] reporting in 2026. So, it's important for companies to get their heads around not just the first two sustainability objectives, but the full set of six. Nadia, I wanted to ask for some commentary from you on, why were the sustainability objectives staggered in terms of their development and secondly, what do we need to know about these next four objectives that have just been finalized?

Humphreys

The simple answer to why were they staggered is just a matter of time and capacity. It took us two years to develop the adaptation and mitigation objectives, and then it took us a further two years to develop the remaining four environmental objectives. And so as a result of those, they have been staggered through their introduction. Maybe a couple of things that are interesting to your listeners would be as a result of the new four environmental objectives, what are we estimating will happen in the market? If I look at eligibility, I'm estimating that an additional 6,000 companies will be newly eligible and this is internationally to the taxonomy as a result of the introduction of the four environmental objectives. And about 2,000 companies, again internationally, would have an eligibility figure that has grown. The new inclusions are definitely pharmaceuticals and health. We can also see a broadening of transport. We can also see a broadening in retail in effect as a result of a lot of circular economy criteria, encouraging repair and reuse rather than single production. And if I look as well at the top countries that are benefiting. Where these companies are located? If I look at Europe alone, my top three are Sweden, France and Germany. That's where I see most of my companies that will be newly eligible. If I look internationally, probably no surprises here. Internationally, it's the US, China and India that seem to have the larger concentration of companies would be newly eligible under those criteria. So yeah, I think there will definitely be a shift. It's a lot to contend with. I think the staggering makes sense as people start to think about mitigation and adaptation. It'll be really interesting if we see a change in flavor of those financial products that Evan talked about. At the moment, what you can see is quite a lot of gearing towards decarbonizing as the objective. You don't necessarily see a full fleshed circular economy style or water management style product. They still seem to be very niche, but as they get access to better quality data within those environmental objectives, perhaps we will see a broadening of the type of product that will be introduced to the market as well.

Tomlinson

This is such a good point as well, Nadia, to emphasize that the type of activities that are under each of the six sustainability objectives are specific to the nature of the objective. If you're thinking about climate change mitigation, the type of activities that sit under that objective are in those heavy emitting GhG sectors, that part of the taxonomy maybe covers, 60% of EU economic activity, but probably about 90% of EU GhG emissions, because it's clustered in manufacturing, buildings, energy and transport. Whereas, if you're looking at pollution prevention and control, that's going to be a different set of activities which would be relevant to a company in a different industry which could have zero relevance to it in relation to climate change mitigation. Evan, these next four sets of environmental objectives are gonna produce a huge expansion in data, huge expansion in the type of disclosures in relation to a new batch of economic activities. As an investor, what are you most excited about? What do you think has the most potential in terms of assessing the performance and prospects of the companies that you follow?

Tylenda

For me, it would simply be the circular economy objective. It's by far the next largest objective, with 21 economic activities captured behind the 90 captured within climate change mitigation, but that's well ahead of the roughly 8 to 9 activities for any of the other objectives. So, circular economy is the next biggest. But I think what we are witnessing is this is becoming just a growing theme that's gaining focus amongst corporates and regulators for a few reasons. First, the circular economy is actually a direct contributor to a low-carbon net-zero economy. You actually cannot solve for a net-zero economy without first solving for a circular economy. It is a very clear relationship with material usage, waste and emissions. That means we need to focus on a circular economy as well, but also we're seeing this gaining traction from what we think is a potentially looming critical material crisis, where we may not have a sufficient supply of critical materials, copper available to actually deploy all the renewables, all the EVs necessary to achieve broader net-zero decarbonization goals. This is raising this as a relevant theme for investors and the taxonomy actually does, we think, quite a good job at covering many of these circular economy activities beyond just recycling. It includes things, like sale of spare parts, repair and refurbishment, sale of secondhand goods, promoting product lifetime extensions and so forth. For me, it would definitely be the circular economy and we are seeing growing interest on the corporate investor side at the moment around that.

Tomlinson

Evan and Nadia, this has been a terrific conversation. Thank you so much for the insights. I think you've really communicated the fact that taxonomy is both a compliance exercise for getting there in terms of the regulation, but actually it's a really important capital markets forward story, strategic communication device as well and needs to be thought about in both those terms. Many of our clients are going to be newly scoped into reporting on the taxonomy in 2026 for financial years beginning 2025. Would love to get a few thoughts from both Nadia and Evan, some words of advice, some key takeaways for that group of companies, Nadia.

Humphreys

Thanks, Brian, and I think you're quite right. My piece of advice is the taxonomy is not just a European tool and instrument, that it is a critically important instrument for you to be able to assess your business, for you to be able to measure your transition, and for you to be able to communicate with your investors about your plans to become more environmentally sustainable. And it is a beautiful opportunity for companies outside of Europe to see how much they align, whether it's compliance or whether it's purely to attract that capital to come to them to demonstrate financial outperformance relative to environmental integrity.

Tomlinson

That's fantastic. Evan.

Tylenda

My advice to corporates would be make the taxonomy work for you. I mean this is some feedback that we've shared with a lot of companies is do your taxonomy reporting, establish and think of it as effectively a baseline and where you're confident in meeting the criteria, report on that. But then there are elements in cases of where companies may be also making incremental low-carbon investment that may not be captured, but it's also important to disclose that and so the way I think about what the taxonomy could almost be akin to would be thinking of non-GAAP equivalent standards. You have GAAP accounting, you have IFRS [International Financial Reporting Standards], but then companies report non-GAAP, non-IFRS and similarly the taxonomy can be kind of that baseline that gets built up over time, and then investors can see the whole picture of well this is green by law, by definition, but then here's the kind of incremental investment that companies are also making that is having some contribution, but may not be definitively green yet today and just providing that level of transparency is super helpful to the market.

Tomlinson

That's terrific. Well, Nadia and Evan, thank you so much. Couldn't ask for more expert and insightful speakers. Great to have you.

Corson

If you’ve enjoyed this or any episode of The EY Better Finance podcast, please leave a rating or review and don’t forget to subscribe so you get future episodes. You’ll find related links in the show notes or ey.com/betterfinance. As always, thank you for listening and if you have ideas or topics you would like to see covered or guests you’d like to see featured, please don’t hesitate to reach out. I look forward to speaking to you next time on The EY Better Finance podcast.

Presenters

Brian Tomlinson

Managing Director, Environmental, Social and Governance, Ernst & Young LLP

Myles Corson

EY Global and Americas Strategy and Markets Leader, Financial Accounting Advisory Services

Podcast

Season 6, Episode 11

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0h 39m 54s

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EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.

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Why the EU Taxonomy could be a game-changer for green investments

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Presenters

Brian Tomlinson

Myles Corson

In this series

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