'Make EU taxonomy simpler, but not less strict'

Although financial institutions are largely willing to implement the directive properly, they perceive the rules as too strict and too complex. There is also a lack of available data, and the KPIs do not yet cover all economic activities, sustainability objectives, and loans and investments provided by banks and insurers.

Identifying and assessing sustainable investments

The EU taxonomy defines which economic activities can be classified as sustainable ('taxonomy aligned'). 'The primary goal is to create a common language and structure for investors, companies, and policymakers to identify and assess 'taxonomy-aligned' investments,' says PwC's ESG specialist Job van Hemert. 'The standardised reporting framework provides transparency, promotes comparability, and combats greenwashing. But despite its importance, the EU taxonomy has not yet fully succeeded in accurately reflecting the sustainability profiles of financial institutions. At the same time, the European Commission does see banks starting to use the EU taxonomy in their lending strategies and in their assessment of companies' investment plans.' 

Key findings of the benchmark study

PwC's benchmark study on the effectiveness of the EU taxonomy among 19 credit institutions in the Netherlands, Germany, and France reveals several key findings:

• The KPIs of the EU taxonomy cover only a small portion of the economic activities financed by insurers and banks (e.g., no healthcare or socially oriented activities) and a small portion of the total outstanding financing (e.g., no SME and government exposures).
• Due to the limited coverage of the KPIs, complexity of the legislation, strict criteria, and limited availability of data, a significant portion of the assets covered by the KPIs is considered non-sustainable ('not taxonomy-aligned') and not aligned with the taxonomy ('non-eligible').
• What financial institutions currently classify as sustainable mainly includes sustainable mortgages. As a result, the KPI provides relatively little information about the capital flows to sustainable economic activities of private enterprises.
• There is a lack of transparency regarding economic activities that do not qualify as sustainable. This can include social investments focused on healthcare or green government bonds for infrastructure projects, as well as financing of oil and gas exploration. As a result, the KPIs of the EU taxonomy provide only a limited view of the sustainability profile of banks' and insurers' investments.
• There are different interpretations and approaches in the market when calculating the KPIs. This limits comparability between financial institutions.
• In addition to the sustainability of investments, insurers report on EU taxonomy-related insurance activities: the premium received for insuring damage from climate risks. Insurers struggle to meet the strict technical screening criteria and the minimum safeguards (requirements related to human rights, corruption, bribery, fair competition, and fair tax practices), and the share of the total premium received from insuring climate risks is very small.
• As a result of these findings, most financial institutions do not yet have plans to incorporate the KPIs of the EU taxonomy into their investment decision-making or set specific goals for increasing 'taxonomy-aligned' investments.
• The number of templates and the complexity of the regulations make the interpretation of the KPIs extremely difficult for stakeholders and society.
• In combination with the CSRD and the SFDR, the EU taxonomy is an essential pillar in the regulatory landscape for transparency on the sustainability profile of financial institutions.

Mortgages the main reason for high 'taxonomy alignment'

A commonly heard criticism is that the strict criteria of the EU taxonomy result in low alignment percentages among banks, where 'alignment' refers to 'actually sustainable'. Van Hemert: 'Our benchmark study shows that the alignment figures range from 0.1 to 22.9 percent. For almost all evaluated financial institutions, mortgages stand out as the only asset class that is significantly in line with the alignment criteria of the EU taxonomy. This is largely due to relatively achievable criteria. Furthermore, the bank itself is responsible for the data and therefore has limited dependence on external parties. In addition, mortgages have a large share in the assets that determine the KPI. For other parts of the portfolio, determining 'EU taxonomy alignment' is a greater challenge.'

Improving comparability of sustainability profiles

Another goal of the EU taxonomy is to improve the comparability of the sustainability profiles of financial institutions. Although the regulations prescribe the disclosure of comparable EU taxonomy KPIs, limitations arise when using these figures to compare sustainability profiles.

'For example, the EU taxonomy currently excludes investments in non-listed small and medium-sized enterprises (SMEs)', explains Van Hemert. 'As a result, it is difficult to accurately analyse the sustainability of a portfolio without having detailed additional information about that portfolio. In addition, inconsistencies arise because financial institutions use different approaches to determine which assets are in line with the EU taxonomy. This complicates comparisons and highlights the limitations in comparing EU taxonomy figures.'

To improve the usability of the taxonomy and its market introduction, the European Commission is working on implementation guidelines that will be regularly updated and made available through the Taxonomy Navigator and a FAQ overview.

Usability of EU taxonomy improves over time, boosted by CSRD

Ruben Bongers, also an ESG specialist at PwC and involved in the benchmark study, believes that after three years of reporting under the EU taxonomy, the KPIs still say little about capital flows towards sustainable activities. 'The KPIs are hardly used as an instrument yet. That is a shame because the potential of the EU taxonomy is enormous. It defines what is sustainable and where the money should go to finance the goals of the EU Green Deal.'

'Financial institutions are largely willing to implement the EU taxonomy properly', Bongers continues. 'The problem is that the rules are too strict on the one hand and leave too much room for interpretation on the other hand. There is also a lack of available data, and the KPIs do not yet cover all economic activities and sustainability objectives. As a result, the KPIs of all institutions are low, and you see limited differences between ING and Triodos, for example.'

Nevertheless, the usability of the EU taxonomy improves over time. 'The figures are already more reliable and standardised compared to last year', reports Bongers. 'Back then, only eligible data was reported. With the increasing availability of EU taxonomy data due to the phased implementation of the CSRD, there will be converging interpretations and a broader scope of application of the EU taxonomy with increasingly meaningful KPIs.’

The European Commission has also noted that companies are increasingly using the EU taxonomy to steer and present their capital investments in key sectors, to meet the Green Deal objectives. According to a recently published factsheet, capital investments in EU taxonomy-related activities have increased in 2024 compared to the previous year. In 2023, approximately six hundred European companies reported capital investments of 191 billion euros in EU taxonomy-related activities. So far, companies have already reported 249 billion euros in 2024, indicating significant growth. In total, this amounts to 440 billion euros in 2023 and 2024 as of May 6, 2024.

‘These figures are expected to further increase as companies start reporting on the next four environmental objectives of the EU taxonomy', concludes Bongers. ‘This will expand the number of eligible companies. What I would further advise is to simplify the rules, but not be less strict. For example, by reducing the number of templates and providing more clarity on the interpretation of the rules. Financial institutions can also collaborate more to ensure consistency, and the EU needs to increase data availability. This can be done by facilitating a database with all CSRD companies in the EU - for which the EU has plans and a legal basis.’