This article was written by Nadia Humphreys, Business Manager, Sustainable Finance Solutions at Bloomberg, Co-rapporteur on the Platform for Sustainable Finance of the European Commission.
Since January 2022, financial and non-financial companies in Europe have had to report the percentage of turnover, capital expenditure and operating expenses that are eligible to the EU Taxonomy. The Taxonomy is a new system, introduced first in Europe, to help understand whether all or part of a company is operating in an environmentally sustainable way. But what does being ‘eligible’ mean?
Eligible is not an indication of ‘green’, it’s an indication that a company could be operating in a way that is aligned to the EU Taxonomy. For example, if I make cars, I would be considered eligible even if the cars I make are petrol or diesel fuelled. Being eligible to the Taxonomy prompts the important conversation between investor and investee on why you are not operating in a way that could be aligned. In the case of a car manufacturer, why am I building or selling new fossil fuel dependent vehicles when I could be expanding my fleet of zero emission vehicles? In essence, first you must be Eligible then you can determine if you are Aligned. If you are Aligned, that is an indication of ‘green’.
Bloomberg has observed that nearly 4,000 companies recognized the EU Taxonomy in their non-financial statement this year, however, as of June 2022, only 300 of these companies reported their Taxonomy-eligibility metrics. For financial companies, the expectation is that they use the eligibility values from their investee company or counterparty in their own reporting. Limited data is therefore an obstacle to a financial company truly representing its eligible share.
This problem was recognized by the Platform for Sustainable Finance, in their December guidance document on eligibility reporting. Financial Market Participants and Financial Undertakings can voluntarily report Taxonomy-eligibility themselves, as long as they apply the precautionary principle in doing so. As noted earlier, given limited company-reported data, estimated data sets can be used in voluntary reporting so long as they comply with a few key rules:
- Eligibility should be derived from the financial statement of the company
- Under the precautionary principle, eligibility should be estimated as in line or larger than the true reported value
- Eligibility should not be reported as enabling or transitional – a company can only be enabling or transitional if found to be substantially contributing to an environmental objective
- Eligibility is not an indicator of the ‘green share’ of the company
Why are estimated values different from company reported data?
Estimated eligibility is derived from the financial statement of a company. Companies who report in line with IFRS accounting standards will typically apply a 10% minimum threshold to their segment revenue or turnover. The Taxonomy reporting (under Article 8) does not set any minimum threshold. This means that a large oil and gas company, who is starting to invest in renewable energies but whose share of turnover for renewables is less than 10% may co-mingle fossil and non-fossil based revenue segments in their annual accounts. Under the Taxonomy guidance from the Platform for Sustainable Finance, estimated eligibility should take the reported segment from the financial statement of the company. In this case, the eligible segment includes both fossil and non-fossil fuels and would be an over-estimation of eligible but correct under the precautionary principle. Until such a time as the energy company accurately breaks out its renewable versus non-renewable share of revenue, the estimate will represent all energy production. This approach serves two benefits:
- Encouraging companies to correctly report their segment revenue in their annual accounts
- High eligibility prompts investor conversations on how to align to the Taxonomy
As financial companies grapple with the new reporting requirements, it is important that they have data they can rely on. Bloomberg can help investors apply the Taxonomy to assess if investments are aligned with the EU’s environmental objectives, for more information, please go to European regulation tab in BESG <GO>. To learn more about Bloomberg’s Sustainable Finance Solutions, please click here.