The Role of Finance and the EU Taxonomy in the Circular Economy – Part 1

FEATURED ARTICLE

In this Part 1, we explain how finance can play a critical role in promoting sustainability and tackling environmental challenges. As part of its commitment to achieving a climate-neutral economy by 2050, the European Union has introduced a range of measures designed to encourage private sector involvement in meeting the Paris climate agreement. These include the EU Taxonomy for Sustainable Activities and the Sustainable Finance Disclosure Regulation, which aim to boost investment in green initiatives, increase transparency and accountability, and reduce instances of ‘greenwashing’ in the financial sector. We examine the six environmental objectives of the EU Taxonomy for Sustainable Activities, including the “Transition to a Circular Economy” objective, as well as the Technical Screening Criteria for the other objectives and current draft recommendations.

Foreword

Financial markets, through the deployment and reallocation of capital, can play a significant role in addressing today’s environmental challenges. Many market participants now acknowledge that environmental risks and social risks are financial risks. Using the theory of efficient allocation of resources, this should lead to significant inflows into sustainability-focused businesses in the years ahead.

Why was the EU Taxonomy created?

By passing the Green Deal in 2019, the European Union (EU) set the course for more sustainable investments, for example in areas like renewable energy, biodiversity or circular economy. The goal is to reach a climate-neutral economy in the EU by 2050, with a reduction of 55% already implemented in 2030. To achieve these climate goals, the Green Deal includes an investment plan of 1 trillion euros over the next 10 years. Despite this huge investment, the EU depends also on the support of the private sector to achieve the Paris climate agreement.

The EU Taxonomy for Sustainable Activities (the “EU Taxonomy”)[1] and the Sustainable Finance Disclosure Regulation (“SFDR”)[2] are implemented to ensure equal competition and legal certainty for all companies operating within the EU. Both regulations follow the objective of the Green Deal and have the following key goals:

• Reorientation of capital flows with a focus on sustainable investments
• Establishing sustainability as a component of risk management
• Promoting/encouraging long-term investment and economic activity

Combined, the EU Taxonomy and SFDR will accelerate Europe’s transition to a low-carbon economy by promoting transparency and accountability, boosting green investment and reducing ‘greenwashing’ in the investment industry.

What exactly is the EU Taxonomy?

The EU Taxonomy regulation describes a framework to classify “green” or “sustainable” economic activities executed in the EU. Previously, there was no clear definition of green, sustainable or environmentally friendly economic activity. The EU Taxonomy regulation creates a clear framework for the concept of sustainability, exactly defining when a company or enterprise is operating sustainably or environmentally friendly. Compared to their competitors, these companies stand out positively and thus should benefit from higher investments. Thereby, the legislation aims to reward and promote environmentally friendly business practices and technologies. The focus lays on the following six environmental objectives:

As one of the six environmental objectives of the EU Taxonomy, The Transition to a Circular Economy has its own set of screening criteria for determining which economic activities make a substantial contribution to the realisation of the objective. Accordingly, the transition to a circular economy is a hugely significant pillar of the European Green Deal.

In June 2021, the European Commission adopted the delegated act for the Technical Screening Criteria (“TSC”) for the first two environmental objectives of the EU Taxonomy (“Climate Change Mitigation” and “Climate Change Adaptation”) which started applying from 1 January 2022.

In March 2022, the Platform on Sustainable Finance (the “PSF”)[3], a permanent expert group mandated by the European Commission to assist them in developing its sustainable finance policies, published its draft recommendations for the TSC for the four remaining environmental objectives of the EU Taxonomy, which included “The Transition to a Circular Economy” objective.

At the time of writing, the European Commission has not yet formally adopted the TSC for “The Transition to a Circular Economy” objective. However, it is anticipated that the current version of the TSC for “The Transition to a Circular Economy” as proposed by the PSF to the European Commission in March 2022 will be adopted in their current form. This was the case with the TSC for the first two environmental objectives which were adopted in full by the European Commission.

Importantly, however, the PSF has, in the draft TSC for “The Transition to a Circular Economy” objective, highlighted that “due to resources, workload and time available, it was considered that the PSF would only be able to address up to about 20 economic activities per environmental objective in the first phase of the work.”[4] The PSF notes that some sectors, including Batteries and Vehicles, are currently omitted from the draft TSC. The PSF states that this is due to the potential overlap and conflict with the previously adopted TSC for Climate Change Mitigation and Climate Change Adaptation. Accordingly, the draft TSC for “The Transition to a Circular Economy” objective are not to be considered as exhaustive or complete; rather they are the first iteration of a work in progress. The PSF is expected to release and propose that the European Commission adopts, further iterations of the TSC in the future to capture economic activities not currently covered by the draft TSC and to resolve any overlap and conflicts across all six environmental objectives.

Given the incomplete status of the TSC for “The Transition to a Circular Economy” objective, we (SMS) have, for the purposes of defining the SMS Circular Economy Enablers Thematic Classification, proposed a number of economic activities for inclusion which address the key product value chains and economic activities (such as “Batteries and Vehicles” and “Packaging”) that are currently omitted from the TSC but which we expect will be progressively added to the TSC in future iterations. To assist with this, we have extrapolated from the various studies and reports that have been published by the European Commission (and other leading independent bodies championing the transition to a circular economy in recent years), particularly the European Commission’s “Circular Economy Action Plan” 2020, while we wait for further iterations of the TSC to be released.

The various studies and reports are referenced in Part 2.

This Featured Article has been produced by Sustainable Market Strategies. Rize ETF Ltd make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability or suitability of the information contained in this article.

Related ETF

CYCL: Rize Circular Economy Enablers UCITS ETF

References

[1] Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088. Available at: https://finance.ec.europa.eu/sustainable-finance/tools-and-standards/eu-taxonomy-sustainable-activities_en

[2] Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability‐related disclosures in the financial services sector. Available at: https://eur-lex.europa.eu/eli/reg/2019/2088/oj

[3] European Commission, “Platform on Sustainable Finance”, 2022. Available at: https://ec.europa.eu/info/business-economy-euro/banking-and-finance/sustainable-finance/overview-sustainable-finance/platform-sustainable-finance_en

[4] Platform on Sustainable Finance, Part A: Methodological report, March 2022, See Section 2.3 (“Prioritised economic activities”). Available at: https://ec.europa.eu/info/sites/default/files/business_economy_euro/banking_and_finance/documents/220330-sustainable-finance-platform-finance-report-remaining-environmental-objectives-taxonomy_en.pdf