What is EU Taxonomy?

What is EU Taxonomy?

The EU Taxonomy is a science-based classification system established by the EU Taxonomy Regulation (2020/852) that defines criteria for determining whether an economic activity is environmentally sustainable. It sets performance thresholds—called technical screening criteria (TSC)—for activities across sectors, measured against six environmental objectives: climate change mitigation, climate change adaptation, sustainable use and protection of water and marine resources, transition to a circular economy, pollution prevention and control, and protection and restoration of biodiversity and ecosystems. Companies subject to the CSRD must disclose the proportion of their revenue, capital expenditure, and operating expenditure that is Taxonomy-aligned.

Why It Matters

The EU Taxonomy addresses a fundamental problem in sustainable finance: the absence of a common definition of "green." Before the Taxonomy, a fund marketed as "sustainable" could hold virtually anything. A "green bond" could finance activities with questionable environmental credentials. ESG ratings assigned green scores using opaque, inconsistent criteria. The Taxonomy provides a definitive, science-based answer to whether specific economic activities meet environmental sustainability thresholds—creating a common language for investors, companies, regulators, and financial product designers.

The financial market impact is substantial. The EU's Sustainable Finance Disclosure Regulation (SFDR) requires financial products marketed as Article 8 or Article 9 (sustainable) to disclose their Taxonomy alignment. This creates demand-side pull—fund managers building sustainable products actively seek Taxonomy-aligned investments, creating a capital allocation advantage for companies with high Taxonomy alignment. Early data shows that Taxonomy-aligned companies access green bond markets at 10–30 basis point spreads below conventional issuance.

For non-financial companies, Taxonomy reporting reveals the green composition of business activities with unprecedented granularity. A utility company must report what percentage of its revenue comes from Taxonomy-aligned renewable energy generation versus non-aligned fossil fuel generation. A real estate company must disclose what proportion of its buildings meet Taxonomy energy efficiency thresholds. This transparency enables investors to make quantitative comparisons of green revenue exposure across companies and sectors.

The Taxonomy is also a strategic planning tool. Companies can use the technical screening criteria as targets for capital allocation—investing in activities and technologies that will increase their Taxonomy alignment over time. A manufacturer evaluating whether to invest in energy-efficient production equipment can assess whether the investment would shift capex into Taxonomy-aligned categories, improving both sustainability performance and access to green capital.

How It Works / Key Components

An activity qualifies as Taxonomy-aligned if it meets four conditions: it substantially contributes to at least one of the six environmental objectives (by meeting the TSC for that objective), it does no significant harm (DNSH) to any of the other five objectives, it complies with minimum social safeguards (aligned with OECD Guidelines, UN Guiding Principles, and ILO core conventions), and it meets the technical screening criteria specified in the delegated acts.

The Climate Delegated Act (2021) and Environmental Delegated Act (2023) define technical screening criteria for hundreds of economic activities. For climate mitigation, criteria are sector-specific: electricity generation from solar PV is automatically aligned; natural gas power plants must emit below 270g CO₂e/kWh; building renovation must achieve 30% primary energy demand reduction; new buildings must have energy performance 10% below national nearly-zero energy building standards. Each criterion was developed with input from the Platform on Sustainable Finance and reflects current scientific and technological benchmarks.

Companies report three Taxonomy KPIs: revenue (turnover) alignment, capex alignment, and opex alignment. Revenue alignment shows what proportion of current business activity is green. Capex alignment reveals how much investment is flowing toward green activities—a forward-looking indicator of transition. Opex alignment covers operating expenditures related to maintaining Taxonomy-aligned assets. For companies transitioning their business models, capex alignment may be significantly higher than revenue alignment, signaling investment in future green capacity.

Implementation challenges are significant. Determining Taxonomy eligibility (whether an activity is covered by the Taxonomy) is relatively straightforward, but proving alignment (whether the activity meets all four conditions including TSC and DNSH criteria) requires detailed technical data that many companies don't readily collect. The DNSH criteria can be particularly demanding—a solar panel manufacturer might substantially contribute to climate mitigation but must also demonstrate no significant harm to water resources, biodiversity, and circular economy objectives through its manufacturing processes.

Council Fire's Approach

Council Fire supports clients through EU Taxonomy assessment, from eligibility screening and alignment analysis against technical screening criteria, through DNSH and minimum safeguards evaluation, to KPI calculation and CSRD-integrated reporting. We help companies identify pathways to improve Taxonomy alignment through targeted capital allocation, operational changes, and supply chain engagement—turning the Taxonomy from a compliance obligation into a strategic tool for green transition planning.

Frequently Asked Questions

Does the EU Taxonomy apply to non-EU companies?

Directly, only if they're within CSRD scope (non-EU companies with €150M+ EU net turnover meeting subsidiary criteria report from fiscal year 2028). Indirectly, the Taxonomy affects any company seeking EU green capital—if a European fund needs Taxonomy-aligned investments to meet SFDR requirements, non-EU companies that can demonstrate Taxonomy alignment gain preferential access. Banks applying the Taxonomy to their Green Asset Ratio may also favor Taxonomy-aligned borrowers regardless of geography. Several non-EU jurisdictions (Singapore, ASEAN, South Africa) are developing their own Taxonomies with varying degrees of interoperability with the EU framework.

What's the difference between Taxonomy-eligible and Taxonomy-aligned?

Taxonomy-eligible means the economic activity is described in the Taxonomy's delegated acts—it's covered by the classification system. Taxonomy-aligned means the eligible activity meets all four requirements: substantial contribution to an environmental objective, DNSH to other objectives, minimum social safeguards, and specific technical screening criteria. Eligibility is a low bar (is this activity type covered?); alignment is a high bar (does this specific activity meet all performance thresholds?). A company might have 60% Taxonomy-eligible revenue but only 25% Taxonomy-aligned revenue because many eligible activities don't meet the technical criteria.

How does the EU Taxonomy interact with green bond issuance?

The EU Green Bond Standard (EU GBS), finalized in 2023, requires that proceeds of bonds marketed as "European Green Bonds" finance activities aligned with the EU Taxonomy. This creates a direct link between Taxonomy alignment and access to the EU's labelled green bond market. Companies with higher Taxonomy alignment can issue larger green bonds with credible use-of-proceeds frameworks. Green bonds under the EU GBS also require allocation and impact reporting against Taxonomy criteria, with external review. The standard aims to eliminate greenwashing in the €500+ billion annual green bond market and gives Taxonomy-aligned companies a structural funding advantage.