EU Taxonomy, Assurance Requirements, and its Implication on India and Indian Chartered Accountants
Over the past couple of years, we have been hearing the terms EU Taxonomy, Green taxonomy, Sustainability reporting, and ESG (Environmental, Social, and Governance) reporting and other related terminologies. It is now evident that these reporting are part of the Financial reports and as a Chartered Accountant, we are responsible for the assurance of these reported numbers.
In this article, we will briefly discuss the EU taxonomy since the EU Taxonomy reporting has already been started by large companies in the European Union. The Statutory Auditors of these companies are responsible for Limited assurance for these reports. We will understand the background for implementing EU Taxonomy, Objectives, CSRD, SFDR, Reporting requirements, Keywords, and KPIs of EU taxonomy. We will understand the applicability of these reporting and Assurance requirements from the Statutory Auditors. We will continue the discussion with India\'s efforts towards green taxonomy and what to expect in the upcoming years. It is also worth mentioning that the Indian Government is also working on a policy similar to the Green Taxonomy pioneered by the European Union (EU).
EU Taxonomy - Introduction
One of the greatest challenges that our generation and our upcoming generation will be facing is the impact of climate change. With this view, almost all the countries entered into an international treaty on climate change in 2015 named as \"Paris Agreement\". The aims of this agreement are:
- Temperature Goal: The aim is to keep the rise in global average temperature significantly below 2°C compared to pre-industrial levels, and to limit it even further to 1.5°C.
- Adaptation and Resilience: Enhance ability to adapt to climate change\'s adverse effects, fostering climate resilience and promoting low greenhouse gas emissions development.
- Finance Alignment: Financial flows should align with a pathway toward low greenhouse gas emissions and climate-resilient development.
Owing to the Paris Agreement, the European Union became the pioneer in implementing European Green Deal initiatives and EU Taxonomy.
Objectives of EU Taxonomy
The main aim of the European Green Deal is to prevent greenwashing and also help investors make informed decisions related to sustainable investments. EU Taxonomy translates climate and environmental objectives into clear criteria, combating market fragmentation, preventing greenwashing, and accelerating financing for sustainable projects.
EU sustainable finance framework
To achieve the objective, the EU has created an EU Sustainable Finance Framework which incorporates three-dimensional corporate sustainability disclosure regimes:
Corporate Sustainability Reporting Directive (CSRD)
CSRD aims at enhancing and standardizing the reporting of non-financial information, improving consistency, quality, and transparency. It introduced the European Sustainability Reporting Standards (ESRS). Companies will need to start applying the new rules for the 2024 financial year, with reports published in 2025.
Sustainable Finance Disclosure Regulation (SFDR)
SFDR increases transparency in the financial markets regarding sustainability for financial market participants and advisers. SFDR categorizes investment funds into Dark Green Funds (Article 9), Light Green Funds (Article 8), and Grey Funds (Article 6).
EU Taxonomy
EU Taxonomy provides a classification system for environmentally sustainable economic activities, serving as the foundation for both CSRD and SFDR.
Reporting of Taxonomy KPIs
Organizations are required to report Taxonomy Key Performance Indicators (KPIs).
- For Financial undertakings, the KPI is the Green Asset Ratio (GAR).
- For non-financial entities, KPIs include reporting Eligibility and Alignment of Turnover, Capital Expenditure (Capex), and Operational Expenditure (Opex).
Eligibility: An activity that could make a potential contribution to one or more of six environmental objectives (Climate change mitigation, adaptation, sustainable use of water, circular economy, pollution prevention, biodiversity protection).
Alignment: An eligible activity that meets technical screening criteria: Substantial Contribution, Do No Significant Harm (DNSH), and Minimum Social Safeguards (MSS).
Applicability
The timeline for application in the EU:
- 2022: Large undertakings report proportion of eligible/non-eligible activities.
- 2023: Large nonfinancial undertakings report activities aligned with EU Taxonomy.
- 2024: Large financial institutions disclose eligible and aligned activities.
- 2026: Credit institutions report Taxonomy alignment for trading books and fees.
It also applies to non-EU entities offering financial products in the EU, EU subsidiaries of non-EU companies, and non-EU companies listed in the EU-regulated market.
Assurance Requirements
Under CSRD, companies are required to seek limited assurance over compliance of the KPI and the process followed to arrive at the information. The European Commission plans to adopt assurance standards for limited assurance by October 2026 and reasonable assurance by October 2028.
India\'s efforts towards green taxonomy
India\'s financial sector regulators (SEBI, RBI, IFSCA) have made progress in promoting green finance. SEBI formalized disclosure requirements for green debt securities and introduced the Business Responsibility and Sustainability Reporting Framework in 2021. The RBI mandated regulated entities to formulate green deposit policies. The Department of Economic Affairs set up a Task Force on Sustainable Finance in 2021 to draft a taxonomy.
Implications on India
India\'s financial decisions will be impacted by the EU\'s taxonomy due to globally integrated capital markets. India is at risk of losing foreign investment in green capital if there is a delay in formulating a green taxonomy. Non-EU Indian subsidiaries of EU parent companies have already started providing required information.
Conclusion
Indian-listed companies have started voluntarily reporting Taxonomy KPIs. Indian policymakers should expedite developing a locally tailored green taxonomy. Chartered Accountants play a crucial role in implementation and providing assurance for the Taxonomy KPI\'s reporting.
- CSRD. paragraphs 60, 61, and 62, and EU Audit Directive (2006/43/EC)
- European_Commission. (2022, January). FAQs: How should financial and non-financial undertakings report Taxonomy-eligible economic activities
- Khanna, M. (2023, May 2). Navigating India\'s Green Taxonomy
- Khanna, S. H. (2023, May 1). India should use G20 presidency to address the green question
- Singh, S. C. (2023, January 27). India plans to classify clean activities