The EU Taxonomy Regulation as a lever to foster private sector adaptation to climate change?

To ensure a smooth transition to a low-carbon financial and economic system and to prepare for climate-related risks, companies must develop and implement appropriate management measures. The EU Taxonomy Regulation is here to ensure this

Therefore, a scientifically sound, forward-looking disclosure of climate-related data is key, enabling the identification, assessment, and appropriate response to climate change-related impacts. Furthermore, companies also face an increasing demand to deal with climate-related information for non-financial reporting, where the incorporation of climate change scenarios into risk and vulnerability analyses as well as adaptation plans are required.

To show that their economic activities are environmentally sustainable following the classification system of the EU Taxonomy Regulation, companies must meet certain thresholds and criteria, e.g., for proof of a substantial contribution to one of the six environmental goals established by the EU Taxonomy Regulation.

Currently, however, companies primarily still focus on disclosing historical CO₂ emissions within the topic of climate mitigation, leaving notable gaps in the incorporation of forward-looking climate data and scenarios into reporting and long-term (adaptation) planning strategies.

An important aspect in this context is addressing the “Tragedy of the Horizon”, as highlighted by Mark Carney already in 2015. This concept pertains to the catastrophic impacts of climate change that will be felt beyond the traditional horizons of most financial actors, imposing costs on future generations that the current generation has no direct incentive to address.

Establishing an early policy framework providing planning certainty is expected to facilitate the necessary reallocation of assets without disrupting or inflicting adverse consequences on the financial system, which could result from a belated and abrupt transition to a climate change trajectory well below the global warming limit of 2°C.

Opportunities to foster corporate adaptation to climate change

In this context, the requirements of the EU Taxonomy Regulation present new challenges for companies but also offer great opportunities to foster corporate adaptation to climate change. Thereby, this new regulation, operating under the umbrella of the European Green Deal, should be perceived as an integral component of a broader framework for fostering sustainability within the EU financial landscape (see Figure 1).

The Sustainable Finance Disclosure Regulation (SFDR) governs disclosure obligations within the financial services sector, while the Corporate Sustainability Reporting Directive (CSRD) mandates sustainability information disclosure for companies. To ensure consistent definitions, the EU Taxonomy Regulation establishes a system for classifying environmentally sustainable economic activities and imposes disclosure requirements on both companies and financial market participants. Consequently, it serves as a bridge between these two realms.

The EU Taxonomy Regulation classification system serves two primary purposes:

• a) providing clarity to companies and financial market participants on economic activities deemed as being environmentally sustainable, and
• b) enabling investors to identify and invest in sustainable assets. The EU Taxonomy Regulation aims to redirect capital towards sustainable activities, incentivizing companies to initiate new projects or expand existing ones.

Furthermore, it supports the transformation of the European economy and facilitates the achievement of the European Green Deal objectives by incorporating six environmental objectives, including, amongst others, climate change adaptation on equal footing with climate mitigation and four corresponding requirements for business activities to be recognized as environmentally sustainable within the taxonomy framework.

Article 3 of the regulation stipulates that the economic activity must:

• Substantially contribute to at least one of the six environmental objectives outlined in Article 9 of the EU Taxonomy Regulation.
• Avoid causing significant harm to any of the other environmental objectives.
• Comply with specified minimum human rights and labor law protection standards.
• Meet specified technical screening criteria.

In the Delegated Regulations accompanying the EU Taxonomy Regulation, technical screening criteria for the six environmental objectives – in the Climate Delegated Act, particularly for climate mitigation and adaptation to the impacts of climate change – are defined for economic activities in different sectors.

To demonstrate that an economic activity either substantially contributes to climate change adaptation or avoids significant harm to it, a climate risk and vulnerability analysis must be carried out. This requires a robust analysis of available climate change data and projections for future climate scenarios.

Appendix A to Annex I and II of the Delegated Regulation to the EU Taxonomy Regulation further stipulates that impact assessments must adhere to best practices and available guidance as well as incorporate the best available science for vulnerability and risk analysis and related methodologies.

A pivotal tool for fostering corporate adaptation

Hence, the EU Taxonomy Regulation can be a pivotal tool for fostering corporate adaptation to the impacts of climate change by calling for the integration of future climate change into corporate strategies. By setting general criteria for determining the conditions under which an economic activity qualifies as contributing substantially to climate change adaptation and for determining whether that economic activity causes no significant harm to it, the regulation provides a structured framework for businesses to assess and improve their preparedness for impacts of climate change.

The consideration of the requirements of the EU Taxonomy Regulation ensures that corporate strategies should be scientifically grounded and well-prepared for the challenges posed by climate change. Furthermore, it promotes transparency and accountability. By requiring companies to disclose their fulfillment of the adaptation criteria, it enhances investor and stakeholder confidence.

This transparency can contribute to greater competitiveness and resilience in the face of climate change. By getting businesses on course with the EU’s environmental goals and climate science, the EU Taxonomy Regulation also encourages a holistic approach to addressing climate change, promoting resilience and adaptation alongside mitigation efforts.

Climate Service Center Germany (GERICS) and their work

However, there is still a great need for research to develop and apply an adequate methodology for companies to deal with the specific requirements from the EU Taxonomy Regulation in practice.

Against this background, the Climate Service Center Germany (GERICS) develops a process model approach as an innovative way to integrate forward-looking climate change information, scenarios and impacts into corporate processes, whereby this transdisciplinary and problem-driven approach is developed in close collaboration and co-creation with companies.