Blog post by Lisa Chase: What is “Sustainable,” …
What is “Sustainable,” and Why Does the EU Taxonomy Matter to the Building Industry?
With the Sustainable Finance Disclosure Regulation (SFDR) entering its first year of reporting requirements, and the Corporate Sustainability Reporting Directive (CSRD) set to be finalised this year, companies have been awaiting guidance about how to measure and report sustainability factors. The EU Taxonomy Regulation provides clarification and establishes a classification system to define environmentally sustainable activities. This is important both for companies subject to the SFDR and CSRD and for companies in the building industry supply chains.
The Taxonomy defines environmental sustainability according to an economic activity’s contribution to climate change and climate adaption using key performance indicators (KPI) for an extensive array of environmental factors. It defines an environmentally sustainable activity as one that:
- Contributes to one or more environmental objectives
- Does not significantly harm the environment or detract from environmental objectives
- Complies with environmental safeguards
- Complies with the Taxonomy’s technical criteria
Since the draft CSRD applies to small and medium size companies (SMEs) in “critical industries,” including construction, any company marketing building products will need to familiarise itself with the Taxonomy, to understand how its products align. Building renovations or new construction projects will also need to ensure they comply with the Taxonomy to attract financing from banks subject to the SFDR. The Taxonomy aims to align with the Energy Performance of Buildings Directive (EPBD), although the Taxonomy’s targets for ‘green’ renovations are much lower than the 60 percent energy savings that building efficiency advocates have recommended.
For example, the Taxonomy specifies that building renovations must meet the EPBD’s energy performance requirements for major renovations or achieve a primary energy demand reduction of 30 percent. To secure financing, the developer of a planned renovation would need to demonstrate it can meet the EPBD or Taxonomy requirement, since investors need to ensure their investment portfolios are SFDR (and Taxonomy) compliant. Similarly, an insulation supplier could market its products to builders by demonstrating that they align with the Taxonomy’s criteria for “climate mitigation,” and would also want to verify that its products can meet the EPBD thermal performance requirements. Once the revised EPBD is published, the Taxonomy will likely be updated to align with more stringent energy efficiency requirements.
The Taxonomy applies to the SFDR and will likely apply to the CSRD as well. For example, beginning in January 2023, a Bucharest-based investment firm would follow the Taxonomy to evaluate and report the environmental KPIs of its EU and non-EU real estate projects, in order to comply with the SFDR. Once the CSRD is finalized, a building materials supplier would need to assess and report the environmental KPIs for its entire global supply chain, according to the Taxonomy. In addition to EU based financial institutions that need to comply with the SFDR, supranational banks like the European Investment Bank (EIB), will also be integrating the Taxonomy criteria into their investment decisions. Real estate developers in the EU and in CEE candidate states will need to demonstrate that their projects’ environmental performance aligns with the Taxonomy, in order to attract financing from EU investors.
The Taxonomy is in the process of being developed and refined. In April, the Commission released detailed technical specifications for how companies subject to the SFDR must measure and report sustainability factors. The specifications include, for example, formulas for calculating carbon dioxide emissions per unit of fuel consumed and for calculating “inefficient real estate assets.” They also introduce indicators for assessing a variety of social impacts, including human rights and corruption, and corporate governance factors. Updated social indicators will likely be released later in 2022.
The new sustainability specifications should provide a robust framework for the pending CSRD implementation. In late February, the European Commission also released its proposal for a Directive on corporate sustainability and due diligence, which is intended to complement the CSRD and the SFDR. The Due Diligence Directive would focus on supply chain disclosure requirements for large companies and would likely align with the Taxonomy specifications. The European Parliament is reviewing the Commission’s proposal but has not announced when it may release a draft Directive.
Considering the controversy over the Taxonomy’s classification of natural gas as a more “sustainable” fuel source, and the EU’s planned decoupling from Russian sources, the Commission could make significant Taxonomy changes this year. Real estate companies and construction suppliers can prepare now for the expected updates, and CEE financial institutions that are already evaluating environmental factors can help developers assess their projects for Taxonomy alignment.
As the Commission implements plans to reduce and potentially eliminate Russian petroleum imports, led by CEE governments, improved energy efficiency in every sector will be increasingly critical. The EPBD and complementary financing and corporate accountability policies will be central to achieving EU climate impact and energy independence priorities, particularly in the CEE region.
About the author:
Lisa A. Chase has researched and written extensively on sustainable development and design for Harvard Graduate School of Design, Harvard University’s Real Estate Academic Initiative and Harvard Business School. She has co-authored publications on social entrepreneurship and corporate social responsibility in Stanford Social Innovation Review, Harvard Business Review and Harvard Business School Working Knowledge. Lisa has presented to academic and industry audiences, including Yale University, Fordham University, C4E Forum, VSE CEE Conference and SEE SDEWES Conference on policy and financing mechanisms for environmental and climate solutions. She holds a Master of Laws in European Union Law from King’s College London, where she researched the convergence of EU energy efficiency and corporate accountability policies. Lisa‘s consultancy, Lucky Fish Communications, specializes in policy analysis and content development for urban design and the built environment.