Shipping | EU Taxonomy – Classification system for sustainable economic activities – approval by the European Commission on 21 April 2021

On 21 April 2021 the European Commission approved in principle the first two set of technical screening criteria (climate change mitigation and adaption) determining which economic activities can qualify as environmentally sustainable under the EU Taxonomy.

Amendments and specifications have been made to the screening criteria for maritime transport compared to the consultation draft published on 20 November 2020 (described in our newsletter of 21 January 2021). This newsletter contains an update on the final approved screening criteria for maritime transport.

EU Taxonomy – Overview

The EU Taxonomy is a classification system for sustainable economic activities with a current focus on climate change mitigation and climate change adaption. The classification system will be used to determine when an economic activity is “environmentally sustainable” and, as a result, when an investment is environmentally sustainable.

The classification system will make it easier to consider and compare the climate and environmental impact of companies – and assist companies and investors in determining which economic activities can be considered environmentally sustainable.

It has in particular been highlighted by EU that the classification system is expected to create security for investors, protect private investors from greenwashing, help companies to plan transition, mitigate market fragmentation and eventually help shift investments where they are most needed.

EU Taxonomy Regulation

Subject and Scope

The Taxonomy Regulation entered into force on 12 July 2020.

The Taxonomy Regulation and classification system can be used by any relevant market participant. The Taxonomy Regulation includes however mandatory disclosure obligations for (i) financial market participants and (ii) undertakings subject to the non-financial reporting directive.

Financial market participants that offer financial products which have environmental sustainability as its investment objective, or that promote environmental characteristics, must disclose the proportion of underlying investments that are in environmentally sustainable economic activities as defined under the Taxonomy Regulation (Articles 5 and 6). The disclosures must be made in pre-contractual disclosures and in periodic reports.

Undertakings subject to the non-financial reporting directive must, as part of the non-financial statement, include disclosure of the proportion of turnover, capex and opex that are related to environmentally sustainable economic activities (Article 8).

The Taxonomy Regulation is of relevance for the EEA, but has not yet been included as part of the EEA Agreement. A proposal for legislation incorporating the Taxonomy Regulation has however been developed in Norway, and circulated for comments.

Environmentally Sustainable Economic Activities

Article 3 of the Taxonomy Regulation sets out four overarching criteria for environmentally sustainable economic activities. For the purposes of establishing the degree to which an investment is environmentally sustainable, an economic activity shall qualify as environmentally sustainable where that economic activity:

• Contributes substantially to one or more of the environmental objectives (set out in Article 9 in accordance with Articles 10 to 16);
• Does not significantly harm any of the environmental objectives (set out in Article 9 in accordance with Article 17);
• Is carried out in compliance with the minimum safeguards (laid down in Article 18); and
• Complies with technical screening criteria that have been established by the Commission (in accordance with Article 10(3), 11(3), 12(2), 13(2), 14(2) or 15(2)).

The six environmental objectives established by the Taxonomy Regulation Article 9 are:

• Climate change mitigation;
• Climate change adaptation;
• The sustainable use and protection of water and marine resources;
• The transition to a circular economy;
• Pollution prevention and control; and
• The protection and restoration of biodiversity and ecosystems.

Whether an activity (i) contributes substantially to one or more objectives and (ii) does not significantly harm any of the other environmental objectives, will be regulated by the technical screening criteria.

Technical Screening Criteria – Overview

The European Commission shall establish technical screening criteria for each of the environmental objectives. On 20 November 2020 the European Commission launched a public consultation on the first two sets of criteria determining which economic activities can qualify as environmentally sustainable under the EU Taxonomy. The activities and criteria were based on the recommendations of the Technical Expert Group on Sustainable Finance (TEG) published in March 2020.

On 21 April 2021 the European Commission approved in principle the first two set of screening criteria (climate change mitigation and adaption) determining which economic activities can qualify as environmentally sustainable under the EU Taxonomy. The formal adoption in all official languages of the European Union will take place as soon as all the language versions are available in May 2021.

The first two set of screening criteria concerns those activities that substantially contribute to (i) climate change mitigation (Article 1 and Annex 1) or (ii) climate change adaptation (Article 2 and Annex 2).

Reporting obligations for the first two criteria (climate change mitigation and adaption) will be effective from 1 January 2022, covering the financial year 2021, while reporting obligations for the other four criteria will be effective from 1 January 2023, covering the financial year 2022.

The technical screening criteria covers the following 13 sectors:

• Forestry
• Environmental protection and restoration activities
• Manufacturing
• Energy
• Water supply, sewerage, waste management and remediation activities
• Transport (including maritime transport)
• Construction and real estate
• Information and communication
• Professional, scientific and technical activities
• Financial and insurance activities
• Education
• Human health and social work activities
• Arts, entertainment and recreation

Technical Screening Criteria – Maritime Transport

Maritime transport is covered by the technical screening criteria and has been divided into the following categories:

• Inland passenger water transport;
• Inland freight water transport;
• Retrofitting of inland water passenger and freight transport;
• Sea and coastal freight water transport, vessels for port operations and auxiliary activities;
• Sea and coastal passenger water transport; and
• Retrofitting of sea and coastal freight and passenger water transport.

Screening criteria are set out in Annex 1 (climate change mitigation) and Annex 2 (climate change adaption) for each of the above categories of maritime transport.

The screening criteria are comprehensive and contain several details in terms of maritime transport.

It is worth noting in particular:

Activities:

The activities cover:

• Inland passenger water transport and sea and coastal freight: purchase, financing, leasing, rental and operation of passenger vessels.
• Sea and coastal freight, vessels for port operations and auxiliary activities: purchase, financing, chartering (with or without crew) and operation of vessels designed and equipped for transport of freight or for the combined transport of freight and passengers on sea or coastal waters, whether scheduled or not. Purchase, financing, renting and operation of vessels required for port operations and auxiliary activities, such as tugboats, mooring vessels, pilot vessels, salvage vessels and ice-breakers.
• Sea and coastal passenger water transport: Purchase, financing, chartering (with or without crew) and operation of vessels designed and equipped for performing passenger transport, on sea or coastal waters, whether scheduled or not. The economic activities in this category include operation of ferries, water taxies and excursions, cruise or sightseeing boats.

Transport of Fossil Fuels:

There is a requirement in both Annex 1 (climate change mitigation) and Annex 2 (climate change adaption) that vessels used for inland as well as sea and coastal freight water transport are not dedicated to the transport of fossil fuels.

CO2 Emissions:

There is – as a starting point – a requirement in the criteria, applicable to all maritime transport activities, that the vessels have zero direct (tailpipe) CO2 emission.

The following exemptions will however apply to this requirement:

• Vessels used for passenger water transport and freight water transport: Vessels that do not have zero direct (tailpipe) CO2 emission may still qualify if the activity is a transitional activity as referred to in Article 10(2) of the taxonomy regulation, provided it complies with the remaining technical screening criteria set out for the relevant category of maritime transport. Pursuant to Article 10(2) of the taxonomy regulation, an economic activity for which there is no technologically and economically feasible low-carbon alternative shall qualify as contributing substantially to climate change mitigation where the activity supports the transition to a climate-neutral economy consistent with a pathway to limit the temperature increase to 1,5 degree celsius above pre-industrial levels, including by phasing out greenhouse gas emissions, in particular emissions from solid fossil fuels, and where that activity: (a) has greenhouse gas emission levels that correspond to the best performance in the sector or industry; (b) does not hamper the development and deployment of low-carbon alternatives; and (c) does not lead to a lock-in of carbon-intensive assets, considering the economic lifetime of those assets.
• Vessels used for passenger water transport will qualify (i) until 31 December 2025 for hybrid and dual fuel vessels that derive at least 50% of their energy from zero direct (tailpipe) CO2 emission fuels or plug-in power for their normal operation (inland), (ii) where technologically and economically not feasible to comply with the criterion of zero direct (tailpipe) CO2 emission, until 31 December 2025 for hybrid and dual fuel vessels that derive at least 25% of their energy from zero direct (tailpipe) CO2 emission fuels or plug-in power for their normal operation at sea and in ports (sea and coastal), or (iii) where technologically and economically not feasible to comply with the criterion of zero direct (tailpipe) CO2 emission, until 31 December 2025, where the vessels have an attained Energy Efficiency Design Index (EEDI) value of 10% below the EEDI requirements applicable on 1 April 2022, if the vessels are able to run on zero direct (tailpipe) emission fuels or on fuels from renewable sources (sea and coastal).
• Vessels used for inland freight water transport will qualify until 31 December 2025 where it is not technologically and economically feasible to comply with the criterion of zero direct (tailpipe) CO2 emission and the vessels have direct (tailpipe) emissions of CO2 per tonne kilometre, calculated (or estimated in case of new vessels) using the Energy Efficiency Operational Indicator, of 50% lower than the average reference value for emissions of CO2 defined for heavy duty vehicles in the regulation.
• Vessels used for sea and coastal freight water transport will qualify (i) until 31 December 2025 for hybrid and dual fuel vessels that derive at least 25 % of their energy from zero direct (tailpipe) CO2 emission fuels or plug-in power for their normal operation at sea and in ports, (ii) where technologically and economically not feasible to comply with the criterion of zero direct (tailpipe) CO2 emission, until 31 December 2025 where it can be proved that the vessels are used exclusively for operating coastal and short sea services designed to enable modal shift of freight currently transported by land to sea, the vessels have direct (tailpipe) CO2 emissions, calculated using the International Maritime Organization (IMO) Energy Efficiency Design Index (EEDI) of 50 % lower than the average reference CO2 emissions value defined for heavy duty vehicles in the regulation or (iii) where technologically and economically not feasible to comply with the criterion of zero direct (tailpipe) CO2 emission, until 31 December 2025 where the vessels have an attained Energy Efficiency Design Index (EEDI) value of 10 % below the EEDI requirements applicable on 1 April 2022 if the vessels are able to run on zero direct (tailpipe) CO2 emission fuels or on fuels from renewable sources.

Climate change adaptation

For both passenger water transport as well as sea and coastal freight water transport the following criteria must be fulfilled in order for the activity to be considered as contributing substantially to – and not significantly harm – climate change adaption:

• The economic activity has implemented physical and non-physical solutions (‘adaptation solutions’) that substantially reduce the most important physical climate risks that are material to that activity;
• The physical climate risks that are material to the activity have been identified from those listed in Appendix A to Annex 2 by performing a robust climate risk and vulnerability assessment with the following steps:

(i) screening of the activity to identify which physical climate risks from the list in the appendix that may affect the performance of the economic activity during its expected lifetime;

(ii) where the activity is assessed to be at risk from one or more of the physical climate risks listed in the appendix, a climate risk and vulnerability assessment to assess the materiality of the physical climate risks on the economic activity; and

(iii) an assessment of adaptation solutions that can reduce the identified physical climate risk.

The climate risk and vulnerability assessment must be proportionate to the scale of the activity and its expected lifespan, such that:

(i) for activities with an expected lifespan of less than 10 years, the assessment shall be performed, at least by using climate projections at the smallest appropriate scale; and

(ii) for all other activities, the assessment shall be performed using the highest available resolution, state-of-the-art climate projections across the existing range of future scenarios consistent with the expected lifetime of the activity, including, at least, 10 to 30 year climate projections scenarios for major investments.

• The climate projections and assessment of impacts are based on best practice and available guidance and take into account the state-of-the-art science for vulnerability and risk analysis and related methodologies in line with the most recent Intergovernmental Panel on Climate Change reports, scientific peer-reviewed publications and open source or paying models.
• The adaptation solutions implemented:

(i) do not adversely affect the adaptation efforts or the level of resilience to physical climate risks of other people, of nature, of cultural heritage, of assets and of other economic activities;

(ii) favor nature-based solutions or rely on blue or green infrastructure to the extent possible;

(iii) are consistent with local, sectoral, regional or national adaptation plans and strategies;

(iv) are monitored and measured against pre-defined indicators and remedial action is considered where those indicators are not met; and

(v) the solution implemented is physical and consists in an activity for which technical screening criteria have been specified in the annex, the solution complies with the do no significant harm technical screening criteria for that activity.

The referenced Appendix A to Annex 2 covers classification of climate-related hazards, mainly: (i) temperature-related, (ii) wind-related, (iii) water-related and (iv) solid mass-related, with several sub-categories.

Other Requirements

There are also specific requirements as to inter alia sulphur oxides emissions, nitrogen oxides (NOx) emissions, ballast water, noise and vibrations.

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Access to “green” capital is important for all participants in the maritime industry in order to realize a green transition and continue the technological developments towards a climate neutral fleet. The comprehensive requirements to maritime transport set out in the technical screening criteria may result in more limited access to green capital, and can make the green transition more difficult for the sector. It is important that the relevant players in the maritime industry have sufficient incentives and opportunities to continue the technological developments and green transition. This was also noted by the Norwegian Government in its feedback to the consultation draft.

It was highlighted by the European Commission in the delegated act that it will be necessary to further assess maritime shipping and, where appropriate, establish technical screening criteria for maritime shipping applicable as of 2026 with reference to the status of zero emission vessels.

BAHR’s View and Key Takeaways

There is an increasing focus on the environmental footprint of companies, projects and investments. We expect the EU Taxonomy Regulation and technical screening criteria to be relevant for several market participants as a common ground for determining environmentally sustainable economic activities and investments.

One of the objectives of the Sustainable Finance Action Plan initiated by the EU is to facilitate a major re-allocation in capital towards sustainable investments. The EU Taxonomy Regulation is the building block, determining which investments are sustainable and which are not sustainable. Alignment with the technical screening criteria may represent a potential opportunity for companies with activities recognized as “green” in terms of access to capital and cost of capital.

Companies should in particular:

• Evaluate whether the Taxonomy Regulation will be mandatory to the company – alternatively whether the Taxonomy Regulation is otherwise of relevance to it.
• Consider the effects the Taxonomy Regulation is expected to have on its business – including access to equity and financing.
• Identify any disclosure and data requirements and establish reporting procedures where relevant.
• Assess any organizational and financial impact on company and group level.
• Be aware the content of the Taxonomy Regulation and relevant effective dates.

Further details can be found here.

Do not hesitate to contact any of BAHR’s shipping or regulatory team members for further information.