1. What exactly is the EU taxonomy?

Generally speaking, a taxonomy always refers to a scheme of classification. So, the EU Taxonomy is a classification system for economic activities performed by a company. It aims at identifying the degree to which these activities are sustainable – measured in financial terms, e.g. as share in revenues, capital expenditures and operational expenditures. 
The EU taxonomy is based on one regulation (the EU Taxonomy Regulation, 2020/852/EU) and on various delegated acts and further guidelines which specify this classification system. These documents contain extensive checklists, “technical screening criteria”, for six defined environmental objectives and on economic activities that might contribute to these objectives.
Any economic activity which is documented on one of these checklists for any environmental objective is called taxonomy eligible. This means that it is possible that such an activity is sustainable. E.g. building a house can be sustainable, building a coal power plant cannot. Thus, this analysis has strategic implications about entire business models.
To assess whether such a taxonomy-eligible economic activity actually is sustainable, concrete criteria that are specified in those checklists must be analysed. Firstly, the economic activity must be performed in a clearly defined way: this is called a “significant contribution” to an environmental objective. Secondly, the economic activity must not impact any other environmental objective in a negative way: the “do no significant harm” (DNSH) criterion. Lastly, also certain social standards must be met: the “minimum safeguard” criterion. If an economic activity passes these three tests, it is called taxonomy compliant – and being taxonomy compliant means being sustainable as defined by the EU taxonomy. This has considerable operational implications as well (e.g. on how to conduct specific economic activities).
There are, of course, several restrictions: First of all, currently the EU taxonomy is a “green taxonomy” – that means that only environmental objectives are considered. This is because achieving these environmental objectives – especially climate change mitigation and adaptation – are considered to be the most urgent political and societal tasks at the moment. Being aligned with the EU taxonomy means in that regard that companies consider planetary boundaries and prevent harm to nature. Also, science provides a lot of guidance with regard to such objectives, which makes it easier to arrive at concrete matters that must be addressed via regulation.
Secondly, there are nevertheless different understandings of what “green” means. As the EU taxonomy is a political mechanism, we have to be aware of the fact that we talk about political objectives. The implication of this becomes evident when one considers the recent debates on whether or not nuclear  and gas energy should be part of the EU taxonomy and thus be considered sustainable. In the end, it was a political compromise that triggered protests which even questioned the legitimacy of the whole project of the EU taxonomy.
There are also plans to introduce a second EU taxonomy: a social taxonomy. However, these plans are subject to controversial debates. Historically, very different understandings exist in the EU about socially desirable outcomes of (economic) activities and thus political priorities. Consequently, it might be a better option to develop a different mechanism that does not aim at defining criteria for preventing any harm on a broader scale in social matters, but instead at achieving positive impacts only on a few selected matters. Still, it is unclear how the work on this second EU taxonomy is going to be continued.

2. Why is the EU taxonomy regulation necessary?

The work on the EU taxonomy was considered groundbreaking and has become an “export hit” all over the world. Many jurisdictions are also working on a similar taxonomy and in many cases have taken the EU taxonomy as a starting point.
The EU taxonomy was introduced by the Action Plan on “Financing Sustainable Growth” by the EU Commission in 2018. This Action Plan aimed at transforming the European economy in line with the Paris Agreement 2015 and the new priorities set forth by the SDG. It introduced ten regulatory measures which were based on the idea of sustainable finance – i.e. achieving change via (capital) market mechanisms. Sustainable companies should benefit from access to more and cheaper financing opportunities, i.e. capital flows should be redirected accordingly. This, of course, should have considerable impact on the behaviour of companies, on which economic activities are performed and which are not.
This idea requires, however, that there is a clear understanding of which companies – or to be more specific: which economic activities performed by these companies – are sustainable and thus should be supported. This is what the EU taxonomy aims at: to give  a clear understanding. Thus, it comes as no surprise that the EU taxonomy was the first of the ten regulatory measures included in the Action Plan from 2018. It is the centrepiece of most of the endeavours by the EU Commission with regard to transforming the European economy. What is more, other regulations, e.g. with regard to public subsidies, also consider the EU taxonomy and thus implement its mechanisms in public finance.

3. What are the initial experiences with the implementation of the EU taxonomy?

The initial experiences are ambivalent – at best. In June, the EU Commission published an assessment about the first years of applying the EU taxonomy. The findings were mainly positive: indeed, investors have started  to take the information based on the EU taxonomy into consideration – and companies reflect the increasing importance of this mechanism by shifting their investments towards activities that are covered by the EU taxonomy. So, we are slowly starting to see the desired regulatory impact of the entire mechanism.
On the other hand, most companies had a very hard time with applying the EU taxonomy in the first years of its relevance. Many criteria were incomplete or unclear, some concepts that were introduced are not adequately specified to this day. New delegated acts and FAQ documents were issued frequently, sometimes at very short notice, which had to be incorporated into reporting processes. Consultants with relevant expertise on the EU taxonomy were hard to find for support.
Finally, there is one main issue: a lack of data for companies regarding all the documentation required in order to assess whether or not their economic activities are taxonomy aligned. And especially for the financial sector – whose investments are, to a large extent, in companies that are not (yet) subject to the EU Taxonomy Regulation and thus do not provide any reports on it. But without data, the entire mechanism is bound to fail.

4. Is the EU taxonomy a good tool to avoid greenwashing in companies?

Introducing a mechanism that is based on clearly defined criteria for assessing the sustainability of companies is a major step towards avoiding greenwashing. The term “sustainability” itself is a very broad one; there are many different understandings about what is sustainable or not – some of these understandings might be based on scientific evidence, some on moral judgements, others more on self-interest of people or companies. With its extensive technical screening criteria and many other pronouncements, the EU taxonomy is a major leap forward to put an end to this “terminological jungle”.
At the same time, however, the EU taxonomy is not the ultimate source of truth about what sustainability really is – it is a political compromise. Recently, many NGOs stopped contributing to the work on the EU taxonomy because they considered that it has lost its ambitions and strayed away from any scientific basis. Instead, they have started working on a new “Independent Science-Based Taxonomy”.
Also, the work on the technical screening criteria depends on many contributions by company representatives – especially with regard to the necessary expertise about impacts and thresholds that have to be considered. At least in the past, these contributions were very limited. This is reflected in the quality of the technical screening criteria which must be employed now and that often lack consistency.
The EU taxonomy is not meant to be a comprehensive list of all sustainable economic activities – but just of high priority environmental activities that might have an immediate and high impact on its six environmental objectives. Consequently, however, many industries that still contribute a lot to environmental objectives are completely left out. This underlines another important conclusion: economic activities that are either not taxonomy eligible or not taxonomy aligned are not necessarily “unsustainable”.
Finally, there is a new problem emerging: it is sometimes referred to as “taxonomy washing”. Also, the technical screening criteria of the EU taxonomy are often open to interpretation. And in many cases, external verification is required or at least possible – while it is unclear who has the necessary competencies and the legitimacy to issue such verification. In fact, there have been media scandals in the recent past illustrating questionable certification practices by third parties which for sure did not contribute to the overall aims of the EU taxonomy. The EU taxonomy has become “big business” for many service providers, but in many cases, the substance behind such services cannot be seen clearly.