The EU Taxonomy in the maritime transport industry
In the maritime sector, several measures are needed in order to reduce emissions to the extent necessary, and the EU Commission approach this challenge by presenting a basket of measures, one of them being the EU Taxonomy. By setting harmonised criteria for determining whether an economic activity qualifies as environmentally sustainable, it is intended to incentivise the greening of the sector.
According to the Taxonomy, an economic activity must meet three overarching requirements to qualify as environmentally sustainable;
- substantially contribute to at least one of the environmental objectives
- do no significant harm to the other objectives; and
- meet the requirement to comply with certain minimum social safeguards
It is not a requirement for businesses to be taxonomy-aligned, and investors will continue to be free to choose the companies they invest in. However, investors and lenders are increasingly relying on the EU Taxonomy when assessing whether an investment is in fact environmentally sustainable. The main objective of the EU Taxonomy is to redirect capital towards sustainable activities, and companies not meeting the Taxonomy requirements may face increasing difficulty in accessing new capital and financing.
Being classified as taxonomy-aligned is therefore expected to be increasingly important when attracting new capital or securing financing. The maritime industry is capital intensive, and large investments must be made if the industry shall transition towards climate neutrality. Access to competitive green financing and capital is key to develop the new technology and solutions necessary to transition the industry.
The requirements to the shipping industry
In April 2021, the European Commission established technical screening criteria applicable to, among other sectors, the maritime transport industry. The EU Commission has provided a list of environmentally sustainable activities relevant for the shipping industry in its technical screening criteria. The shipping activities which are considered to substantially contribute to the environmental objectives, and thus meeting the first overarching criteria, are divided into the following 6 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
- Retrofitting of sea and coastal freight and passenger water transport
Vessels dedicated to the transport of fossil fuels may never be considered to substantially contribute to the aforementioned environmental objectives.
Within these categories, a range of activities are considered to meet the “substantial contribution” criteria, including the purchase, financing, chartering, leasing and operation of vessels. The relevant activities vary somewhat depending on which of the above mentioned categories are applicable.
The EU Taxonomy distinguishes between economic activities where CO2 emissions are very low, “low-carbon activities”, and “transition activities”, in which the emissions are significantly lower than that of the industry average. The latter is the relevant alternative for the majority of the shipping activities, as there are few low carbon solutions applicable for the maritime industry.
For shipping in general, zero direct tailpipe CO2 emissions is a requirement in the technical criteria for substantially contribution to climate mitigation. A buffer period will apply until 2025 to allow a certain amount of direct emissions, depending on what the vessel is used for. Generally speaking, vessels will meet the criteria if they derive a minimum of 25 % of its energy from zero direct emission fuels. However, there are very few such fuels available.
Extended Environmental Taxonomy
Another challenge is that the EU Taxonomy does not define how activities that do not meet the criteria, should be treated. A company may be making large investments and important progress towards being climate neutral, without being classified as taxonomy-aligned. However, access to finance through non-green activities may be important for a successful transition.
The current system in the “green” taxonomy does not distinguish between activities that harm the environment and activities that just narrowly fail the sustainability test. Moreover, low-impact activities may collectively contribute to environmental goals.
To cater for this, on March 29, 2022, the European “Platform on Sustainable Finance” expert group published its report on a future “Extended Environmental Taxonomy”. The report considers the EU Taxonomy’s overall binary (“green”/“non-green”) approach to be insufficiently differentiated. The report therefore considers whether and how to extend the EU Taxonomy to also cover activities that have a mixed impact on environmental sustainability (“amber”), and activities that – to the opposite extreme – have a significantly detrimental impact on the environment (“red”).
The Platform recommends introducing new categories into the EU Taxonomy and graduating its approach, so as to cover potentially the entire economy. To facilitate the understanding of this new structure, the Report recommends using a traffic light colour scheme:
- Red – Substantial environmental harm (must decommission) / Substantial environmental harm (may transition)
- Yellow – Intermediate performance
- Green – Substantial contribution to environmental sustainability
- White – Low environmental impact activities
The Report specifically mentions shipping as a sector identified for transition finance. Reaching the “green” taxonomy level is considered especially hard for the shipping industry, as the decarbonisation challenge is extremely complex and hinging on an collaborative approach from governments, investors and banks. An extended taxonomy could therefore prove very beneficial for the shipping industry.
The need to finance transition activities in the shipping sector has already been picked up by some investors and financial institutions. For example, as elaborated upon in the Transition Linked Finance article in this newsletter, Transition-Linked Financing Guidelines were developed by KLP and other Nordic financial institutions earlier this year. The Guidelines set out specific targets and indicators for borrowers within the shipping industry, encouraging further alignment with the EU Taxonomy even if they are not currently taxonomy-aligned. With an Extended Taxonomy, investment in transition activities at the “amber” and “red” level would be incentivised and recognised also by the EU Taxonomy system.