If it’s true that environmental, social, and governance aspects are becoming increasingly important for companies, consumers and investors, it’s also true that ESG data still lack proper disclosure and standardization.
In that light, European authorities worked to create an EU-wide classification system for sustainable activities. The result of those efforts has been the creation of the EU Taxonomy Regulation. A comprehensive transparency tool adopted by the European Parliament and Council in June 2020.
While the EU Taxonomy is undoubtedly a significant milestone toward a more sustainable market, now that it enters into effect, it also entails significant challenges and complexities for financial market participants (FMPs) and companies.
The objectives of the EU Taxonomy
As we have seen in an article that we published recently, the EU Taxonomy clearly defines six environmental objectives:
- 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;
- the preservation and restoration of biodiversity and ecosystems.
As a consequence, significant opportunities along with challenges for companies are emerging. This regulation introduces new transparency obligations and changes the legal responsibilities for all the market participants, further expanding what was already in place with the Sustainable Finance Disclosure Regulation (SFDR).
Not enough data or too much data?
It may seem a paradox, but both things are true.
There is too little data available and too much data to manage related to the ESG and the Taxonomy. Here we take a deeper look to understand the reasons.
The amount of data that companies need to report can be complex for investors to analyze. Companies need, for example, to disclose the percentage of turnover and their capital expenditure that are Taxonomy eligible.
While it’s good to have more transparency, it can become overwhelming as companies can slice and repurpose data in ways that are sometimes difficult to interpret.
Data scarcity is also an issue, as only certain companies are required to report under the new EU Taxonomy. In fact, at the moment, are just the European companies in the scope of the Non-Financial Reporting Directive (NFRD) and those with more than 500 employees that are obliged to report.
Even buying ESG data sets from third-party providers is more complex for SMEs as these companies are not subject to large data collectors.
“The regulators have done their best to be as objective as possible, but each step of this [assessment process] is highly subjective, […] And where there isn’t subjectivity, there’s often opacity at the corporate level […] That subjectivity in interpretation combined with estimation ends up with a lot of discrepancies.” said Alex Bernhardt, Global Head of Sustainability Research at BNP Paribas Asset Management, highlighting some of the most common concerns regarding the current state of things.
Data challenges for SMEs
While it’s easy to agree that there are issues in collecting and assessing data regarding small and medium enterprises, are we able to define what are the key issues? A good analysis of this is presented in a report about the implementation of the EU Taxonomy published by Avantage Reply, where six main problems have been identified:
1. Limited data availability due to uneven reporting or no reporting at all;
2. Poor quality data when annual reports are not available;
3. Mismatch with Taxonomy requirements or irrelevance of
reported data (for example, in cases when only gross revenue or limited balance sheet are available);
4. Low data granularity, when there’s no breakdown per activity;
5. Low data comparability and standardization, for example, when part of the activity reported is outside Europe;
6. Low quality of disclosure when annual reports have not been digitized.
AI: the solution to data challenges and compliance complexities?
With European banks’ considerable exposure to SMEs, data shortages for these companies represent a crucial challenge when applying the EU taxonomy.
It’s evident that significant efforts are required from all players to improve this framework further and reach the desired outcome to redirect capital flows towards sustainability.
However, technology, and in particular artificial intelligence, are of fundamental importance in finding a short-term solution to a highly complex Taxonomy. But also a long-term one, as regulation will keep evolving and companies need the proper support tools to stay compliant.
TAXO TOOL, the solution we created at Dydon AI, in partnership with Bundesverband Öffentlicher Banken Deutschlands (VÖB) and VÖB-Service, is aimed to solve these issues. A tool that has been created taking into consideration all the pain points of the different stakeholders.
What this tool does it’s pretty straightforward: it makes the whole process smoother and more manageable with the clever use of artificial intelligence that allows our clients to calculate missing information using a complex knowledge base for each economical activity mentioned in the EU Taxonomy. Book a free demo today to see with your eyes what the possibilities are.