EU TAXONOMY: ESG Disclosure Obligations For Large Companies

In recent years, public and private organizations have had difficulty comprehending sustainability in a practical sense. This challenge, shrouded in ambiguity, has had significant implications on the ESG compliance of these organizations. This is mostly due to the lack of a standard framework that clearly defines the term by which a company can declare itself to be sustainable. The EU taxonomy regulation addresses this issue extensively by establishing a concise framework for classifying the economic activity of entities under the jurisdiction of the European Union.

“Many have signed up to be net-zero by 2030, 2040, or 2050. We need a structured way to get there. The taxonomy offers a science-based structure,” says Andreas Johansson, Head of the Quantitative Equity Team, SEB Investment Management.

The EU taxonomy regulation establishes a comprehensive framework for the concept of sustainability, precisely specifying whether a corporation or enterprise is operating sustainably or ecologically friendly. When compared to their competitors, these companies stand out favorably and should benefit from more investment. The regulation intends to reward and promote environmentally friendly business practices and technologies.

A framework for economic sustainability. 

The EU taxonomy regulation took effect in June 2020 after the endorsement of the European Parliament. However, the preparatory work started two years earlier in 2018 with the creation of the Technical Expert Group, tasked with the creation of screening criteria for which economic activities can be classified as environmentally sustainable. The TEG released a final report in March 2020 that contained recommendations that would eventually influence the creation of taxonomy regulations. This report also came with a technical guide on how to properly assess the significant contributions of economic activities to climate change mitigation. These recommendations created the six EU environmental objectives, which are the basis of the taxonomy regulation.

The passing of the Green New Deal in 2019, which includes an investment plan of 1 trillion euros over the next ten years, has caused the European Union to set a course for more sustainable investment. Without the existence of the taxonomy regulation, there will be great difficulty in deciding which companies and enterprises are environmentally sustainable, particularly in areas such as renewable energy, circular economy, and so on. 

The EU taxonomy can be used as a tool to aid investors and businesses in navigating the transition to a low-carbon, resource-efficient economy, which is a very important objective that can be attained. The taxonomy establishes performance thresholds, or “technical screening criteria,” for what constitutes sustainable economic activity. These criteria are:

  • Make a substantive contribution to one of six environmental objectives;
  • Do no significant harm (DNSH) to the other five, where relevant; and
  • Meet minimum safeguards (e.g. OECD Guidelines on Multinational Enterprises and the UN Guiding Principles on Business and Human Rights).

The purpose of the EU Taxonomy regulation. 

The implementation of the EU taxonomy regulation is available for companies and investors who desire to have a positive environmental impact, providing achievable and consistent objectives which provide a common consensus on what environmentally sustainable economic activities are using this as an adaptable framework. This framework also creates a baseline and legal benchmark for equal competition for all organizations operating in the European Union, with the aim of:

  • Redirecting capital flows with a focus on sustainable investments
  • Promoting long-term investment and socio-economic activities
  • Establishing sustainability as a component of risk management.

A closer look at the Six environmental objectives

The adoption and compliance with ESG standards of both small and large organizations were hampered by the lack of a clear definition of what constitutes a sustainable and environmentally friendly economic activity. Businesses could well engage in greenwashing and other related climate crimes. Six environmental goals are established by the EU taxonomy regulation. These goals help to clarify the idea of sustainability by clearly defining when an organization is acting in the environment’s best interests. As earlier mentioned, there are six objectives :

  • Climate change mitigation

Climate change mitigation efforts are geared towards significantly reducing economic actions that have negative environmental consequences. Mitigation strategies are focused on the reduction of greenhouse gas emissions, holding the increase in the global average temperature to well below 2 °C and pursuing efforts to limit it to 1.5 °C above pre-industrial levels, utilizing new and renewable energy sources while finding ways to optimize existing processes to become more energy efficient and climate-friendly. 

Mitigation measures in the context of the EU Taxonomy regulation mean net-zero emissions by 2050 and a 50–55% reduction by 2030, consistent with the commitments under the EU Green Deal. To reach these goals, sectors already at near-zero carbon levels must be expanded, and heavily emitting sectors must rapidly decarbonize. For an economic activity to be considered as substantially contributing to climate change mitigation, it must demonstrate consistency with medium and long-term climate goals. Certain organizations are championing the climate change mitigation course. An example is Microsoft, which released a detailed approach to its mission to become carbon negative by 2030. Nike has also made similar steps with the “Move to Zero” campaign, which documents its efforts toward zero emissions and the adoption of renewable energy by 2025. 

  • Climate change adaptation

Reduced carbon emissions are only the first step in the right direction; climate change adaptation is critical in organizations’ and governments’ preparedness for current and anticipated climate situations such as rising seas, higher temperatures, worsening droughts, and the impact climate change can have on the planet and our socioeconomic development. Adaptation measures are dynamic and dependent on a variety of local factors; as such, it is critical to have a clear understanding of local risks, which serves as the foundation for adaptation strategies. 

Climate change adaptation strategies are dynamic and dependent on a variety of local risk factors. For example, in 2018, an adaptation preparedness scoreboard was published, which evaluated 28 countries on how best to adapt to climate change situations. In February 2021, the European Union released its new EU climate adaptation strategy, which outlined the best possible adaptation processes for countries under its jurisdiction. Companies are also pivoting to climate adaptation strategies, Volkswagen is investing a total of 35 billion euros in electronic mobility (vehicles) as a potential replacement for petroleum-powered vehicles by 2025. This is an adaptation strategy that aims to acclimatize consumers to rely less on fossil fuels. 

  • The sustainable use and protection of water and marine resources

The oceans, seas, and coastal regions are an integral part of the planet’s ecosystem and should be treated as such. The EU taxonomy regulations stipulate that an economic activity by an organization is considered sustainable where that activity either contributes substantially to positively impacting bodies of water, including bodies of surface water and groundwater, or to preventing the deterioration of bodies of water. Sustainable measures for the protection of water bodies and marine resources involve protection from urban and industrial waste, improving water management and efficiency, protecting and enhancing the status of marine ecosystems and long-term protection of available water resources. Several companies are taking steps to take sustainable measures towards water and marine resources. Maersk is already taking steps in the right direction by extending and expanding its partnership with The Ocean Cleanup, which aims to get rid of 90% of floating ocean plastic by 2040. PepsiCo announced in 2021 its “Net Water Positive” commitment, which is geared towards reducing and replenishing its water sources.

  • The transition to a circular economy

Circular economy here refers to an economic system where the value of products and other resources is maintained for as long as possible, enhancing their efficiency and usage in production and consumption, hence reducing the environmental impact of their utility, significantly reducing waste and the release of environmentally unfriendly substances at all stages of their life cycle. The EU taxonomy regulations highlight that a transition to such an economy emphasizes waste management and reductions, recycling, and reuse of these products and materials. A great deal of attention is paid to the creation of products and services with longevity, durability, repurposing, and future upgrades where applicable. This transition begins at the manufacturing stage, with these concepts of how well a product will thrive in a circular economy taking a central role in the creative process. One of the firms at the forefront of transitioning to a circular economy is Coca-Cola, which has worked towards redesigning packaging to contain at least 50% recyclable material, among other innovations and partnerships. Nestle, in 2020 invested $30 million in moving towards a circular economy

  • Pollution prevention and control

According to the EU taxonomy regulations, an organization can qualify as contributing notably to pollution prevention and control by reducing and preventing entirely, where possible, the emission of pollutants into the air, land, or water. In this case, pollutants are not inclusive of greenhouse gases. The improvement of air, soil, and water quality in areas of these economic activities, while actively preventing and minimizing any harmful impact on human health and the environment with the disposal of pollutants. This requires strict monitoring and pollutant disposal procedures to ensure that they pose no threats to people or any environmental ecosystem. One of the many companies taking an innovative response to pollution is IKEA. By converting burnt crops, which cause a great deal of air pollution, into renewable energy. 

  • The protection and restoration of biodiversity and ecosystems

An economic activity which contributes to the conservation and restoration of natural ecosystems is considered sustainable by the EU taxonomy regulation. The protection of these terrestrial and aquatic ecosystems with the aim of improving their state and increasing their capacity to develop even more  plays a crucial role in the long-term sustainability of these ecoregions. Other implementation practices focus on sustainable forest management, the prevention of any further degradation to forest ecosystems with actions such as deforestation, habitat loss, which may have a significant negative effect on its biodiversity. Hewlett-Packard, a leading American manufacturer of software and computer services, is partnered with the World Wildlife Fund for forest protection, restoration, and management. This is but one of the many firms showing an example of how an organization can comply with the EU taxonomy regulations and have a genuine positive impact. 

Bottom Line.

Since the introduction of the ESG concept, large organizations have had difficulty implementing it. As a result, even when some organizations made an effort to comply, they may have unintentionally engaged in greenwashing at times. However, the EU taxonomy regulation has established a middle ground between ESG concepts, organizations, and investors. As was previously stated, a company or economic activity is only deemed sustainable if it significantly advances one of the six goals while not impairing the other five state environmental goals.

Organizations can clearly understand what is expected of them with this in mind. ESG-focused investors have a framework for evaluating a potential investment’s sustainability. With the help of this framework, investors can carry out due diligence on their existing and prospective investment holdings, find opportunities for sustainable investments, develop green financial products, and assess the sustainability impact of their investments.