As the EU brings in new regulations and reporting regimes, it’s now more important than ever for companies to make sure they are EU taxonomy aligned businesses. 2021 was a record year for sustainable finance: in 11 months to the end of November, investors had already directed over US $285bn into ESG funds. Moreover, global sustainable bond insurance more than doubled compared to 2020, according to a leading European bank. The momentum has continued into 2022, because investors are keen to hold onto their ESG debt, and corporates see that ESG issues affect their business and investment risk.
What Does The Future Hold For EU Taxonomy Aligned Businesses?
There are some key themes that businesses need to watch out for going forward, as being an EU taxonomy aligned business is now crucial. Net zero is here to stay. Last year companies’ net zero pledges sharply increased, as the UN Environment Programme requires them to put these commitments into action, in addition to their obligations under the EU Taxonomy.
Furthermore, the coming months will bring new developments in the wake of the EU’s plans to publish the technical criteria for the remaining targets of its taxonomy. These are: sustainable use and protection of water and marine resources; the transition to a circular economy; pollution prevention and control; the protection and restoration of biodiversity and ecosystems. Following these proposals, in order to be an EU taxonomy aligned business, several criteria will need to be met.
Firstly, we can expect the focus of regulators to shift from defining a list of socially sustainable activities (Social Taxonomy) and a classification system for transition paths of companies operating in traditionally brown sectors (Transition Taxonomy). Both will provide guidance on how to be an EU taxonomy aligned business, and how to manage the transition of existing business models.
Secondly, banks’ ESG performances are increasingly under the spotlight. In 2022, the ECB and the Bank of England will review their practices of ESG risk management and conduct climate stress tests, which could have implications for bank capital requirements. It is expected that other regulators will try to catch up. Thirdly, the EU Green Bond Standard is set to be adopted in 2022, which is intended to serve as a ‘gold standard’ for green bonds. Standardisation of green bonds already exists, although its international application is an unresolved issue. These regulations will nonetheless affect capital and lone markets this year, and EU taxonomy aligned businesses will need to closely watch which bonds they invest in.
The Future of Sustainability Reporting
Sustainability reporting is set to move from the discussion stage into implementation. In Europe, companies need to keep a watchful eye on new developments regarding the Corporate Sustainability Reporting Directive (CSRD). The new directive will require companies with more than 250 employees to disclose data on their sustainability performance, in order to meet their obligations as EU taxonomy aligned businesses. Although this rule doesn’t officially come into force until 2024 for the 2023 financial year, a first set of sustainability reporting standards is expected to appear in mid-2022. It is also likely that other jurisdictions will extend their ESG reporting.
ESG impact in supply chains are particularly important in the transition to a net zero economy. The requirements of an EU taxonomy aligned business includes an obligation to track Scope 3 emissions and decarbonise their supply chains. This is especially the case for value chains of global retailers and original equipment manufacturers. Companies are being pushed to seek green materials, such as green steel or aluminium. Social and governance factors will also come into the spotlight. The EU is still working on a due diligence law, which aims to improve the ESG performance across value chains.
While EU taxonomy aligned businesses will need to pay close attention to all the regulatory initiatives, the macroeconomic environment could be the biggest challenge in moving the ESG transition forwards this year. This is due to the fact that companies will likely have to contend with inflated prices for energy, carbon and commodities over a longer period of time than was first envisaged. It seems that higher energy prices are here to stay for the moment. When paired with the increasing demand to invest in decarbonisation technology, the two are said to be creating a ‘greenflation’ trend.