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The Domino Effect of Sustainability – How does the EU Taxonomy Regulation affect society?
Research & Advisory / 16. November 2021
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Project Coordinator FIRE & SafeFBDC
Alexandra is currently working as a Project Coordinator at FS FIRE Center. Before joining FS, she worked on climate risk and ESG related topics in both the private and international development sectors.

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„But it’s unethical for companies to lie to consumers about the benefits of a product…“ I said, giving my Consumer Behaviour professor a sceptical look.

Paying no mind, he solemnly responds with “They can because no one is policing the claims.”

In the 2000s, as sustainability became more mainstream in the business community, pressure on businesses to consider the environment in their practices resulted in companies making false „green“ claims. Volkswagen, for example, used deceptive marketing to promote „clean diesel“ vehicles in 2015.

So, who was policing these false claims?

EU taxonomy regulation for sustainable activities

The European Commission introduced the Taxonomy Regulation in 2020 (as part of the EU Green Deal), a classification system that provides a uniform language on what constitutes green economic activities and serves as the foundation for promoting sustainable investments. It establishes definitions and rules to assist investors and businesses in transitioning to a low-carbon economy. It establishes a shared understanding of the EU’s climate and environmental goals, as well as the criteria for identifying green activities.

What does green mean?

Green activities substantially contribute to the six environmental objectives and don´t significantly harm the environment. The regulation also specifies four conditions that an economic activity must meet to be classified as „green“.

But what exactly qualifies as “substantial contributions”?  An activity must either have a positive environmental impact or reduce a negative impact. Hence, the Taxonomy is a tool intended to align economic activities with the European Green Deal and the Paris Climate Agreement.

What impact does the taxonomy regulation have on society?

Curbs greenwashing

Financial market participants will have to disclose information on green assets in their portfolios under the disclosure regulation. Issuers of financial products, who claim to be sustainable, are required to report on the proportion of their total income derived from green activities, and the proportion of expenditures associated with green activities. Regulators will require non-financial participants e.g., member states and large public corporations to disclose how their activities align with the environmental objectives.

Creates the first official sustainability benchmark

ESG disclosures have gained traction around the world, and the Taxonomy may have an impact on international reporting frameworks over time. As climate change and COVID-19 rage on, new regulations and increasing pressure to invest in sustainable activities make ESG disclosure valuable to investors.

Accelerates the flow of funds to green companies 

To meet the goals of the Green Deal, investors will need to direct funds toward sustainable activities, and the taxonomy is one tool for doing so. Directing private funds to “green” investments should reduce funding to “brown” firms, resulting in a fall in GHG emissions. This, however, has the potential to create a bubble. As money flows into certain green activities, asset prices may rise to unsustainable levels, reducing the intended effect.

Fosters development in science and innovation

The taxonomy may foster science and industrial growth, encouraging innovation in green technologies and rewarding green efforts; an opportunity for researchers and innovators to access sustainable financing for solutions that help accelerate decarbonisation.

Challenges the fate of brown investments

Currently, the taxonomy regulation seems to strictly categorise activities as either environmentally friendly or harmful with no room for compromise. As a result, regulators/participants may mistakenly consider activities that do not meet the four conditions as unsustainable, resulting in stranded assets. In such cases, a compromise would be required to reduce the risk of stranded assets by allowing businesses to adjust their strategies. However, it is unclear whether non-qualifying investments will be barred.

It is here to stay

The EU taxonomy regulation establishes a common reference for green activities, bringing us closer to a low-carbon Europe. We will probably see the emergence of more green taxonomies across the globe.

A longer version of the post can be found here.

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