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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 dubious look that matched my statement.

Paying no mind, he solemnly responds with “They can because nobody is policing the claims.”

As sustainability became mainstream in the business community in the 2000s, pressure on businesses to consider the environment in their practices resulted in companies making false “green” claims e.g., the case of Volkswagen in 2015, used deceptive marketing to promote “clean diesel” cars.

But, who was policing these claims?

The EU Taxonomy Regulation for sustainable activities

In 2020 (part of the EU Green Deal), the European Commission introduced the Taxonomy Regulation, a classification system that provides a uniform language on what constitutes green economic activities and serves as the basis for promoting sustainable investments. It sets out definitions and rules to help investors and companies transition to a low carbon economy—providing a common understanding of the EU’s climate and environmental objectives, and the criteria to identify green activities.

The definition of green

Green activities substantially contribution to the six environmental objectives and don´t significantly harm the environment. The regulation further sets out four conditions an economic activity must meet to qualify as green.

But what qualifies as “substantial contributions”?  An activity must either contribute 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.

The impact of the Regulation 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. Likewise, non-financial participants e.g., member states and large public corporations will also need to disclose how their activities align with the environmental objectives.

  • Creates the first official sustainability benchmark

ESG disclosures have gained traction globally and the Taxonomy may affect international reporting frameworks over time. New regulations and increasing pressure to invest in sustainable activities — as climate change and COVID-19 rage on — makes ESG disclosure valuable to investors.

  • Accelerates the flow of funds to green companies 

To meet the goals of the Green Deal, investors will have to direct funds towards sustainable activities and this taxonomy is one tool to achieve that. Directing private funds to “green” investments should reduce funding to “brown” firms, resulting in a fall in GHG emissions. However, this could create a bubble, as money flows into certain green activities, asset prices may rise to unsustainable levels, lowering 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 without a middle ground. Activities which don´t meet the four conditions may be mistakenly considered as unsustainable leading to stranded assets. A middle ground would reduce the risk of stranded assets, allowing for companies to adjust their strategies. However, it remains unclear whether investments that don’t qualify will be excluded.

It is here to stay

The EU taxonomy regulation provides a shared reference for green activities, ultimately steering 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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