Sustainable finance taxonomies represent a step change for the environment, business and human rights – developments that legal advisers to businesses need to be aware of.
The government’s recent appointment of a Green Technical Advisory Group to advise on the development and implementation of a ‘green taxonomy’ marks another milestone in the quiet revolution reorienting public and private capital flows to sustainable activities which is already well under way in other jurisdictions.
It has been widely recognised that the financial system has a vital role to play in meeting pressing global targets to rein in climate change and protect biodiversity. In seeking to accelerate a green transition by business, governments have been adopting a range of measures to direct capital to so-called sustainable economic activities.
Sustainable finance taxonomies are foundational to regulatory and policy approaches to this challenge. They provide the welcome step of a shared lexicon for governments, regulators, investors and others seeking to mobilise finance in support of environmental policy objectives through definitions which determine whether a given investment can be considered sustainable. It is significant that, as such approaches mature, a broad range of environmental, social and governance (ESG) elements are being included within their remit.
Under the EU’s Sustainable Finance Taxonomy Regulation, adopted in 2020, economic activities must substantially contribute to at least one of six environmental objectives to be classed as environmentally sustainable. Such activities must additionally do no significant harm to any of the other objectives and meet certain minimum social safeguards.
The first two objectives, climate change mitigation and adaptation, enter into force in January 2022, so businesses seeking access to funds on EU markets or from large European institutional investors need to be preparing as a priority. The remaining objectives – water and marine resources, circular economy, pollution prevention and control, and biodiversity and ecosystems – will be defined from the end of this year and enter into force in January 2023. Also, the EU is considering the development of a separate ‘social taxonomy’ to encourage investment in businesses advancing agreed social aims, including respect for human rights.
The inclusion of minimum safeguards within the taxonomy marks a groundbreaking development – the formal integration of certain soft law standards into EU law for the first time. The requisite threshold is defined as alignment with the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights (UNGPs).
In practical terms, this introduces a requirement for companies to conduct human rights due diligence on their activities if they are to be considered environmentally sustainable: it is not enough to contribute to reduced carbon emissions if doing so infringes on the rights of workers, communities and other affected people.
Building on sustainable foundations
It is now 10 years since the adoption of the UNGPs and the most recent revision of the OECD guidelines. In taking stock of progress, the UN Working Group on Business and Human Rights has recognised that the EU taxonomy represents ‘a step towards more coherence in the field’, and underscores that financial actors ‘have an unparalleled ability to influence companies and scale up progress on implementation’ of the corporate responsibility to respect human rights.
Shared definitions are just one piece of the puzzle, but other legislation can build on this foundation. For example, the EU’s Sustainable Finance Disclosure Regulation has required certain financial actors to disclose information about their human rights due diligence on taxonomy-aligned activities since March 2021. The recently announced Corporate Sustainability Reporting Directive will seek to provide taxonomy-aligned information. While enhanced reporting and disclosure is hardly radical, the incremental and technical nature of these developments has the potential to make the UNGP approach mainstream, addressing risks to people through the financial system as the ESG investing landscape continues to mature.
Chancellor Rishi Sunak has indicated that the UK green taxonomy will take the EU’s version as its starting point. The EU’s approach of integrating minimum social safeguards represents a key element of that picture. While the EU’s forthcoming mandatory human rights and environmental due diligence proposal will likely also bring together environmental and human rights-related risks to people, legal and compliance professionals should be aware that the integration of relevant standards into legislation has already begun.
Benn Hogan is deputy director at the Global Business Initiative on Human Rights