SEI experts dissect the new EU Taxonomy

Suljada: The EU Taxonomy is a regulatory classification system by which companies’ activities are defined as sustainable from an environmental point of view. Activities classified as “environmentally sustainable” make a substantial contribution of some sort to one of six of the EU’s climate and environmental objectives without significantly harming any of the other five. In practice, listed European companies and asset managers must disclose their share of taxonomy-aligned activities. This facilitates the comparing of companies and investment portfolios in terms of sustainability.

Suljada: “Do no significant harm” means ensuring that one activity doesn’t contribute to one environmental objective at the expense of any of the other five. This could mean that a wind turbine investment contributing to climate change mitigation would not be classified as sustainable if it would potentially harm the biodiversity in the area where it’s established. This leads to a more holistic view of the environment and human health. The idea of capturing these different objectives is that, if applied rigorously, any investment in an economic activity that meets the criteria should have a net positive impact across these objectives and make the EU’s economy more sustainable overall.

Wagner: The taxonomy hardwires a holistic view of sustainability into the EU’s regulatory and financial policy framework. This way, private investments must align with the European Green Deal, Europe’s growth strategy that aims to improve the well-being and health of citizens, make Europe climate-neutral by 2050 and protect, conserve and enhance the EU’s natural capital and biodiversity. The EU Taxonomy is a robust, science-based transparency tool for companies, investors, and the general public to help align investments with the ambition of the Green Deal. It creates a common language for all to use when assessing the sustainability of projects and investments.

Suljada: The most recent proposed list of criteria for the taxonomy runs to 1000 pages, covering 100 economic activities across 10 sectors from agriculture to energy, construction, and manufacturing. It is a big undertaking and extremely ambitious, so in that sense, it is a major achievement. But in terms of chemical manufacturing and the criteria that define sustainable activities such as pollution prevention, control, and circular economy, there is room for improvement. 

Wagner: Some of the criteria have a low threshold for chemical products to be considered “inherently safe”. It relies on either manufacturers classifying substances themselves as hazardous or the inclusion of hazardous substances in legislation that does not keep up with scientific findings. In short, we think the taxonomy must classify chemicals as hazardous based on the current state of the science and have the flexibility of adjusting when new scientific research is presented.

Wagner:  There are currently around 350 000 chemicals on the market and the production volume of chemicals is expected to double over the next decade, but the EU definition of what counts as hazardous chemicals is years behind the scientific community. Currently, only about 50 substances of very high concern have been phased out under the EU chemical regulation, REACH, with a further 200 on the candidate list. This compares to over 1000 substances that meet the REACH criteria for phase-out, according to the Substitute It Now! -list, which is compiled by the International Chemical Secretariat, an independent non-profit organization.

There is also a data problem. We only have enough data on toxicity for a fraction of the rapidly expanding chemicals on the market. This opens the possibility that companies replace “bad” chemicals with chemicals that are less well-studied and unregulated, but which potentially pose an equal threat to human health and the environment. This is known as “regrettable substitution”.

To close this loophole, it is important that the taxonomy explicitly refers to non-regulatory information to determine whether a substance is hazardous, like for example the Substitute It Now! list. We also need to accelerate the screening of substances for which we have little or no toxicity information to characterize their hazard potential.

Wagner: Chemicals are ubiquitous in our daily lives. They are important components of everything from textiles, furniture, food packaging and toys. But some chemicals also negatively impact the environment and human health, for example by causing cancer, affecting reproductive health or lowering immune function. Man-made chemicals are found everywhere in the environment, from glaciers to the deep sea. In humans, several hundred substances are routinely detected. Already, 84% of Europeans are rightfully concerned about the impact chemicals in consumer products have on their health. To meet the ambition of the Green Deal of improving our health and well-being by phasing out hazardous chemicals, the taxonomy needs to keep up with the Zero pollution action plan and its chemicals strategy.

Suljada: This could be a risk that comes with strengthening environmental legislation in the EU, but shifting production is not so simple when large investments in manufacturing have already been made. There are many factors besides environmental regulation that companies consider when making investments and one of these is consumer awareness about safe and sustainable products. This is one way the taxonomy and its reporting requirements can help companies to better understand and communicate how sustainable their activities are. As the taxonomy is unprecedented in scale and scope, it could also have the effect of raising global standards. Investors everywhere will be able to benefit from the taxonomy for their European investments. It is also possible that the taxonomy will influence the development of similar classification systems in other jurisdictions.

Wagner: Private investment is critical for the EU to realize the ambitious goals set out in the European Green Deal. Major investments are required but can only be achieved by mobilizing both public and private capital. Many private investors want to support the green transition and consider it profitable but need guidance on how to allocate their investments and consider ESG (Environmental, Social, and Governance) factors as well as profitability. This is where the Taxonomy could be a valuable tool for companies. Because it classifies specific activities, it can provide a guide for companies and investors to transition their operations to be increasingly aligned with a green transition.

Suljada: In my opinion, the proposed inclusion of a fossil fuel such as natural gas in the Taxonomy obstructs EU’s efforts to attain its climate goals. It would signal a green light for new gas-fired generation and other infrastructure up to 2030. In addition to the resulting greenhouse gas emissions, it would make Europe even more dependent on gas, which is expensive and volatile due to import fluctuations. One argument that is being brought forward is that standby gas-fired generation can fill shortfalls in wind and solar power due to weather conditions, however, this could also be addressed with taxonomy-aligned, sustainable investments such as additional renewables capacity, electricity storage, and electricity grid expansion. When it comes to nuclear, waste disposal is the key issue of concern. Nuclear waste would compromise the taxonomy objectives of pollution prevention and control. It is also an expensive technology so it is unclear whether its inclusion in the taxonomy would actually result in substantial investments. While nuclear is used in some EU countries for baseload power, it could not be used to help the grid manage the intermittency of renewable sources because nuclear power plants cannot be switched on and off easily based on demand.

Wagner: The taxonomy is innovative because it does not focus on a single sustainability objective, but on six! Its holistic view on sustainability is unprecedented in scale and scope. To avoid shifting environmental externalities from one area to another, the taxonomy criteria need to be equally strong across all six objectives. When it comes to chemicals, the guidance on which substances of concern cannot be used could be made clearer, to avoid room for erroneous interpretation and loopholes. Referring to NGO lists like ChemSec’s Substitute It Now! alongside the regulatory lists currently included in the taxonomy, the criteria would ensure fewer chemicals hazardous to the environment and human health can be produced and used by companies that want to be considered sustainable. Ultimately, the taxonomy will create much-needed transparency about the sustainability of private investment, which will help the private and public sectors contribute to a green transition.