How the EU’s Taxonomy Combats Greenwashing
The European Union’s criteria for identifying green activities can be a better guide for investors than standard ESG measures.
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Frontiers
Alex Nabaum/theispot.com
The European Green Deal, launched in 2019, includes the goals of reaching net-zero emissions in the European Union by 2050 and helping capital markets identify sustainable investment targets. To that end, a classification system of sustainable business activities was developed to determine whether companies subject to the Green Deal’s reporting requirements are meeting its benchmarks. More global companies with operations in the EU will be subject to the taxonomy in just two years.
Despite a recent retrenchment of corporate environmental, social, and governance (ESG) initiatives, asset managers and companies know that sustainable business practices are crucial for reducing risk and delivering shareholder value. Still, they need a reliable way to tell when a business’s activities are truly green and when it’s greenwashing — claiming that its products, services, and initiatives benefit the environment when they do not.
That critical question — what is or isn’t green — has been difficult to answer definitively and authoritatively. That is where the European Union’s taxonomy steps in.
Introduced in 2020 as part of the EU’s European Green Deal strategy for achieving economywide climate neutrality by 2050, the taxonomy uses objective, largely science-based criteria for identifying sustainable business activities. Most important, it establishes the notion of “green by law”: Companies can’t simply claim that their activities are green but must show that they satisfy applicable EU benchmarks. That can make it a powerful safeguard against greenwashing. Large companies with significant operations in the EU, which eventually will include many U.S.-based concerns, have to report on their activities under the taxonomy.
Primarily designed to provide clarity to capital markets and other investors, the taxonomy sets criteria for the sustainability of more than 150 economic activities, such as manufacturing cars, operating a data center, running a water treatment plant, or generating electricity. It asks companies two questions: Do any of your activities contribute to the EU’s sustainability objectives, and do you conduct those activities in a sustainable way?
To be considered green under the taxonomy, an activity has to meet certain benchmarks showing progress toward the Green Deal’s six objectives for sustainability: (1) climate change mitigation and (2) adaptation, (3) contribution to a circular economy, (4) sustainable use of water and marine resources, (5) prevention and control of pollution, and (6) protection and restoration of ecosystem biodiversity. For example, under the criteria, in order to be considered green, a cement manufacturer’s greenhouse gas emissions can’t exceed a certain level for each ton of cement produced. Manufacturing cars counts as green only if the vehicles manufactured don’t produce tailpipe emissions. In a data center, the global warming potential of refrigerants used in cooling can’t exceed a certain level.
The taxonomy isn’t prescriptive — it doesn’t say what companies can or cannot do.
