ChemRegs Newsletter – March 2022
Sustainable finance taxonomy – Regulation (EU) 2020/852
The EU sustainable finance Taxonomy Regulation (Regulation (EU) 2020/852) was published in the Official Journal of the European Union on 22 June 2020 and came into force on 12 July 2020. It will fully come into force over a number of years.
As its title suggests, it is largely about finance reporting. However, it will also influence the world of chemical regulation.
The Taxonomy Regulation is the latest manifestation of ESG. The abbreviation ESG will be familiar to many readers, it is part of the alphabet soup of ESG reporting acronyms that make up environmental standards and guidelines.
ESG stands for Environmental, Social and Governance.
The majority of ESG reporting is not currently mandatory in the UK. However, some specific metrics that come under the ESG regulation reporting umbrella are mandatory, such as energy usage for certain users, emissions reporting etc.
Each country/trading block are coming up with their own versions of ESG to suit their own particular needs and interests, in a constant attempt to get other people to limit their impact on the environment and mitigate the damage that is being done to fragile ecosystems.
It is 50 years since the seminal 1972 report titled ‘The Limits to Growth (LTG)’ was published. This report outlined the consequence of interactions between the earth and human systems and looked at the exponential economic and population growth with a finite supply of resources, studied by computer simulation.
The report concluded that, without substantial changes in resource consumption, “the most probable result will be a rather sudden and uncontrollable decline in both population and industrial capacity”.
The message was simple – the world had a rapidly growing human-biological-resource-pollution system problem that, coupled with exponential growth, meant that huge problems were coming down the line.
Generally speaking, as the human population grows, our consumption of all resources increases – more humans consume more freshwater, more land, more energy, more resources, causes more pollution, more of everything.
Another problem the report identified was the economic growth model that most societies have.
Economic growth is an increase in the production of economic goods and services, compared from one period in time to another.
In other words, if it takes a certain amount of energy, resources, and pollution to achieve a certain economic output in one year then you will need an increase in energy, resources, and pollution to achieve economic growth next year.
For example, if a country uses a million barrels of oil a day it will need more than a million per day next year if it wants to grow the economy.
Therefore, our economy and business growth model uses all the resources (and the ability to deal with waste and pollution) of the natural world at an exponential rate.
Something must give.
This is because, as the 1972 report clearly states, there is a limit to growth.
The thinking behind ESG is to improve the rate of resource productivity, or, ‘do more with less’.
This is where the EU’s new Taxonomy Regulation comes in.
It is designed to support the transformation of the EU economy to meet its European Green Deal objectives, including the 2050 climate-neutrality target.
The EU taxonomy is a green classification system, establishing a list of environmentally sustainable economic activities. It translates the EU’s climate and environmental objectives into criteria for specific economic activities for investment purposes.
It uses the classification as a tool and aims to provide clarity for companies, capital markets, and policy makers on which economic activities are sustainable. If the activities are deemed sustainable then they will get access to loans, be able to tender for more business, and in theory, have a more successful future.
The classification system or taxonomy was created to address the spectre of greenwashing to enable market participants to identify and invest in sustainable assets with more confidence.
It hopes to achieve this via two measures.
The first measure defines what is a sustainable economic activity and sets out four conditions that an economic activity must meet:
- Making a substantial contribution to at least one environmental objective;
- Doing no significant harm to any other environmental objective (DNSH);
- Complying with minimum social safeguards;
- Complying with the technical screening criteria.
The technical screening criteria are developed in delegated acts. For each economic activity considered, the technical screening criteria specify environmental performance requirements that ensure the activity makes a substantial contribution to the environmental objective in question and does no significant harm to the other environmental objectives.
The second measure states the six environmental objectives of the Taxonomy.
- Climate change mitigation;
- Climate change adaptation;
- Sustainable use and protection of water and marine resources;
- Transition to a circular economy;
- Pollution prevention and control; and
- Protection and restoration of biodiversity and ecosystems.
In pursuing one or more of the six objectives to qualify as sustainable, it cannot cause significant harm to any of the other Taxonomy objectives.
For example, if a company places on the market a wood preserver derived from spent industrial lubricant it may claim it is sustainable because, in reusing a waste product, it accords with the objective of transitioning to a circular economy.
However, if the wood preserver was also a marine pollutant that then entered the groundwater after rain, it would fall foul of objective 5 (pollution prevention and control) and would be caught by the do no significant harm (DNSH) principle.
I would like to explain ‘de facto’ and ‘de jure’.
‘De facto’ means a state of affairs that is true in fact, but that is not officially sanctioned. In contrast, ‘de jure’ means a state of affairs that is in accordance with law (i.e. that is officially sanctioned).
For example, John may be the de jure owner of an empty house, but Jane is squatting in it and so is the de facto occupier of the house.
Chemical regulations tend to come from multifarious sources, some are backed by law, some are issued as guidance, and some are historical norms. The taxonomy guidelines have the de facto power to leapfrog or overreach these de jure chemical regulations, guidance, and norms.
An example of this leapfrogging ability is the obligations for chemicals that are Substances of Very High Concern (SVHC) under the REACH Regulation.
In general terms, SVHC are substances that have hazards with serious consequences. For example, they can cause cancer, reproductive defects, or they have other hazardous properties or can remain in the environment for a long time with the amounts in humans or animals gradually building up (accumulating).
Substances meeting these criteria may be placed on one or both of two lists that are defined in the REACH Regulation: the so called ‘Candidate List’ and the ‘Authorisation List’ (Annex XIV). It is possible that some substances that meet the criteria will not appear on either list.
The process by which a substance gets put on the Candidate List is that a member state will prepare an Annex XV dossier proposing and justifying the addition of the substance to the list.
There are certain obligations that arise once a substance appears on the Candidate List:
- Suppliers should update their safety data sheets to advise their downstream users that a SHVC is in the product and on the Candidate List;
- Suppliers of articles containing the substance at levels > 0.1% must advise downstream users that the article contains the specific substance and, if necessary, provide information on safe use;
- If the article contains the substance at lower levels, they must provide the same information to downstream users on request.
These obligations are not exhaustive, and they are in addition to the rules on labelling, safety data sheets etc.
SHVC chemicals are still permitted to be used even if they are on the Candidate List and unfortunately are present in a lot of consumer goods. They are also commonly used in industry. There is a huge volume of law surrounding their use e.g. REACH, the CLP Regulation, RoHS etc.
It can take years for a potential SVHC to make the ‘Authorisation List’, meaning it is still in use and causing harm.
However, if we go back to the Taxonomy Regulation, we find that SHVCs cannot be reconciled with most of the taxonomy objectives. This will have the effect of forcing suppliers to tell their financiers that their products breach one of the six taxonomy objectives and is thus, not sustainable.
Or to put it another way, the powerful ‘show me the money’ stick is being used alongside the hitherto carrot of trying to get SHVCs out of the supply chain because it is a nice thing to do, and they are bad for us.
Taxonomy regulations will, for the most part, include large public-interest companies with more than 500 employees, including listed companies, banks and insurance companies.
These companies must report on climate change mitigation and adaptation from January 2022, and on all six environmental objectives by January 2023.
Although the EU Taxonomy focuses on finance, the scope is larger than that, stretching far beyond banking and other financial services. It will also have global repercussions. Although it is primarily EU legislation, as it is a finance regulation it will require reports from EU companies, banks and investors, regardless of where their facilities and products are located.
Further, even though the UK has left the EU and is not subject to the taxonomy rules, it is working on similar schemes. The Bank of England, HM Treasury, and FCA, have been collaborating in developing the UK’s technical screening criteria, which will be used to “define what economic activities are environmentally sustainable, which in turn will inform the UK green taxonomy.
It has only taken 50 years for the message from ‘The Limits to Growth’ report to be taken seriously.
Let’s hope that taxonomy makes a difference.
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