Clifford Chance

The EU Taxonomy Regulation requires businesses to implement business and human rights frameworks to qualify as 'environmentally sustainable'. This is a key step toward the mandatory human rights due diligence laws planned at the EU level.

The Taxonomy Regulation

The EU Regulation no. 2020/852 on the Establishment of a Framework to Facilitate Sustainable Investment (the Taxonomy Regulation) came (save for the disclosure requirements therein) into force on 12 July 2020. It forms a key plank of the European Commission's Action Plan on Financing Sustainable Growth, the EU's sustainable finance initiative in response to the challenge of climate change.

The Taxonomy Regulation is intended to provide both businesses and investors with a common basis for identifying business activities as environmentally sustainable (or not). It sets high-level criteria by which a business activity may qualify as 'environmentally sustainable' for investment purposes. Detailed 'technical screening criteria' will follow to give the high-level criteria more granular content and assist in the classification of individual business activities. On 10 November 2020, UK Chancellor Rishi Sunak announced in Parliament that the UK will similarly implement a new "green taxonomy", taking the scientific metrics in the Taxonomy Regulation as its basis (subject to review for suitability for the UK market).

For more detail on the Taxonomy Regulation, see our briefing here and Practical Guide for Alternative Investment Managers here. For further guidance on how companies and financial institutions can make disclosures using the Taxonomy, in particular concerning the Taxonomy's approach to the 'Do No Significant Harm' principle, see also materials produced by the Technical Expert Group (TEG) on Sustainable Finance available here.

What have human rights got to do with it?

The Taxonomy Regulation requires that, in order to qualify as 'environmentally sustainable', businesses' "economic activities" must align with the OECD Guidelines for Multinational Enterprises (the OECD Guidelines) and the UN Guiding Principles on Business and Human Rights (the UNGPs). We expect that businesses of all kinds will experience market pressure to make their business activities qualify as environmentally sustainable. The classification system set up by the Regulation will be used in various ways, and we expect regulators and standardization organisations to adapt their requirements to bring them in line with the Taxonomy Regulation.

Article 3(c) of the Taxonomy Regulation requires an economic activity to comply with minimum safeguards in Article 18. Article 18 specifies that the minimum safeguards "shall be procedures implemented by an undertaking that is carrying out an economic activity to ensure the alignment with the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights, including" the core international human rights treaties and International Labour Organisation instruments referred to in the OECD Guidelines and the UNGPs.

In practice, this wording appears to mean that a business hoping for their activities to qualify as environmentally sustainable must be taking steps in order to implement the OECD Guidelines (which themselves incorporate the UNGPs) and the UNGPs.

The OECD and UNGPs frameworks are designed as business management tools for incorporating the respect for human rights into business operations on a holistic basis. They set out various practical implementation steps, including, for example, requirements for businesses to:

• issue a policy statement from senior management committing to the responsibility to respect human rights;
• reflect that commitment in their operational policies and procedures; 
• establish human rights due diligence processes to identify, prevent, mitigate and account for how they address their adverse human rights impacts, and integrate the results of such assessments into their operations;
• communicate how they address human rights impacts;
• act to remedy adverse impacts, including by establishing or participating in effective operational level grievance mechanisms, and track the effectiveness of such actions.

The March 2020 recommendations of the Technical Expert Group noted that "the Taxonomy applies them at activity level and not company or institution level". Full company-level implementation of the UNGPs and OECD Guidelines, therefore, falls outside the scope of the Regulation (contrasted with the new EU Green Bond Standard proposals, which require companies to make statements concerning their approach to sustainability as a whole).

Pending the future 'technical screening criteria', it is not clear how this requirement will be applied to the different economic activities a business may conduct, particularly given that the UNGPs are expressly aimed at business-wide implementation steps. The European Commission will publish a report by the end of 2021 assessing the case for more detailed preconditions regarding these labour and human rights minimum safeguard requirements.

The Taxonomy Regulation also imposes disclosure requirements regarding environmentally sustainable businesses' human rights processes. Once the relevant provisions are in force from January 2022, financial market participants aiming for qualifying investments must disclose in pre-contractual disclosures and periodic reports (such as annual reports) how the investments underlying their financial products are in businesses that meet Art. 3. In broad terms, 'green' investment products will need to be accompanied by disclosure of how and to what extent the investee businesses implement the OECD Guidelines and UNGP. EU businesses of all kinds that produce non-financial statements will also have to disclose the proportions of their turnover, capital expenditure and operating expenditure that relate to business activities qualifying as environmentally sustainable under the Taxonomy Regulation criteria. The UK Chancellor announced on 10 November an intention to impose further disclosure requirements on UK businesses too, announcing the Government's intention for the UK to be the first country in the world to make disclosures aligned with the Task Force on Climate-related Financial Disclosures fully mandatory across its economy by 2025.

Implications

Businesses should be aware that the authoritative new market standard for environmental sustainability requires human rights due diligence (HRDD).

The EU Taxonomy Regulation's embedding of HRDD processes as 'minimum safeguards' also points to the EU Commission's plans for mandatory human rights and environmental due diligence legislation in 2021, covered elsewhere in this blog.

As a result of the Taxonomy Regulation, businesses have an additional reason to be able to demonstrate implementation of the UNGP and OECD Guidelines now and not only in the future when mandatory HRDD will be implemented, in order to qualify as environmentally sustainable.

The EU has signalled that it will deal with the issues of climate change and human rights as linked. At the same time, this linkage and its implications for businesses trying to address the climate transition are not widely understood. Businesses would be wise to consider this, and to avoid the pitfall of treating their governance of climate and of human rights risk as unrelated.