14-10-2022 09:54

EU Taxonomy Minimum Safeguards: What are they and why do they matter?

The EU Platform on Sustainable Finance published its final report on the functioning of the Minimum Safeguards laid out in the EU Taxonomy Regulation. The Minimum Safeguards ensure that companies engaging in sustainable activities meet certain standards when it comes to human and labour rights, bribery, taxation and fair competition.
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The Minimum Safeguards, part of the EU Taxonomy Regulation, are based on recommendations, originating from the European Parliament and the Technical Expert Group, to ensure that any investments or activities labelled as “Taxonomy-aligned” meet certain minimum governance standards and do not violate social norms, including human rights and labour rights.

Ultimately, the Minimum Standards act as safety net aimed at preventing any purely green investments from being viewed as “sustainable” if they, for example, violate human or labour rights, or engage in corrupt, anti-competitive or non-compliant taxation practices. The Taxonomy Regulation specifies that one of the three criteria for economic activities to be considered environmentally sustainable is that they are “carried out in compliance with the minimum safeguards.”

Compliance with the Minimum Safeguards is determined by assessing performance criteria against four core topics:

  • Human rights, including workers’ rights
  • Bribery/corruption
  • Taxation
  • Fair competition

The Minimum Safeguards criteria have been anchored in guidance provided by competent and accepted international bodies (listed below), in addition to upcoming EU regulation (CSDDD, CSRD, SFDR). The Taxonomy Regulation, however, states that the Minimum Safeguards do not supersede more stringent requirements set out in EU law. Therefore environmentally sustainable economic activities must also meet criteria for responsible business conduct already outlined in:

The report provides much needed clarity for those attempting to navigate the new regulatory landscape.

David Ray, Nordea Sustainable Finance Advisory

What is included in the Final Report on Minimum Safeguards?

The report provides guidance on the application of the Minimum Safeguards with respect to the Taxonomy Regulation (Articles 3 and 18). Although there are no big surprises in the report, it does provide much needed clarity for those attempting to navigate the new regulatory landscape. The report delivers concrete and practical information on the details of the upcoming requirements, covering the following areas:

  • The embedding of Minimum Safeguards in existing regulation (SFDR, CSRD, CSDDD)
  • The identification of substantive topics relating to the standards and norms laid out in Article 18 of the Taxonomy Regulation
  • Advice on compliance with Minimum Safeguards

The report provides advice in the context of existing and upcoming EU regulation on corporate sustainability and other relevant EU initiatives on subjects such as taxation, corruption and fair competition. Notably, due to specific mention of the SFDR in the relevant section of the Taxonomy Regulation, the report has incorporated the five mandatory social principal adverse impacts (PAI) of the SFDR in its guidance.

Regulation of human rights due diligence (with the Corporate Sustainability Due Diligence Directive, or CSDDD) and sustainability reporting (with the Corporate Sustainability Reporting Directive, or CSRD) is yet to be finalised. As such, uncertainty surrounding implementation remains, and it is likely that the recommendations will be amended once the aforementioned regulation has been finalised and tested. In lieu of referencing finalised regulation, the report highlights the following as preliminary indicators of non-compliance:

  • Inadequate or non-existent corporate due diligence processes on human rights, including labour rights, bribery, taxation and fair competition
  • Final liability of companies for breaches in any of these areas
  • Lack of collaboration with a National Contact Point (NCP), and an assessment of non-compliance with OECD guidelines by an OECD NCP
  • Non-response to allegations by the Business and Human Rights Resource Centre

Summary of criteria for alignment with the Minimum Safeguards

EU companies in scope of CSRD: EU companies which meet two of the following three characteristics: more than 250 employees, a turnover of over EUR 40 million and a balance sheet of more than EUR 20 million.

 

EU CSRD companies are considered non-compliant if one of the two criteria apply:

Human Rights

1. The company has not established an adequate human rights due diligence (HRDD) process as outlined in the UN Guiding Principles (UNGPs) and OECD Guidelines for Multinational Enterprises (MNEs).

2. There are signals that the company did not adequately implement human rights due diligence and/or did abuse human rights. These are:

  1. The company has been finally found in breach of labour law or human rights.
  2. OECD or Business and Human Rights Resource Centre (BHRRC) indicators signal that the company does not engage with stakeholders.

Corruption

1.The company has no anti-corruption processes in place.

2. The company or its senior management, including the senior management of its subsidiaries, has been finally convicted in court of corruption.

Taxation

1. The company does not treat tax governance and compliance as important elements of oversight, and there are no adequate tax risk management strategies and processes in place.

2. The company or its subsidiaries have been finally found to have violated tax laws.

Fair Competition

1. The company does not promote employee awareness of the importance of compliance with all applicable competition laws and regulations.

2. The company or its senior management, including the senior management of its subsidiaries, has been finally convicted of violating competition laws.

Non-EU companies and EU companies until CSRD is fully implemented:

 

Non-CSRD companies are considered non-compliant if one of the two criteria apply:

Human Rights

1. The company has not implemented an adequate HRDD which follows the six steps of the UNGPs. As audit/assurance of these disclosures will be voluntary, an additional check on implementation is necessary. To do this, investors might consider data resources such as the World Benchmark Alliance (WBA) for an assessment.

2. There are signals that the company did not adequately implement HRDD and/or did abuse human rights. These are:

  1. The company has been finally found in breach of labour law or human rights.
  2. OECD or Business and Human Rights Resource Centre (BHRRC) indicators signal that the company does not engage with stakeholders.

Corruption

1. The company has no anti-corruption processes in place.

2. The company or its senior management, including the senior management of its subsidiaries, has been finally convicted in court of corruption.

Taxation

1.The company does not treat tax governance and compliance as important elements of oversight, and there are no adequate tax risk management strategies and processes in place.

2. The company or its subsidiaries have been finally found in violation of tax laws.

Fair Competition

1. The company does not promote employee awareness of the importance of compliance with all applicable competition laws and regulations.

2. The company or its senior management, including the senior management of its subsidiaries, has been finally found in violation of competition laws.

How to consider Minimum Safeguards for green bonds and other use-of-proceeds instruments

  • Public, private, or listed company under CSRD: The company is the “undertaking carrying out the activity.” Therefore criteria for large CSRD companies apply to the issuer of the green bond and other use-of-proceeds instruments. (In the case that an SME issues a green bond, the respective criteria apply.)
  • Non-CSRD company: The company is the “undertaking carrying out the activity.” Therefore criteria for large non-CSRD companies apply to the issuer of the green bond and other use-of-proceeds instruments. (In the case that an SME issues a green bond, the respective criteria apply.)
  • Sovereigns and sub-sovereigns: The sub-sovereign is the “undertaking carrying out the activity,” therefore criteria for sovereigns and sub-sovereigns (yet to be fully developed) apply to the issuer.
  • Bank: The bank is not the undertaking carrying out the activity, but the entity receiving the loan or other form of financing is the “undertaking carrying out the activity” and should meet the respective criteria for companies or for sub-sovereigns. Households are an exception as Article 18 documents only refer to businesses. Minimum Safeguards are not applicable to households.

Links between the Minimum Safeguards and the broader EU regulatory landscape

Sustainable Finance Disclosure Regulation (SFDR):

The SFDR has introduced a set of disclosure requirements for financial products that either promote environmental or social characteristics (Article 8) or have specific sustainable investment objectives (Article 9). Within these disclosure requirements, the concept of principal adverse impacts (PAI) has been defined. Under the requirements relating to PAI, financial market participants are required to disclose the principal adverse impacts of investment decisions on sustainability outcomes (including environmental, social and employee matters, respect for human rights, anti-corruption and anti-bribery matters).

The Regulatory Technical Standards outlining specific requirements dictate that financial market participants assess investments against 18 mandatory environmental and social PAI. Of these 18 PAI, 5 are of relevance to demonstrating compliance with Minimum Safeguards:

  • Violations of UN Global Compact principles or OECD Guidelines for Multinational Enterprises
  • Lack of processes and compliance mechanisms to monitor compliance with UN Global Compact principles and OECD Guidelines for Multinational Enterprises
  • Unadjusted gender pay gap
  • Board gender diversity
  • Exposure to controversial weapons (anti-personnel mines, cluster munitions, chemical weapons, and biological weapons)

From the above list, the first two are of most relevance for demonstrating compliance with Minimum Safeguards. As the indicators cover both the direct violation of principles and the existence of policies to monitor them, it can be understood that both performance and process  are adequately covered.

The definition of sustainable investment under SFDR is broader that that outlined in the Taxonomy Regulation, and therefore the Minimum Safeguards. It is therefore recommended that the five mandatory social PAIs above remain the focus of reporting. SFDR and Minimum Safeguard definitions both reference the OECD Guidelines for Multinational Enterprises, which include the UNGPs, so can be considered aligned. It is worth noting that companies with exposure to controversial weapons are not able to define activities as taxonomy aligned due to non-compliance with the do no significant harm principle under SFDR.

Corporate Sustainability Reporting Directive (CSRD):

The CSRD outlines both what and how sustainability-related information is disclosed. The new regulation will act to amend the Non-financial Reporting Directive (NFRD), provisions of the Transparency Directive, the Audit Directive, and the Audit Regulation, and will initially apply to companies with more than 250 employees, a turnover of over EUR 40 million and a balance sheet of more than EUR 20 million.

Although the standards that will underlie the CSRD disclosure requirements, the European Sustainability Reporting Standards (ESRS), have not yet been finalised, it is so far clear that the standards will draw from concepts outlined by the UNGP and so will broadly align with Minimum Safeguards criteria. However, at this stage it cannot be said that mandatory disclosures required by CSRD will be sufficient to fully satisfy alignment with Minimum Safeguards. For example, it is not clear if or how Minimum Safeguard “taxation” criteria will be covered by the CSRD.

Companies within scope of the CSRD will be required for the first time to ensure that sustainability-related disclosures are audited by a third party. Within the final report, the Platform on Sustainable Finance expressed desire for the CSRD to fully incorporate compliance indicators for Minimum Safeguards, allowing for the auditing of Minimum Safeguard disclosures under the main audit of other sustainability disclosures, thereby reducing the administrative burden.

Corporate Sustainability Due Diligence Directive Proposal (CSDDD)

On 23 February 2022 the European Commission adopted a proposal for the CSDDD, aimed to foster “sustainable and responsible corporate behaviour and to anchor human rights and environmental considerations in companies’ operations and corporate governance.”

In explanatory guidance, the Commission noted significant similarity with reporting on Minimum Safeguards compliance: “Similarly, this Directive will complement the recent Taxonomy Regulation […] by providing a categorisation of environmentally sustainable investments in economic activities that also meet a minimum social safeguard. The reporting also covers minimum safeguards established in Article 18 of the Taxonomy Regulation […] By requiring companies to identify their adverse risks in all their operations and value chains, this Directive may help in providing more detailed information to the investors.”

As a result of this already acknowledged significant overlap, it is likely that future compliance with the CSDDD may be considered sufficient for demonstrating compliance with the Minimum Safeguards requirements under Article 18 of the Taxonomy Regulation. This is, however, dependent on the current proposal being ratified into law without any significant changes.

Demonstrating sufficient due diligence

Compliance with existing national due diligence regulation is not automatically sufficient for meeting Minimum Safeguard standards. For example, the Norwegian Transparency Act, Åpenhetsloven, does not necessarily capture all of the elements required to demonstrate alignment with Minimum Safeguards.

Due diligence practices in place and referenced must meet certain minimum standards of governance and control. It is not enough to simply state that a due diligence practices exist.

Authors

Name:
David Ray
Title:
Nordea Sustainable Finance Advisory
Name:
Lea Gamsjäger
Title:
Nordea Sustainable Finance Advisory

Nordea Sustainable Finance Advisory

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