THE LONG ROAD TO SUSTAINABILITY

If climate change could be fought with words, then the decisive step toward victory would have been taken on December 12, 2015. “Today, we can look into the eyes of our children and grandchildren, and we can finally … tell them that we have joined hands to bequeath a more habitable world to them and to future generations,” said then-UN Secretary-General Ban Ki-moon. When future historians would look back on that day, Ban said, they would find that the fight against climate change had taken a “dramatic turn.”

Ban Ki-moon made this pronouncement on the day that the global community agreed to the Paris Climate Accords. The agreement at that time was that global temperature increases should remain well under 2 degrees Celsius, or 1.5 degrees at best. Yet it was already clear at the time that words wouldn’t be enough, particularly because it was left up to each country to decide what measures would be taken to achieve the goal.

The European Union set an ambitious target after the Paris conference: according to its Green Deal, it wants to become climate neutral by the year 2050 with net-zero greenhouse-gas emissions, meaning that it will fully compensate for any emissions that are still being produced. To achieve this, the entire economy within the EU will have to be transformed—and this will be expensive: the measures necessary will cost up to one trillion euros just until 2029. To ensure that the private and public funds flowing into this transformation are spent in a targeted manner, the EU has issued a slew of regulations and directives with the goal of increasing the transparency of the economy with regard to sustainability. It’s a daunting task—and a huge opportunity for all companies. Christian Jöst is familiar with both sides of the issue. Since summer 2022, he’s been a member of the new Sustainable Finance Advisory Council of the German Federal Government, where he primarily represents the interests of small and medium-sized enterprises (SMEs) in the country. His own company, Jöst abrasives GmbH, produces abrasives and abrasive systems in Odenwald, in southwestern Germany. Particularly since last year he’s noticed growing interest among his customers in issues of sustainability and supply chains. “I spent more than thirty working days in 2021 filling out other companies’ questionnaires to provide information about our efforts in this area,” he says.

Along with specialist wholesalers and large distributors, his clients also include some major industrial companies that are already subject to some of the new EU regulations. “We supply globally,” Jöst says with pride in his voice. “Wherever surfaces need to be processed, our products are used.” Meanwhile, his larger customers want to know how much carbon dioxide his production process emits, how well his supply chain is monitored and, for instance, whether he can rule out the use of child labor or forced labor at his company and in his supply chains—as required by the new German Supply Chain Act.

Jöst believes that this sort of transparency is correct and important, but feels it could function more efficiently. “We need a European-wide index where all companies can register; then I wouldn’t have to continually fill out new questionnaires,” he suggests. The good news for Jöst is that the EU Commission is working on it. The European Single Access Point will provide precisely what he describes. The bad news: it will take some time before the database is ready.

First off, the question as to what is actually sustainable—and what is not—must be answered, of course. This is precisely the task of the so-called EU Taxonomy, the centerpiece of the various EU regulations. The taxonomy is a classification system that creates a list of ecologically sustainable economic activities. It’s a tool that countries outside the EU also use as a guide. The classification is also supposed to provide security for investors, help avoid greenwashing and support companies in their transformation. “We first need guidance as to what is sustainable and what isn’t; that’s what makes the EU Taxonomy so important,” says Alexandra Themistocli, who is responsible for the issue of sustainability at the Swedish financial institution Skandinaviska Enskilda Banken (SEB) in Germany.

The EU Taxonomy has six environmental goals. For the first two, climate protection and adaptation to climate change, the technical assessment criteria have already been defined—and regulation enthusiasts will have a field day. Across 349 pages, the assessment criteria describe in detail whether an individual economic activity is sustainable. The good news is that no company must struggle through every last page of the taxonomy. For SMEs, there’s now even an online self-test from the Frankfurt School. In just a few clicks, companies can find out if they’re affected by the taxonomy—and in what areas.

“The taxonomy is the EU’s biggest transparency tool,” says Prof. Dr. Christian Klein, who holds the Chair for Sustainable Finance at the University of Kassel and has been a trailblazer from the very start. “Twenty years ago, when I started focusing on the topic, I got a lot of funny looks,” he says. His colleagues thought his research had something to do with donations. “Nowadays that has changed: sustainable finance is moving into the mainstream, and not just in academia.” He believes that performing well according to the EU Taxonomy will be decisive for how companies are financed in the future. As of now, the regulation does not yet forbid investments in non-sustainable industries; in the future, however, such companies will only be able to get money at less favorable terms. For instance, they may be excluded from receiving government subsidies.

“With a bit of imagination, the EU Commission could also use the taxonomy for hard-core regulations. For instance, at some point they could say that non-sustainable companies shouldn’t get any funds at all,” Klein says. It could also regulate which industries should receive investments in the future: in July 2021, electricity gene­ration from nuclear energy and natural gas was classified as sustainable under certain circumstances—partly due to pressure from France and a few mid-Eastern-European countries and despite strong protests from other EU member states and numerous EU parliamentarians.

The taxonomy will also become much more comprehensive in the future. After all, the technical details for an additional four environmental goals in the EU Taxonomy are still being formulated. The Commission will use these four additional chapters to define what is included in the sustainable use of water resources, how the transformation to a circular economy can be designed, and what contributes to the prevention of pollution, the protection of ecosystems and the preservation of biodiversity. It sounds like a huge undertaking, which it is, but according to Themistocli, there’s no alternative. “You have to look at environmental protection and climate protection together,” she says. Biodiversity is closely intertwined with climate protection. Global warming is causing coral reefs to die and biodiversity to decline. “We need to push this issue on all fronts,” she adds.

Building on the taxonomy, there’s another regulation that will be crucial for companies: the Corporate Sustainability Reporting Directive (CSRD). Starting in 2024, this will gradually apply to companies with more than 250 employees, total assets of more than 20 million euros, or sales of more than 40 million euros, thus to virtually all capital-market oriented companies.

“If the previous rules were a wave, then companies will now be facing a tsunami,” says Johann Schnabel, partner at the accounting and professional services conglomerate KPMG. In Germany, the rules will directly affect around 15,000 companies, including many SMEs.

Above all, the CSRD stipulates that companies must provide extensive information about the impact of their activities on the environment—and also how the environment affects them in turn. “There is currently talk of more than 200 specific key indicators that they will use to determine all of this,” Schnabel says. It will be the biggest innovation in corporate reporting in decades, he adds. “The problem is that they will have to translate non-­financial issues into a logic of valuation—and it all has to stand up to scrutiny.”

Schnabel warns that this will be a major challenge for businesses, as companies will be facing a lot of things all at once. “These include corona, raw materials shortages, increasing energy prices, war in Ukraine,” he says, listing a few of the current issues. Nevertheless, they also shouldn’t lose sight of climate change. As Schnabel puts it, “Climate protection should be the most important issue for us all.”

“Many of our companies don’t yet see themselves able to take a position on sustainable finance—or are affected by the CSRD,” says Matthias Bianchi from the German Association for Small and Medium-Sized Enterprises (DMB). Even his association hasn’t yet agreed on an official position. What is already clear for SMEs is that although there will be extensive lists of exceptions, deadline extensions and simplifications, they will still have to deal with sustainability reporting nonetheless.

Larger companies will have to examine their entire supply chain and also obtain the necessary data from their suppliers for this reporting. Jöst also emphasizes this, yet he views it as a huge opportunity. He says many family-owned SMEs are already concerned about sustainability in any case. “They are usually closely connected to their locations and employees, so they automatically want to make sure that their immediate environment is intact.”

Along with the UN authorities, there was recently someone who even better captured the urgency of the moment in words: “We are the first generation to feel the effect of climate change and the last generation who can do something about it.” Former US President Obama spoke these words just four months before the big climate summit in Paris and announced tougher measures for his country. It’s a statement that is being increasingly confirmed of late, in light of recent heatwaves and disastrous floods, and requires effective actions be taken.