The EU taxonomy can strengthen SMEs in the green transition

Small and medium-sized companies will remain exempt from new disclosure rules on the EU’s sustainable finance taxonomy starting in 2022. However corporate leaders would be well-advised to follow its implications, including SMEs, writes Finn Wendland.

Finn Wendland is an economist specialised in climate and energy policy at the German Economic Institute.

The EU taxonomy raises the sustainability disclosure requirements for large public-interest companies as of January 2022, yet small and medium-sized companies (SMEs) will be spared from the new rules until 2026.

Despite the formal exemption, chances are that large investors and end-producers will pass through their reporting requirements to intermediate producers regardless – many of whom are SMEs – with the aim of ensuring taxonomy alignment.

In this context, the recent initiatives from big manufacturers, such as Porsche or Siemens, to set their own carbon neutrality goals for their supply chains can be seen as prominent examples in a much wider trend for more transparency in traditional industry sectors.

The EU taxonomy and related regulations contribute to the growing top-down pressure for intermediate producers and SMEs to prepare standardised sustainability information. As only one out of three companies in Germany has implemented a sustainability strategy, according to a survey from Commerzbank (2021), it appears reasonable to suspect that few companies are actually prepared.

With the EU taxonomy entering into force, the ability to report in line with the technical screening criteria – and, ideally, prove a high share of taxonomy alignment – is likely to be rewarded both from a regulatory and business perspective. Rather than waiting in passiveness, SMEs should seize the current situation as a first-mover opportunity to prepare for the looming reporting requirements on the EU taxonomy and to build competitive advantages ahead of the green transformation.

Preparing for informational readiness in advance can strengthen SMEs’ positioning to improve business resilience, financing conditions and sales prospects.

To recapitulate, the EU has adopted the EU taxonomy in 2020 as the lead instrument to promote transparency on the sustainability performance of economic activities in Europe and beyond.

By introducing quantitative reporting requirements for listed companies with more than 500 employees from January 2022, the EU taxonomy represents a binding precedent among numerous voluntary eco-labels and standards.

The European Commission plans to extend the EU taxonomy to six environmental objectives and rules for about 50,000 companies by 2026. Relevant disclosure information includes the shares of turnover, capital expenditure (CapEx) and operational expenditure (OpEx) that can justifiably be linked to ecologically sustainable activities.

Given the ambitious thresholds to be reached under the screening criteria, the EU taxonomy is viewed by some as the new gold standard to certify the greenness of business models and investments.

Although the new mandatory disclosure rules are limited to large market participants first, there is reason to believe that SMEs may feel its consequences both at a larger scale and earlier than expected. The apparent lack of preparedness and discussion on possible taxonomy implications among SMEs in intermediate producing sectors seems especially surprising given the different financial and economic dependencies with large stakeholders.

In particular, the growing importance of financial transparency for investors and the new regulatory incentives for end producers hint towards two potential lines of conflict.

First, as sustainability has become a main concern for politicians and consumers, numerous investors have raised their commitments on sustainable project finance. In 2019, the European Investment Bank, the EU’s central infrastructure and development bank, announced to raise its share of sustainability-compatible investments to at least 50% by 2025.

Principally, the new interest in green finance among creditors well coincides with the growing demand from companies to fuel their investment needs for carbon-neutral technologies and innovation. The European Commission plans to embed the EU taxonomy at the heart of financial instruments, credit ratings and banking rules in the aim of easing the sustainable finance conditions.

As the EU taxonomy seems bound to become the key selection tool for sustainable finance across the EU, it may also turn out critical for the potential blacklisting of investments without a minimum degree of compliance. In this context, preparing sustainability documentation in line with the EU taxonomy from early on can help SMEs to avoid excess financing costs and gain investors’ confidence.

Second, as the first batch of the EU taxonomy’s screening criteria focuses on activities in energy-intensive intermediate sectors, such as power generation and manufacturing, its implications are likely to affect supply chains and supplier-producer relationships at a wider range.

Under Article 8 of the EU taxonomy, companies can credit parts of their turnover and OpEx derived from taxonomy-aligned input for their environmental performance, leaving final producers with an inherent interest to ensure full taxonomy-alignment of their supply chains.

As the degree of taxonomy-alignment becomes a supplier selection criterium in the future, SMEs in intermediate sectors which can prove their taxonomy-compliance put themselves in a potentially advantageous position vis-à-vis competitors.

Recent initiatives from Daimler and Volvo to involve in long-term partnerships with prospective green steel producers (H2GS and SSAB) hint towards a keen interest by manufacturers in traditional industries to address key emissions sources and to restructure their supply chains in response to the environmental challenges.

To sum up, while numerous companies stay exempt from the new disclosure rules on the EU taxonomy as of 2022, corporate leaders and managers are well-advised to follow its implications as industry leaders and market structures reorganise to address the long-term environmental objectives.

Further, SMEs can carve out competitive advantages to strengthen business resilience, improve financing conditions and promote sales prospects by dealing with the EU taxonomy and preparing for informational readiness from early on.

[Edited by Alice Taylor]