Challenges and Solutions for the EU Taxonomy’s Minimum Safeguards Criteria

Using advanced technology to address EU Taxonomy’s minimum safeguards reporting

The EU Taxonomy is a standardized classification system for identifying environmentally sustainable activities. An activity is ‘eligible’ when it fits the description of one of the activities defined in the EU Taxonomy regulation. Such activity is considered ‘aligned’ if it contributes to an environmental objective while ensuring that it 1) does not negatively impact other environmental objectives (“do no significant harm” or “DNSH”), and 2) maintains minimum safeguards. Starting this year, companies are required to report their EU taxonomy alignment. For further details on upcoming deadlines, refer to our recent article.

Why are minimum safeguards important in the EU Taxonomy Regulation?

The minimum safeguards under the EU Taxonomy Regulation are necessary because they ensure that economic activities considered environmentally sustainable also meet social and governance standards. These safeguards require compliance with minimum human and labor rights standards, preventing activities that breach key social principles. They also ensure that investments and business conduct align with responsible practices. By incorporating these safeguards, the Taxonomy Regulation promotes sustainable and inclusive growth, in accordance with the European Pillar of Social Rights principles. This helps maintain ethical and responsible conduct within the EU Taxonomy framework.

How are the minimum safeguards defined in the EU Taxonomy?

The requirements for minimum safeguards were further clarified by the European Commission as recently as June 2023 and encompass two key elements.

The international standards correspond to the OECD Guidelines for Multinational Enterprises (OECD MNEs) and the UN Guiding Principles on Business and Human Rights (UNGP). The EU Taxonomy Regulation requires companies to implement due diligence and remedy procedures to align with the OECD MNEs and UNGP. The OECD MNEs mainly covers responsible business conduct and supply chain management, while the UNGP address human rights. This includes adherence to fundamental labor conventions and the International Bill of Human Rights. 

On the other hand, the SFDR principle of DNSH ensures minimum social standards are defined at the European level and maintains consistency in European legislation. Implementing the SFDR principle of DNSH requires considering the mandatory Principal Adverse Impact indicators (PAIs) for social and employee matters, respect for human rights, anti-corruption, and anti-bribery matters, which are the following five indicators:

• PAI 10: Violations of UN Global Compact principles and Organisation for Economic Cooperation and Development (OECD) Guidelines for Multinational Enterprises.
• PAI 11: Lack of processes and compliance mechanisms to monitor compliance with UNGC and OECD-GME.
• PAI 12: Unadjusted gender pay gap.
• PAI 13: Board gender diversity.
• PAI 14: Exposure to controversial weapons.

What are the main challenges financial market participants (FMPs) face with minimum safeguards?

Financial market participants (FMPs) face two significant challenges when dealing with the EU Taxonomy regulations: scalability and limited reported data. The task of reviewing large volumes of reports for EU Taxonomy metrics can be tedious and may not be viable on a large scale. Additionally, data is lacking; while many EU companies utilize the EU Taxonomy or the SFDR templates for reporting, non-EU companies fail to disclose whether they meet the minimum safeguards. As a result, FMPs must find other ways to collect the necessary information.

How can Clarity AI support FMPs addressing these challenges?

Clarity AI provides specific solutions to scalability and data limitations. We have collected EU Taxonomy indicators from over 1,500 companies, over 1,200 of whom have self-reported whether they meet the minimum safeguards.

For companies not reporting their compliance with the EU Taxonomy or the SFDR templates, we use innovative techniques for an accurate estimation. Our advanced Natural Language Processing (NLP) algorithms analyze over 100,000 news articles daily from 30,000+ sources, covering approximately 45,000 companies. Using this information, we can monitor any active violations that may compromise alignment with Mandatory PAI 10. As of August 2023, our approach detects about 200 active violations impacting roughly 150 companies.

Clarity AI also addresses mandatory PAIs 11, 12 and 13 by leading data collection campaigns, and we scrutinize available data regarding the optional PAI 9, related to companies’ human rights policies. For mandatory PAI 14, we use databases to assess companies’ involvement in producing controversial weapons. 

Recognizing that the SFDR social indicators relevant to minimum safeguards may change should the SFDR delegated act be reviewed, we stay updated with regulatory revisions for the benefit of our clients. Contact us at Clarity AI, and we will help ensure that your portfolio meets the minimum safeguard standards.