EU Climate Policy: What Rules will be Relevant for Companies?

As the dangers of climate change become more prominent, governments around the world begin to look for solutions and mobilise resources to protect their environment. Clearly, at the forefront of this movement, the European Union has been consistently introducing laws and regulations over the last two decades to address the climate crisis and trying to keep up with the demands for more aggressive measures.

My goal with this article is not only to provide an overview of the current EU climate legislation but also to point out the aspects which are still missing. By outlining the policies that touch on the subject of climate change, this guide will help you understand the potential impacts of the upcoming changes for your organisation and stay ahead of the curve.

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Climate Policy and the EU

The EU’s efforts to slow down climate change have evolved significantly over time, broadening the scope of legislation to accommodate new scientific evidence of the grave climate crisis.

Over the years, the EU has continuously invested in research and innovation, international cooperation and market-based mechanisms as a pathway to addressing the climate crisis, and by publishing the all-encompassing European Green Deal in 2019, the EU Commission outlined a clear vision for the future of the block.

Although from a scientific standpoint, one could argue that changes are not being made fast enough considering the urgency of the climate crisis, from a practical point I believe that European institutions have adopted a diligent approach towards the fight against climate change. In 2021, the EU officially adopted the EU Climate Law, legally committing the EU to become climate neutral by 2050. The legislation that is being put forward to implement this target will likely result in tangible progress, while still taking into consideration how fast industries and economies can actually adapt and transition.

How will the EU become climate neutral by 2050? The Fit for 55 Package and the Emissions Trading System (ETS)

Last December, representatives from the European Parliament, the Council of the EU, and the European Commission finally came to an agreement on how to update the terms of the EU Emission Trading System (ETS) as part of the Fit for 55 Package.

The Fit for 55 Package is an extensive legislative proposal that puts into practice the requirements established by the EU Climate Law. Made up of 13 interlinked legislation revision proposals and 6 new policy proposals, the Fit for 55 Package aims to align the European environmental tax and regulatory framework with a number of ESG principles and accelerate emission reductions within the sectors covered by the ETS. The Fit for 55 Package regulates emission reductions in sectors ranging from energy, transport, industry, aviation, buildings and heating.

Understanding the EU Emissions Trading System

The EU Emissions Trading System (ETS) is the world’s first and largest carbon market, and in simple terms, became a mechanism by which the European Union put a price on greenhouse gas emissions. By making heavy polluters pay for their negative contribution to climate change, the block has not only incentivised organisations to reduce their carbon emissions, but also to research and invest in new climate-friendly technologies.

Standing at the core of the EU Climate policy, the Emissions Trading System encompasses greenhouse gas (GHG) emissions from the following sectors:

• electricity and heat generation;
• energy-intensive industry sectors including oil refineries, steel works, and production of iron, aluminium, metals, cement, lime, glass, ceramics, pulp, paper, cardboard, acids and bulk organic chemicals;
• commercial aviation within the European Economic Area;
• including a separate system for suppliers of fuels to road transport and buildings;

As you can see, the ETS framework leaves a number of large and important industries out of its scope but remains a successful initiative by establishing mandatory participation from the sectors responsible for the highest emission rates within the European Union.

What about EU climate policy for sectors not covered by the EU carbon market?

While I certainly agree that the EU ETS is the cornerstone of the European climate efforts, it does not cover all sectors emitting emissions in the EU. It is also far from being the only noteworthy initiative when it comes to addressing carbon emissions emitted by businesses. For instance, EU market players belonging to sectors not covered by the Emissions Trading System are not exempt from meeting climate-related requirements, as the ones included in the policies outlined below. So, here are the main pieces of legislation that businesses from nearly all industries will be expected to comply with.

Corporate Sustainability Due Diligence Directive

Published in late February 2022, the Corporate Sustainability Due Diligence Directive establishes regulations for big corporations to identify and prevent negative impacts on the environment and on human rights in their own operations and within the operations of their business partners and suppliers. This extended level of responsibility also indicates that companies who wish to trade in the EU will likely be required to adopt a plan to ensure that the business model and strategy of the company is compatible with the transition to a sustainable economy and with the limiting of global warming to 1.5 °C in line with the Paris Agreement.

This will require companies to plan ahead and develop more comprehensive sustainability strategies, with initiatives capable of reducing carbon emissions on a much larger scale.

Corporate Sustainability Reporting Directive

The recently adopted Corporate Sustainability Reporting Directive, or CSRD, is one of the EU’s legislations aimed at increasing transparency in sustainability reporting from companies regarding their operations and their value chain.

It establishes that larger companies and listed small and medium sized enterprises must annually report on their environmental and social impact activities, including data on their carbon footprints. These reports should support policymakers, investors and other stakeholders in evaluating a company’s non-financial performance. At the same time, access to such information can help consumers in making more conscious purchase decisions.

The CSRD encourages more climate-responsible business practices among EU market players, among other things, via the mandatory disclosure of scope 1, 2 and 3 carbon emissions. This means that organisations will be obligated to publish performance data regarding the following:

• Scope 1 Emissions: Emissions from sources directly owned or controlled by the organisation, such as those resulting from the fuel burned by a fleet of company-owned vehicles;
• Scope 2 Emissions: Emissions indirectly caused during the production of the energy which an organisation purchases to run its operations.
• Scope 3 Emissions: All other indirect emissions occurring across a business’ value chain and which are not covered by scopes 1 and 2. This would include emissions from employee commute, use of sold products, waste disposal, etc.

Sustainable Finance Taxonomy Regulation

It was June 2020 when the European Commission officially adopted a piece of legislation called Sustainable Finance Taxonomy Regulation. It essentially laid the foundation for the EU taxonomy, which is a classification system that establishes a list of environmentally sustainable economic activities.

Under the Taxonomy Regulation businesses’ sustainability performances are evaluated against six environmental goals:

1. Climate change mitigation;
2. Climate change adaptation;
3. Sustainable use and protection of water and marine resources;
4. Transition to a circular economy including recycling;
5. Pollution prevention and control;
6. Protection and restoration of biodiversity and ecosystems.

Companies in scope of the EU Taxonomy are required to assess whether their economic activities meet the technical screening criteria outlined by the supporting secondary legislation anticipated under the Taxonomy. The Climate Delegated Act regarding climate change adaptation and mitigation was already adopted in 2022.

Economic activities of companies are considered environmentally sustainable if they meet the following criteria:

• Significantly contribute to at least one of the six environmental objectives mentioned above;
• Do no significant harm to the other environmental objectives;
• Meet minimum safeguards for social and human rights;

Similarly to the CSRD, the Taxonomy Regulation incentivises a shift towards climate neutrality by demanding the disclosure of concrete indicators on climate and drawing a clear line between sustainable and non-sustainable financial investments.

Ecodesign for Sustainable Products Regulation

The Ecodesign for Sustainable Products Regulation (ESPR) is a policy developed to encourage the production and consumption of environmentally friendly products within the European market. Under the ESPR principles, a product should be energy-efficient, made of recycled materials, have long durability and a lower environmental impact.

Unlike other industry-specific policies, the ESPR has the potential to encompass a very large set of products sold on the EU market and is, in my opinion, one of the most ground-breaking pieces of legislation published in recent years.

Many aspects of the ESPR will indirectly contribute to slowing down climate change, but as a direct element, companies should prepare to deal with strict design requirements that could include carbon performance requirements on a product level. This is yet to be agreed by EU policy makers.

Current gaps in EU Climate Policy

While the EU has indeed been creating and implementing one of the world’s most ambitious climate policy frameworks, there are still significant gaps which I could not refrain from commenting on.

As I see it, the current legislation is still lacking in sector-specific goals, with clear targets and deadlines for industries in sectors not covered by the EU’s carbon market, like retail and textile, for example.

Another major issue is that even though organisations are now obligated to meet a wide range of climate-related goals relating to reporting and planning, not enough support is being offered to help them in achieving said goals. More importantly, public institutions should work on creating and complementing policies that help smaller players in implementing the measures already foreseen under current legislation, as it will certainly be harder for them to realise the required changes than for the bigger players in the market. However, likely all players of all sizes will need policy support to go down that path. For instance economic incentives to green supply chains will be essential to adopt in supporting the private sector in the transition towards climate-neutral business practices and operations. More initiatives around data collection and technical support would also be welcome, as this is a critical point to assessing the effectiveness of the actions being taken, and readjusting the course as conditions change.

Recommendations for EU companies and what to expect

There is already some noise being made among members of the EU Parliament who advocate for new climate legislation dedicated to the textile sector specifically, but this is a proposition which would likely only be addressed by the next European Commission, entering office in 2024.

However, this does not mean that industry players in general can just sit and wait. Preparation is key to remaining competitive, and there is no point in waiting since we already know that tracking and tracing emissions across the value chain, for example, will be mandatory as part of the upcoming legislation.

For those who see the value of starting immediately to stay ahead of the curve, my recommendation is to begin by evaluating your organisation’s operations and value chain for carbon emission issues and improvement opportunities. Make sure that your investment plans include renewable energy solutions and review the energy efficiency standards of your current suppliers and business partners. As previously mentioned, developing and implementing strong tracking and tracing systems within your organisation and the value chain will be key to measuring carbon footprints and other impacts that require decisive action, as well as setting up climate plans in line with limiting global warming to 1.5 °C in line with the Paris Agreement.

Want someone with deep experience and connections in the EU to help guide your sustainability strategy? Get in touch!

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