Interview: the EU Taxonomy is a compass for companies on the road to a sustainable economy

"An absolutely unprecedented economic change is coming and even a small delay in the Czech environment can have major consequences for competitiveness. On the other hand, companies that can quickly navigate the changes related to sustainability can access new markets and business opportunities,” Filip Gregor of Frank Bold described in the Hospodářske noviny podcast.

In the interview, he answers crucial questions for the future of Czech companies, investors and banks and explains that the new EU tools - the taxonomy of sustainable activities and sustainability reporting standards - are meant to help them navigate the green transformation.  Here is an extract of the most important parts of the interview.

HN (Martin Ehl): Let's imagine the owner of a small Czech company who is terrified of every state or EU regulation. What is coming at him from Brussels under the strange word taxonomy?

The taxonomy is an overview of activities that contribute substantially to climate change mitigation and will therefore play a key role in the transformation and decarbonisation of the European economy. It also identifies which activities are not included in this list. For each activity, specific technical criteria are defined which determine the threshold at which the activity can be considered green or contributing to climate change mitigation. For example, in the energy sector, the taxonomy includes renewables. In construction, the classification is mainly based on the energy performance of buildings. The taxonomy also includes criteria for heavy and construction industry, cement or steel production, in short, key activities that cannot be excluded from the economy and that are inherently linked to significant impacts or greenhouse gas emissions.

HN: Do you have a comparison for the taxonomy and other regulations that companies will face in the area of sustainability?

It could best be compared to a compass. EU initiatives, be it taxonomies or sustainability reporting standards, show companies what is going to happen and how to make sense of it. They answer questions such as 'where will financial risks and business opportunities start to emerge in the market' or 'what will be expected from buyers and providers of financial capital, banks and investors'. Companies are not being hit by European regulation, they are being hit by global changes in the economy. And European rules act as a clarification. A compass that shows firms how to navigate the changing environment, what is relevant and what is not.

HN: So is this some kind of preparation for the change in the economy that will come in the next ten years?

Exactly, the coming change in the economy is completely unprecedented. What is happening in the West, which is beginning to reach the Czech Republic mainly from the financial sector, will continue to a degree and extent that we have never seen before. It will all happen very quickly. By the time Czech companies find out what is going on, what activities the taxonomy includes, or what data they need to have ready for negotiations with business partners, it could have major consequences for their competitiveness.

The taxonomy explains what is meant by sustainable activities and what is not. It is up to each entrepreneur to decide which path to take.

HN: Let's describe the situation using the example of a small company that produces plastic packaging. What should it prepare for?

The taxonomy is not a regulation of any specific activities, it is purely a classification for the purpose of investment in modernisation and innovation. For the small firm, the taxonomy is relevant when it decides to raise money for modernisation. In that case, the criteria of the taxonomy are very likely to influence how banks and investors will look at its application for finance, and also what the subsidy titles will be in that area. This is not to say that subsidy titles are necessarily the way to modernise, but taxonomy criteria will play quite a major role in subsidies as well. If the company is supplying a sector that is going to undergo major changes, the taxonomy is an indicator of the changes it needs to prepare for.

HN: So the Czech Republic can expect big changes as the nature of industry will change and, for example, the automotive sector will move towards electromobility. Companies that want to prepare, modernise and innovate will have to deal with the taxonomy somehow.

It's true. But exactly how it affects a particular company depends on its position in the market. For some companies, the taxonomy may be very significant, while others will not be affected. The whole transformation of the European economy can be well explained in macroeconomic terms. The United Nations Commission on Business and Sustainability has estimated the value of the opportunities in the economic transition at €10 trillion per year until 2030. CDP, for its part, has aggregated data from more than eight hundred European companies estimating the economic opportunities and risks associated with upcoming market changes, such as the transition to electric vehicles. It estimated the value of the economic opportunities at €1.2 trillion and the economic costs at €192 billion.

It is, of course, macroeconomic numbers that permeate the market. The changes will lead mainly to large companies, but they will also reach smaller Czech companies through the demands of large European companies, to which Czech companies are mainly connected through supply chains and the automotive industry.  It is up to the individual entrepreneur to find a suitable path and assess whether his business will be successful, whether it is to produce classic cars or electric cars. In this respect, the taxonomy is a very subtle tool - it just creates a framework for people to understand what is meant by sustainable activities and what is not. In short, so that business knows where to go and what to expect.

The EU is going the way of the market and free choice for companies

HN: Companies are concerned that the new regulation will impose new costs and additional bureaucratic burdens on them. How will the regulations be controlled or enforced?

The whole system is built on market propulsion, not on state control. There is quite a lot of interest from investors and banks in redirecting investment into transformational and green activities. Financial institutions can calculate that if they do not change their portfolio, they will run into major problems in the future. But now they have nothing to guide their investments. There are corporate activities that could be described as green and transformational, but no one has clear criteria for what exactly these terms mean. That is what the taxonomy is supposed to solve. The new rules will therefore be enforced primarily by the market. Companies themselves will need to collect sustainability information in order to access loans, investment or to be able to negotiate with their customers.

HN: Why is such a fundamental change planned now?

The most important reason is that the current system does not work. There are dozens and perhaps even hundreds of initiatives trying to set criteria or indicators for green investments. If we add up all the recommendations from all the initiatives, we get over five thousand different indicators. Which no company can report. Most of these indicators are about the same things, they overlap, which makes the situation even more chaotic. The second reason is that we have no time left. Either we can transform the economy to a carbon-free model or we cannot. If we do not, our future will not be very favourable. It is therefore high time we took a step towards a carbon-free economy. Europe is taking a specific path towards this, based on market solutions and free choice. The EU merely sets the parameters of the system and leaves the market to deal with it. Which is both people-friendly and, of course, business-friendly.

The transition to sustainability will not weaken competitiveness, on the contrary

HN: Could the forced "greening" of European companies limit their competitiveness in the future? Isn't there a risk that Europe will be the only one to follow the rules it sets, while other countries will not?

The answer to this question has multiple levels, from the philosophical to the practical. On the philosophical level, it is simple - if we do not start doing something in Europe, how can we rely on other countries to decarbonise? The second level is that the trend towards sustainability is already clear everywhere in the world. Even in China and America, they are adopting plans to decarbonise and change the way markets and production work. On a practical level, the Union is counting on the impact of standards beyond the EU's borders. It would not make sense if we greened our economy inside the EU and just moved the 'dirty' activities to China or elsewhere. Therefore, one of the conditions for classifying an activity as green is that the value chain of the activity must not involve negative environmental or human rights impacts. This could be, for example, the clearing of rainforests for the extraction of raw materials.

At the same time, it is not true that by switching to sustainability and modern technologies we will automatically become less competitive. On the contrary, green and modernisation activities are more likely to enhance competitiveness. Of course, they involve initial investment, which is what the EU is trying to address with the taxonomy, which serves to mobilise and better target private and public investment. However, having overcome this, the EU should be far more competitive and put itself in a stronger position in terms of exporting technology to the rest of the world, which will also be modernising and getting rid of unsustainable activities.

HN: Consumers may fear that the emphasis on sustainability will translate into higher prices for products and services. Is this concern justified?

Sustainability is an aspect of quality and all quality comes at a cost. But it very much depends on how widespread the practice is. If we are talking about, for example, fair trade or organic products, these are more expensive not only because of the higher costs, but also because there is a smaller market for them. The moment a certain quality of product becomes mainstream, the cost goes down. That is an economic law. So, if the whole European initiative is successful, the increase in costs should not be so great in the medium to long term. Moreover, all the estimates of the amount of investment versus the return show very positive results. There is a barrier in the form of investment at the beginning, but after that it is much more profitable for the company.

At the same time, if sustainability is a qualitative aspect, it can be likened to all the improvements and upgrades of the past. For example, if we look at the development of mobile phones or cars, the increase in quality in recent decades is completely unimaginable. Yet mobile phones and cars are significantly cheaper. So for the greening of companies to translate into a significant price increase for consumers, something extraordinary would have to happen that has not happened in any other quality shift.