EU flags in front of European Commission in Brussels
ESGComplianceAugust 18, 2023

The European Union leads in climate change regulations

Climate change has shown us that the effects of one country or region’s environmental practices and policies reverberate around the world.

The European Union (EU) is making a strong statement through several climate change initiatives. And because the EU is the third largest economy in the world, these policies are impacting the entire planet. Here are some of the more recent ones that companies should be aware of.

Carbon tax for imported products

Beginning October 1, 2023, the EU’s newest initiative, the Carbon Border Adjustment Mechanism (CBAM), will take effect — representing the first-ever carbon tax for imported goods.

According to the European Commission, CBAM will “put a fair price on the carbon emitted during the production of carbon intensive goods that are entering the EU,” and encourage cleaner industrial production in non-EU countries.

In other words, outside goods will be levied a carbon tax if they do not meet EU’s stringent carbon-free requirements.

EU’s CBAM targets carbon leakage. This occurs when companies based in the EU move carbon-intensive production abroad to countries with less stringent climate policies, or when EU products get replaced by more carbon-intensive imports.

By confirming that a price has been paid for the embedded carbon emissions generated in the production of certain goods imported into the EU, CBAM aims to ensure the carbon price of imports is equivalent to the carbon price of domestic production, and that the EU’s climate objectives are not undermined.

The tax is designed to be compatible with World Trade Organization rules.

Initial industries targeted will be the larger carbon intensive ones such as cement, iron and steel, aluminum, fertilizers, electricity, and hydrogen. Eventually, CBAM aims to capture more than 50% of the emissions in the EU’s Emission Trading System (ETS) covered sectors.

The process is the following:

  1. EU importers of goods covered by the CBAM will register with national authorities. They can buy CBAM certificates, whose price which will be based on weekly ETS allowances.
  2. The EU importer will declare the emissions embedded in its imports and will report the corresponding numbers of certificates each year.
  3. If importers can prove that a carbon price has already been paid during the production of the imported good, the corresponding amount can be deducted.

Companies should not be concerned about a sudden financial burden. There will be a gradual introduction of CBAM, which aligns with the phase-out of the allocation of free allowances under the EU’s ETS.

The CBAM will enter its transitional phase on October 1, 2023, with the first reporting period for importers ending January 31, 2024.

Common standards

The EU is also standardizing sustainability reporting through its new European Sustainability Reporting Standards (ESRS), adopted last month. These “common standards” will be required for all companies that fall within the EU’s Corporate Sustainability Reporting Directive (CSRD).

Companies will be expected to take a double materiality approach. This means that businesses must report on both their impact on people and the environment, as well as how social and environmental issues create financial risks and opportunities for them.

There are 12 ESRS standards, covering the full range of sustainability issues. But each has different requirements. For example, ESRS 1 General Requirements sets general principles to be applied when reporting and does not itself set specific disclosure requirements. ESRS 2 General Disclosures, however, specifies essential information to be disclosed irrespective of which sustainability matter is being considered. It should be noted that ESRS 2 is mandatory for all companies under the CSRD scope.

All the other standards and the individual disclosure requirements and datapoints within them are subject to a materiality assessment. A company will report only relevant information and may omit the information in question that is not material for its business model and activity.

Companies should note, however, that disclosure requirements subject to materiality are not voluntary.

Climate change has wide-ranging and systemic impacts across the economy. For this reason, if a company decides that climate change is not a material topic, and chooses not to report, it must prove this with a detailed explanation of the conclusions of its materiality assessment.

Businesses will have to apply the rules for the first time in the 2024 financial year, with reports published in 2025.

Green claims

In March 2023, the Commission adopted a proposal for a Green Claims initiative. The directive aims to stop companies from making misleading claims about environmental merits of their products and services.

In an attempt to prevent greenwashing, the law requires companies to substantiate their environmental claims by:

  • Relying on recognized scientific evidence and state of the art technical knowledge
  • Demonstrating the significance of impacts, aspects, and performance from a life-cycle perspective
  • Taking into account all significant aspects and impacts to assess the performance
  • Demonstrating whether the claim is accurate for the whole product life cycle or only certain stages
  • Demonstrating that the claim is not equivalent to requirements imposed by law
  • Providing information on whether the product performs environmentally significantly better than what is common practice
  • Identifying whether a positive achievement leads to a significant worsening of another impact

The directive also requires greenhouse gas offsets to be reported in a transparent manner. Accurate primary or secondary information must be included.

Even if your company is not located in the EU, there may be direct or indirect consequences of present and future EU climate change regulations on your business.

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