How the EU's Taxonomy Combats Greenwashing

The European Union's criteria for identifying green activities can be a better guide than standard ESG measures.

- By Brian Tomlinson

Despite a recent retrenchment of corporate environmental, social, and governance (ESG) initiatives, asset managers and companies know that sustainable business practices are crucial for reducing risk and delivering shareholder value. Still, they need a reliable way to tell when a business’s activities are truly green and when it’s greenwashing — claiming that its products, services, and initiatives benefit the environment when they do not.

That critical question — what is or isn’t green — has been difficult to answer definitively and authoritatively. That is where the European Union’s taxonomy steps in.

Introduced in 2020 as part of the EU’s European Green Deal strategy for achieving economywide climate neutrality by 2050, the taxonomy uses objective, largely science-based criteria for identifying sustainable business activities. Most important, it establishes the notion of “green by law”: Companies can’t simply claim that their activities are green but must show that they satisfy applicable EU benchmarks. That can make it a powerful safeguard against greenwashing. Large companies with significant operations in the EU, which eventually will include many U.S.-based concerns, have to report on their activities under the taxonomy.

Primarily designed to provide clarity to capital markets and other investors, the taxonomy sets criteria for the sustainability of more than 150 economic activities, such as manufacturing cars, operating a data center, running a water treatment plant, or generating electricity. It asks companies two questions: Do any of your activities contribute to the EU’s sustainability objectives, and do you conduct those activities in a sustainable way?