Business & Human Rights: Navigating "Minimum Safeguards" under the EU Taxonomy Regulation

The EU Taxonomy Regulation (the "Regulation") is a highly complex piece of legislation which sets out a classification framework in order to determine whether an economic activity carried out by an undertaking is environmentally sustainable. 

As EU Taxonomy alignment reporting obligations begin to bite for companies with operations in the EU, companies are now having to come to terms with the practical implications of the requirements of the Regulation and the various overlapping and disparate sources of guidance.

A disclosure of EU Taxonomy Regulation alignment necessarily includes an analysis of whether a company's operations conform with minimum standards of business conduct, which includes compliance with certain human rights-related principles under the "Minimum Safeguards" principle.

In practice, particularly for companies whose operations or industry area are subject to particular scrutiny, meeting the Minimum Safeguards requirements (or determining whether they have been met) is likely to be complex and onerous.

This article sets out some of the published guidance in relation to Minimum Safeguards and particular areas of caution for affected companies to be aware of. Our October 2023 article contains further information in relation to the Regulation, its scope and reporting requirements more generally.

What are Minimum Safeguards?

Article 3 of the Regulation specifies that one of the four qualifying criteria for an environmentally sustainable activity is that it is "carried out in compliance with the minimum safeguards laid down in Article 18". Article 18 of the Regulation describes the Minimum Safeguards as: "procedures implemented by an undertaking that is carrying out an economic activity to ensure the alignment with the OECD Guidelines for Multinational Enterprises ["OECD Guidelines"] and the UN Guiding Principles on Business and Human Rights ["UNGPs"]…".

The OECD Guidelines and the UNGPs are both non-binding soft law instruments that set out due diligence expectations of undertakings in respect of human rights ("HRDD"), as well as expectations of businesses more broadly, including in relation to companies' approach to corruption risk management, tax compliance and labour-related issues.

A company's HRDD processes and procedures, which apply across the whole undertaking and not to individual activities, will therefore be determinative of whether or not its economic activities meet Minimum Safeguards. The EU's Commission Notice or FAQ of 16 June 2023¹ makes this very clear:

"...undertakings whose activities are to be considered as Taxonomy-aligned must have implemented due diligence and remedy procedures to ensure alignment with the standards for responsible business conduct …in the OECD Guidelines … and the [UNGPs]...an undertaking must implement appropriate procedures, including procedures to continuously identify, prevent, mitigate or remediate the relevant actual and potential adverse impacts connected with their own operations, value chains and business relationships..."

The Minimum Safeguards requirement is effectively an absolute barrier to taxonomy alignment, such that no undertaking can claim any alignment without first establishing that their operations meet the Minimum Safeguards requirements. That is, no matter how environmentally sustainable a particular activity or an undertaking's operations are, it will not qualify as environmentally sustainable under the Regulation without compliance with human rights and labour standards in accordance with the OECD Guidelines and the UNGPs.

However, given the non-binding and high level expression of HRDD principles set out in the UNGPs and OECD Guidelines, assessing a company's operations and the extent to which they do or not meet these human rights standards is complex and has been a particular source of difficulty for companies during the course of preparing their disclosures.

Problems of assessing compliance with Minimum Safeguards – the Platform Report

In October 2022 in order to address concerns raised by stakeholders, the Platform on Sustainable Finance released its "Final Report on Minimum Safeguards" (the "Platform Report").

The Platform Report provides detailed advice on the application of Minimum Safeguards in relation to the Regulation, including embedding Minimum Safeguards in existing EU regulation, identifying substantive topics relating to the standards and norms referenced in Article 18, and presenting advice on compliance with Minimum Safeguards.

The Platform Report emphasises the importance of HRDD as the core of Minimum Safeguards, recommending that undertakings implement HRDD processes based on the six steps of the UNGPs/OECD Guidelines. These steps are:

1. embedding responsible business conduct into policies and management systems;
2. identifying and assessing actual and potential adverse impacts;
3. ceasing, preventing, or mitigating adverse impacts;
4. tracking implementation and results;
5. communicating how impacts are addressed; and
6. providing for or cooperating in remediation when appropriate.

The Platform Report proposes a two-step approach to assess non-compliance with the HRDD element of the Minimum Safeguards:

1. Inadequate or non-existent HRDD processes; and
2. Indicators that that the company does not adequately implement HRDD resulting in human rights abuses.

Criterion (a) requires an evaluation both of the procedures a company has in place and the outcomes of those procedures, specifically looking at how effective the company's HRDD is in preventing and addressing impacts on human rights – across its own operations, value chains and business relationships. It is thus both procedurally and outcome based (i.e. based on the written policies and procedures, and the real-world results of such policies).

Criterion (b) focuses on specific instances of human rights issues that may arise from inadequate HRDD. This includes situations where a company or its top management violates laws related to HRDD, labour, consumer protection, data privacy, humanitarian concerns, or criminal statutes. It also considers whether a company engages in dialogue with an OECD National Contact Point regarding alleged breaches of the OECD Guidelines or if it fails to address issues raised by the Business and Human Rights Resource Centre ("BHRRC").

Minimum Safeguards, the CSRD, the CS3D and other sources of guidance

As noted above, the Platform Report acknowledges that the Corporate Sustainability Reporting Directive ("CSRD") and the Corporate Sustainability Due Diligence Directive ("CS3D") are closely linked to the Minimum Safeguards requirement and may provide a framework for assessing compliance. The Explanatory Memorandum to the CS3D in particular contains a provision that the CSRD will "complement" the Regulation and refers explicitly to the Minimum Safeguards in Article 18 of the Regulation.

The Platform Report states that a company's alignment with new due diligence and reporting laws could aid in determining compliance. For example, a company's disclosures under the European Sustainability Reporting Standards, which have now been put in place under the CSRD, can shed light on the adequacy of the company's HRDD procedures. Similarly, adherence to the HRDD requirements of the CS3D will be relevant, in advance of its coming into effect.

"Controversy screening" – controversy data as an indicator and particular issues for high-risk industries

The Platform Report and the earlier March 2020 "Taxonomy: Final report of the Technical Expert Group [TEG] on Sustainable Finance"² report also highlight the use of so-called "controversy screening" in assessing compliance with Minimum Safeguards. Controversy screening determines companies' involvement in controversial conduct and can be used by both external stakeholders and teams charged with assessing Minimum Safeguards compliance.

Such screening generally involves checking credible information sources, such as reports from international organisations, credible civil society and media, as well as established data providers or entities such as the BHRRC. Stakeholders are also likely to consult reports from national authorities or statements from National Contact Points.

For external stakeholders, a positive result (i.e. indications of human rights issues) is likely to serve as an indicator that there are gaps in a company's HRDD and, potentially, that a company does not meet Minimum Safeguards. Companies professing to meet Minimum Safeguards requirements whilst having public reports of human rights issues may expose themselves to additional scrutiny and/or legal risk.

Companies operating in high-risk industries, such as textiles, agriculture or extractive industries or in high-risk geographies are likely to be the subject of particular scrutiny and thus more likely to be the subject of public reports of human rights issues. A December 2021 study by FTSE Russell³ indicated that just 3.4% of the stocks of the FTSE Global All Cap Index would be deemed by them to have met the Minimum Safeguards requirements in light of controversy screening results. We note that the actual number of companies currently disclosing that they meet Minimum Safeguards requirements does appear to be higher than this figure.

It should be highlighted that the Platform Report is produced by an expert group and is not legally binding. A literal application of the Platform Report will present a real challenge to many companies who are yet to fully engage with the upcoming requirements of the CS3D.

Suggested approach

Companies, and high-risk companies in particular, should therefore take caution in making any disclosure of taxonomy alignment, and are advised to consider the following before doing so:

1. Carrying out a comprehensive analysis of existing HRDD processes and procedures across the entire undertaking, including a consideration of all geographies in which the undertaking operates. This should include a consideration of the extent to which such processes and procedures are in fact embedded across the undertaking, an understanding of the real world outcomes, and an identification of any gaps in the HRDD framework;
2. Monitoring, on an ongoing basis:
   1. all human-rights related reports identifying the company or its operations (i.e. controversy screening), including by regular reference to the BHRRC;
   2. developments in applicable regulation, guidance or soft-law instruments that may have an impact on the company's HRDD obligations; and
3. Responding promptly to any human rights-related complaints made: i) directly to the company, ii) via the relevant National Contact Point, or iii) in any credible media source, and where appropriate taking the necessary measures to the address the issues contained therein. Such measures should address the identified issue on an outcome-determinative basis, in addition to remedying any policy or procedure deficiency identified.

Impacted companies' internal sustainability specialists should work closely and on an ongoing basis with the relevant legal team and, where appropriate, external legal specialists in the area to ensure compliance. We would also advise that legal expertise is incorporated into the entire development process of all sustainability-related disclosures, given the increasing complexity and number of regulations now underpinning such disclosures.