Understanding the impact of minimum safeguards on US companies

In October 2022, the Platform on Sustainable Finance (an advisory committee that provides guidance on how to implement and use the EU taxonomy) published a final report on “minimum safeguards.” This report provides key guidance to the business sector and authorities on how to implement these safeguards (although it is not a binding EU document). The minimum safeguards integrate international standards for responsible business conduct and if companies don’t comply with the minimum safeguards, their activities will not be aligned with the EU taxonomy.

Unfortunately, although the report provided useful guidance on applying these safeguards, they can still be confusing to understand and align with. For US companies, understanding their impact can be even less straightforward. Do they affect US companies? How do they compare to legislation in the US? Should US companies align with these safeguards? Do they have anything to do with other EU legislation, such as CSRD (corporate sustainability reporting directive) or SFDR (sustainable finance disclosure regulation)?

In this article, we’ll tackle some common questions about the minimum safeguards, and help clarify what these safeguards mean for US companies.

In simple terms, “minimum safeguards” are the rules for meeting basic societal expectations for responsible business conduct. The safeguards require companies follow the UN Guiding Principles on Business and Human Rights and the OECD Guidelines for Multinational Enterprises within four key areas:

• Human rights, including labor rights
• Anti-bribery/corruption
• Taxation
• Fair competition

The overall goal of the EU taxonomy is to establish definitions of which economic activities are environmentally sustainable. When the EU taxonomy was developed, there were concerns that certain activities could be labelled “sustainable” but also have negative impacts on human rights or be linked to non-compliant business practices. The safeguards alleviate these concerns by also requiring companies to demonstrate they are aligned with specific responsible business conduct frameworks.

For each of the four key categories, companies need to assess:

• Process: Do we have the right processes in place to ensure our business is meeting societal expectations in this category?
• Performance: Do we have any instances of non-compliance in this category? (For example, are there any known court decisions against us around these topics?)

For further information on what assessment against these criteria looks like, see our previous article introducing the topic: Minimum safeguards – one step closer to clarity.

The steps a company needs to take for due diligence will depend on what issue they are addressing. For example, for human rights, companies will need to complete several key steps:

1. Issue a public commitment to human rights due diligence

a. Develop, adopt, and communicate this commitment to all relevant stakeholders

2. Integrate the commitment into the organization

a. Embed commitment in management systems, operational policies and procedures, capacity building, incentives, etc.

3. Implement internal audit, correction, and remediation processes

a. Establish a system to identify, prevent, mitigate, and account for adverse human rights or other responsible business conduct impacts

4. Track negative impacts and their remedies, establish a reporting mechanism, and communicate

a.Track non-compliance with policy

b.Track remedies for these impacts

c.Communicate on its human rights due diligence

If a company doesn’t comply with the safeguards, it isn’t compliant with the EU taxonomy and its activities cannot qualify as environmentally sustainable under the EU Taxonomy. Since the EU taxonomy is all about disclosure (and not about compliance), there isn’t a penalty for not aligning with the EU taxonomy (as long as the company is disclosing information). However, not aligning with the minimum safeguards / EU taxonomy could have other negative impacts on reputation, access to capital, ability to compete in EU markets, etc.

Luckily, companies can improve alignment. If companies address their deficiencies and implement procedures to ensure issues won’t arise in future, they can become aligned (and therefore align with EU taxonomy).

Since the safeguards are part of an EU regulation, it would be easy to assume they don’t impact US companies. Unfortunately, the answer isn’t quite that simple.

The minimum safeguards apply to all companies looking to classify their activities as taxonomy aligned, which includes for instance:

• Financial market participants offering products in the EU that are pursuing a sustainability-related objective
• Large companies required to publish a non-financial statement (currently dictated by NFRD (non-financial reporting directive) and in the future by CSRD)

What this means is that US companies with significant business in the EU will likely be impacted by these safeguards. For example:

• Company A has an EU division that makes over 150 million in revenue, requiring them to do non-financial reporting CSRD. This means that they would also need to comply with the EU taxonomy and align with the minimum safeguards at company level for any qualifying activities they report.
• Company B is a financial market participant hoping to classify their products as having an environmental objective under SFDR Article 9. To do so, they must disclose their EU taxonomy alignment. This would also require them to assess the minimum safeguards of the investee.
• Company C is a supplier to a major EU company. Since the minimum safeguards assign responsibility to companies for negative impacts in their entire value chain, Company C may need to provide information to support the major EU company with their alignment. Company C may even choose to implement certain due diligence systems and documentation to be in place as a matter of compliance and risk management. These human rights due diligence processes will give US companies a competitive advantage when operating with EU companies.

As an additional note, the minimum safeguards are based on the same international frameworks as SFDR and CSRD. The Platform on Sustainable Finance’s final report provides information on how all these standards and regulations are related.

The US government also requires that companies apply human rights due diligence and respect internationally recognized human rights. For example, federal regulations restrict the import of products made with forced, prison, or child labor (US Tariff Act of 1930). The US is also working to keep these up to date - laws were expanded recently to address atrocities occurring in Xinjiang (Uyghur Forced Labor Prevention Act in 2021).

However, the US has stopped short of establishing mandatory disclosures around these practices. There have been federal several bills introduced in the past few years on this topic, but none have been successfully implemented. Examples include:

• Business Supply Chain Transparency on Trafficking and Slavery Act (2015)
• Corporate Human Rights Risk Assessment, Prevention and Mitigation Act (2019)
• Slave-Free Business Certification Act (2020)

At the state level, only California has passed legislation in this space. The California Transparency in Supply Chains Act (2010) required companies to disclose information on their efforts to eradicate human trafficking and slavery within their supply chains.

This means that companies that chose to align with the minimum safeguards would be going beyond any disclosures or practices required in the US today.

Companies should complete two steps in the short-term:

• Determine how relevant the safeguards are to your company
• If applicable, conduct an internal assessment of your company’s practices to understand where there might be gaps to the established minimum safeguards

The first step is to understand how important it is to your company to comply with the minimum safeguards. As mentioned previously, 1) US companies with significant EU operations or 2) companies that rely on EU investments may be directly affected by these safeguards.

If you company isn’t directly affected by the safeguards, you should still consider:

• Are we planning to grow in the EU in the future?
• Do we have significant business partners in the EU? Are we part of an EU supply chain that may ask us for this data?
• Are others in our industry looking at these minimum safeguards?
• Have we (or our industry) had any negative impacts from business or human rights controversies in the past?

Companies that answered “yes” to any of these may decide to voluntarily align with the minimum safeguards. Benefits to aligning could include:

• Mitigating risk from future legislative impact (such as the up-coming EU Corporate Sustainability Due Diligence Directive)
• Strengthening of international business relationships
• Protecting access to capital
• Improving competitive positioning
• Improving brand reputation

If companies decide to comply with the safeguards, the next step would be to assess the company’s current practices around business and human rights. This will identify areas where companies could improve current practices to meet the minimum safeguards. With those areas identified, companies can develop a plan to improve their internal processes and close the gaps.

To quickly summarize:

• “Minimum safeguards” are part of the EU taxonomy and are rules for meeting basic societal expectations for human rights and business practices
• US companies with significant EU business / funding may need to comply, but these rules won’t directly impact most US business
• Companies should first evaluate whether complying with the safeguards is mandatory or strategic for their specific business
• Companies that are interested in complying should start with understanding their current state and identifying any gaps to the minimum standards

Some companies won’t be ready to fully integrate these minimum safeguards into their business practice – that’s fine. These companies should continue to monitor this space to understand how the minimum safeguards are used in the EU, and how they may impact the US in the future. For example, new EU battery regulation sets rules around comprehensive due diligence (including social considerations) and will impact the global industry. This legislation may provide an indication of where other major EU and national legislation is heading.

Whether companies adopt the minimum safeguards now or not, increased focus on business and human rights is a good thing. Awareness and transparency around these should have positive impact on individuals working around the world and ensure that businesses can grow and thrive in a truly sustainable way.