Request Free Trial
August 10, 2022

Stalled EU social taxonomy raises questions on just transition

Experts warn that added delays to the inclusion of social objectives in the EU taxonomy will leave market participants with disjointed guidelines on how to define socially sustainable investments.

The extension of deadlines and a news report indicating that the social taxonomy may be “shelved indefinitely” have cast doubt on whether the EU will succeed in extending its framework to incorporate social welfare criteria.

In late February this year, the EU Platform on Sustainable Finance – an independent body advising the EU Commission – published its final report outlining proposals for a social taxonomy. These proposals and the commission’s own report on the matter were originally scheduled to be finalised last year but encountered several postponements.

An EU official told Sustainable Views the commission still intends to publish its own report “in due course” as required by the taxonomy regulation. Further, the official added: “The Platform’s report does not prejudge any decision by the commission on the matter.”

What did the Platform propose?

The suggested structure for a social taxonomy mirrors the existing taxonomy by proposing the development of social objectives, types of substantial contributions, ‘do no significant harm’ criteria, and minimum safeguards.

However, it differs from the current structure as it centres on three social objectives (decent work, living standards and inclusive communities) based on three stakeholder groups (workers, consumers and communities). It also contains further sub-objectives such as health and safety, fair wages and non-discrimination.

Though echoing the structure of the environmental taxonomy should help in aligning EU regulation on sustainable finance, it has also generated some criticism from socially conscious investors.

Mathilde Dufour, head of sustainability research at French impact-focused investment firm Mirova, points out that the proposal “for all its internal consistency, poses many challenges if it is to be operational in the daily lives of investors”.

She notes that the Platform’s final report no longer differentiates between the positive contribution of products and services (activities with high social added value such as education and health) and the positive contribution of good practices implemented in the internal processes of a company (good human resources management, respect for human rights).

This is problematic because the lack of differentiation calls into question what objectives the social taxonomy actually serves she says. “The arrangement of objectives per stakeholder and the use of international standards (the Charter of Human Rights and the Organisation for Economic Co-operation and Development principles) in the absence of scientific criteria, reflect the challenge of achieving a consensus on these topics,” she added. 

Dufour suggests that a future development of the social taxonomy – if the European Commission agrees to it – should go further than the Platform’s final report, by clarifying overarching goals and setting specific social objectives.

Moreover, there is no focused guidance that links the concepts of ‘do no significant harm’, minimum safety guards and double materiality across EU legislation, although work is being done to address this, says Sukhvir Basran, senior legal director and global co-head of sustainable finance and investment at law firm Hogan Lovells.

Existing social provisions

The delay in establishing a social taxonomy is likely to hamper efforts to mobilise financial flows towards socially focused economic activities and investments, says Basran. “This leaves market participants with a number of frameworks, leading to a fragmented approach across existing regulation, soft law and industry guidelines.”

At present, EU regulation incorporating social issues focuses predominantly on disclosure, with a few proposals going into more depth. The Sustainable Finance Disclosure Regulation, which has been in force since March 2021, requires market participants to report “principal adverse impacts” of investment decisions on sustainability, which also include social factors.

The Corporate Sustainability Reporting Directive, not yet in force, will also extend mandatory reporting requirements on social factors to all large companies established in the EU and all listed companies in EU regulated markets.

Even the current taxonomy demands economic activities to comply with minimum social safeguards, such as fundamental labour rights, in order for those activities to be labelled “environmentally sustainable”.

However, so far, the most ambitious regulatory initiative is a directive on corporate sustainability due diligence, currently still at the proposal stage. This would embed human rights and environmental considerations in companies’ operations, corporate governance and supply chains inside and outside Europe. 

Mirova’s Dufour says: “While there is no doubt that compliance with certain minimum standards of practice would have enormous social added value in the most sensitive sectors, the main challenge for a social taxonomy is that of ambition; of ensuring genuine social impact that does more than simply rubber stamp good practices without obvious added value.”

Colliding factors

The recent labelling of certain nuclear and gas activities as green under the EU taxonomy has both divided the European Parliament and confused the sustainable finance community.

“New challenges are emerging, such as whether to describe certain previously excluded sectors as sustainable or attempts to pit the objective of climate transition against that of social protection,” says Dufour.

The war in Ukraine has also exacerbated the challenges of achieving of a just transition, as the EU bloc faces the dilemma of tackling energy security and high inflationary pressures while still fulfilling its climate ambitions. An intense debate around the categorisation of defence-related activities in an ESG context has also emerged.

Addressing the social part of ESG is, however, crucial to achieving a just transition to a sustainable future, experts say. In the absence of a social taxonomy, says Basran at Hogan Lovells, convergence, education and awareness will fall on service providers and field-building organisations, and rely on collaboration initiatives and the sharing of case studies.

A service from the Financial Times