EU Social Taxonomy Proposal: simpler and meaningful but half-way through

22 - minute read

 

In line with the Taxonomy Regulation [1] and following the European Commission’s request, the Platform on Sustainable Finance (hereafter the “Platform”) published its final report on the relevance and avenues to extend the EU Taxonomy to social objectives. The study released by the Platform on February 28th attempts to answer whether and how a Social Taxonomy could be developed.

Alike the environmental classification, the purpose of a potential EU Social Taxonomy is to unambiguously define what constitutes a “social investment”. One remembers its future existence is hypothetical because such creation has not been decided yet and hurdles are manifold.

Indeed, the Platform’s report does not bind the European Commission on any decision on the matter. Nonetheless, it provides a compass for whoever is willing to properly embed social dimensions in sustainable finance approaches, initiatives, methods or even products. It offers guidance to define “social investments” and, to a less usable extent, provides measurement instructions. Such work is timely because the provision of basic goods and services (especially for vulnerable groups), in particular by private entities, must be spurred and framed without succumbing to social washing.

The most desirable impact of a Social Taxonomy would indeed be, quoting the Platform, to have a knock-on effect on economic entities, which would “strive to be recognised as ‘social’ investments, provide the necessary data, intensify efforts on social economic activities and implement the necessary processes”.

 

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Contents

A long way to go 

PART I. Content of the Platform's Proposal

    1. A simplified yet substantial Proposal

    2. A comprehensive and diverse set of social sub-objectives

    3. Governance aspects as a separate layer

    4. A three-fold “substantial contribution”

    5. Selecting sectors and activities

    6. Assessment levels puzzle

    7. The AAAQ concept

    8. Articulating environmental and social taxonomies

PART II. Backstage concerns, discussions and proposal status

    1. What is missing or underexploited

    2. The socially harmful activities have been kicked into touch

    3. Enforcement and reliable verification mechanisms

    4. Sincere or feinted misunderstanding?

    5. What desirable status for such hypothetical Social Taxonomy?

    6. Natixis’ view on a shaded Social Taxonomy

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A long way to go

Even though the Report will probably resonate within Brussels, the European legislators are not tied to the Platform’s recommendations. The Commission is poised to publish a communication presenting its own conclusions and intents on the matter by the end of the year. In our view, reaching a politically vetted and fully enforceable hard-law classification endorsed by the Parliament and the Council is more of a moonshot than a short-term regulatory development.

However, the Platform’s insightful work and related discussions could be instrumental. One should not be mistaken; the Platform’s report does not offer on the shelves usable criteria that EU Member States intend to object or dismiss. Nonetheless, it properly identifies the main methodological challenges, constraints and accordingly proposes design principles.

The Report encompasses structural elements around objectives, sub-objectives, substantial contribution, DNSH, and the different types of ‘substantial contribution’ (see Table 6 in Appendix, “Example of sector selection, substantial contribution and DNSH for decent work objective and living wage sub-objective”). This is a preliminary work, with extensive contextual information and approach guidance. It initiates the complex calibration and standardization of social matters.

Efforts towards consistency with the rest of the regulatory landscape are laudable (Corporate Sustainability Reporting Directive (CSRD); the Sustainable Finance Disclosure Regulation (SFDR); and the Sustainable Corporate-Governance (SCG) initiative).

 

PART I. Content of the Platform's Proposal

1. A simplified yet substantial Proposal

As compared to the Draft Report, analyzed in our June 2021 Newsletter [2], the suggested Social Taxonomy layout proposed has been wisely simplified. The horizontal and vertical dimensions of the initial Proposal have been replaced by a single outline based on three social objectives, inspired from the Environmental Taxonomy structure, specifically: i) decent work, ii) adequate living standards and well-being (iii) inclusive & sustainable communities and societies.

The three social objectives are linked to three types of stakeholders affected by business activities:

     A. Decent work for an entity’s own workforce (including value-chain workers);

     B. Adequate living standards and wellbeing for end-users [3] or consumers;

     C. Inclusive and sustainable communities and societies for affected stakeholders (directly or through the value chain).

This stakeholder segmentation is similar to the one in the approach to non-financial sustainability reporting by companies under the proposed Corporate Sustainability Reporting Directive (CSRD) [4]. Such consistency would limit the burden of deciphering EU legislative package (i.e. investors and companies facing different reporting requirements for different legislative Acts) [5].

The Report provides particular guidance around:

• The development of sub-objectives;
• Types of substantial contribution and how they could work;
• The special role of DNSH and minimum safeguards in a Social Taxonomy;
• The rationale for selecting sectors;
• Linking substantial contribution to capital expenditure (CapEx), operational expenditure (OpEx) or turnover.

 

Source: Authors (Natixis GSH), based on Platform’s Report

4. A three-fold "substantial contribution"

The Platform suggests following steps similar to the Environmental Taxonomy by:

    (i) Setting social objectives;

    (ii) Setting out the substantial contribution that can achieve these objectives; and

   (iii) Drawing up criteria that apply the principle of not doing any significant harm, so that contributing to achieving one objective is       not detrimental to the others.

The Platform distinguishes three forms of substantial contribution: maximizing positive impacts, minimizing negative ones, and enabling other activities to provide social benefits (see table 2 below).

Table 2: The three types of substantial contribution for a Social Taxonomy envisioned by the Platform

TYPE OF CONTRIBUTION	EXPLANATIONS OR ILLUSTRATIONS	SECTORS OF RELEVANCE
#1. Maximizing positive impacts	Enhancing the inherent social benefits of activities, products or services contributing to adequate living conditions (additional benefits)	Goods & services related to basic human needs or economic infrastructures (ex: food, water, education, access to housing, healthcare, transport, and telecommunications)
#2. Minimizing negative ones	Avoiding and addressing adverse impacts on workers, consumers and communities, for instance occupational health & safety; training workers for a just transition; paying wages agreed in collective agreements; and ensuring a decent life for the worker and his/her family	High-risk sectors with documented human-rights and labour-rights abuses track-record
#3. Enabling other activities to provide social benefits	Social auditing services which help guaranteeing decent working conditions for value-chain workers Carrying out tests to discover harmful substances in consumer products	Economic activities have the potential to enable substantial risk reductions in other sectors

Source: Authors (Natixis GSH), based on the Platform’s Report

 

5. Selecting sectors and activities 

Unlike the environmental Taxonomy for which activities were selected based on high-emitting NACE sectors, there is currently no single authoritative research resource that covers a large number of economic sectors and identifies their associated social or human-rights risks.

Nevertheless, the Platform explains that there are several organizations, initiatives and resources offering detailed insights and guidance (see table 3 below).

Table 3: Sources offering insights and guidance on social and human right helping in sector selection

Sector-oriented standards and guidance	Relevant ILO reports; OECD sectoral guidelines on responsible business conduct; Sector standards set out by the Global Reporting Initiative; Standards developed by international financial institutions industry and multi-stakeholder initiatives.
Sector-oriented benchmarks	Corporate Human Rights Benchmark; The World Benchmarking Alliance benchmarks; KnowtheChain; The Access to Medecines Index; Ranking Digital Rights.
The Business and Human Rights Resource Centre’s lawsuits and allegations databases	Cover the human rights impacts related to more than 20 000 companies.

Source: Authors (Natixis GSH), based on the Platform’s Report

Furthermore, the Platform suggests selecting economic sectors that are relevant for the “reducing negative impacts” substantial contribution at the sub-objective level (unlike the environmental Taxonomy in which sector selection is performed at the objective level).

Prioritization is proposed regarding economic sectors with the highest general severity of risks (where possible based on gravity, scale and irremediably considerations).  The Table 4 below describes examples of high risks sectors related to decent work and selected sub-objectives.

To take another example, for the sub-objective “training”, high impact sectors could for instance be selected based on skills shortages or sectors negatively affected by the green transition or digitalisation with particular risks of layoffs, and therefore a special need to train certain groups of employees.

Table 4: Examples of sectors of relevance regarding decent work and selected sub-objectives envisioned by the Platform

SOCIAL OBJECTIVE: DECENT WORK
Sub-objectives	Sectors of relevance
Living wage	High-risk sectors including sectors with high prevalence of contingent workers and/or workers earning the minimum wage – including in countries where the minimum wage is below a living wage (for example, calculated as below 60% of the median wage).
Occupational Health and Safety (OHS)	High-risk sectors identified based on Occupational Health and Safety incident statistics, e.g., including: B-Mining and Quarrying; C-Manufacturing; F-Construction; A-Agriculture, Forestry and Fishing; H-Transportation and Storage; D- Electricity, Gas, Steam and Air Conditioning Supply
Training	Sectors with skills shortages, according to OECD and EU data; Sectors negatively affected by the green transition or digitalization with associated risks of layoffs; Sectors with shortages of general skills.
Diversity and inclusion	Relevant in all sectors.

Source:  Authors (Natixis GSH), based on the Platform’s Report

 

6. Assessment levels puzzle

The Platform advises to develop both substantial contribution and Do No Significant Harm (DNSH) at the sub-objectives level (under the same “headline objective”), offering real granularity.
“Do No Significant Harm criteria” can be assessable either at activity or at entity level. Whether contribution must be assessed at entity or activity level is a daunting question. The Report rightly points out that the first type of substantial contribution (#1 maximizing positive impacts) is more relevant at activity-level, calling for activity linked information requirements. It would thus require going beyond CSRD which is a disclosure requirement for entities.

Conversely, corporate governance topics would be more linked to the entity level and eventually recognized as minimum safeguard criteria. The Platform mentions situations where neither turnover nor expenditures can meaningfully be linked to sub-objectives like freedom of association and taxation, topics closely related to measures at the entity level. In that case, DNSH may play a higher role.

 

7. The AAAQ concept

The Platform pinpoints that “most economic activities such as the creation of decent jobs, paying taxes and production of socially beneficial goods and services can be considered inherently socially beneficial”. The challenge is therefore two-fold: guaranteeing DNSH on other social sub-objectives and defining outstanding/additional social performances or benefits.

For the latter, the Platform states that “it must be possible to identify activities which are typically part of minimum standards or ‘business as usual’ and to exclude these activities”. In our view, it might prove difficult to avoid a situation where all/any pro-active risk mitigation is considered a substantial contribution. In the meantime, “business as usual “can also be highly contributive.

The Report proposes to reward measures at activity level that are:

    (i) Credible;

    (ii) ‘Best in class’ in terms of the design and implementation of human-rights due diligence or risk-management processes;

    (iii) Generate meaningful human-rights outcomes for stakeholders.

To develop such criteria, the Platform suggests using the concept of availability, accessibility, acceptability and quality (AAAQ). This framework is used as a tool to implement the rights included in the International Covenant on Economic, Social and Cultural Rights. It is applicable to both public and private products and services. It has been reportedly used for water, food or health related services and the Platform suggests using it for the development of a Social Taxonomy.

Figure 2: illustration of the AAAQ concept with an energy / utility company

Source: Authors (Natixis GSH), based on the Report

The use of the concept of AAAQ would allow to channel capital flows to situations where goods and services for basic human needs and basic economic infrastructure:

    (i) Are not met;

    (ii) Are not accessible to certain target groups; or

    (iii) Are in danger of not being met in the future (for example, because finance for maintenance is lacking).

Within the AAAQ concept, availability and accessibility could help defining substantial-contribution criteria (see figure 2 above). There is a need for dedicated guidance and criteria because the availability and accessibility of social products and services like health care products, social housing or public transport, are unlikely to be addressed under the CSRD.

The Platform suggests the following criteria for selecting or designing metrics or indicators for a Social Taxonomy (see figure below).

Figure 3: Suggested criteria for defining indicators in the context of a Social Taxonomy

Source: Authors (Natixis GSH), based on the Platform’s Report

 

8. Articulating environmental and social taxonomies

A Social Taxonomy incorporating strict DNSH and environmental minimum safeguards would be consistent with the EU’s ambition to increase corporate accountability for adverse human rights and environmental impacts.

Through the Corporate Sustainability Due Diligence Directive (CSDDD) legislative Proposal and its annex (published on February 23rd, 2022), the European Commission aims at improving corporate governance practices by integrating the identification, the prevention and/or the mitigation of human rights and environmental risks and impacts. It could provide new legal grounds for both dissuasive pecuniary sanctions (article 20) and civil liability (article 22) [6].

It is relevant and vital to have minimum environmental safeguards in the context of a Social Taxonomy and vice versa. The challenge lies in their definition as we are orphaned of a granular environmental Taxonomy defining significant harm criteria for non-sustainable activities. The 270 gCO2e/kWh threshold used for climate change mitigation DNSH purpose is an example. But it is limited to power generation. Such environmental safeguards cannot be based on inexistent list of “technologies deemed significantly harmful”. Simpler exclusions are always possible, but as of today, only solid fossil fuels are excluded from the Environmental Taxonomy.  

Another option, unrealistic in our view, would be to have a single taxonomy. As highlighted by the subgroup, that would amount to add together a company’s social and environmental sustainability which measures very different things and narrow the universe of eligible entities/activities or projects.

 

PART II. Backstage concerns, discussions and proposal status

1. What is missing or underexploited

Target populations and country specific context
It is meaningful to have sub-objectives that relate explicitly to target populations such as women, children, disadvantage people, young unemployed people, indigenous population, farmers. Know-your-stakeholders guidance could have been helpful because data regarding the socio-economic profiles and life conditions of companies’ end-users or customers is often lacking.

Furthermore, the lack of contextualization and geo-spatial criteria would make the concept of population targeting less relevant and actionable (there is a mere mention in the Report, for instance, of broadband expansion in under-served areas). In a second phase of work, it would be relevant for the Platform to develop a mapping of reliable databases or proxies to identify, for instance, situations with low levels of collectively agreed wages.

Jurisdictions with uneven requirements
Methods to deal with different national or even regional contexts is an area deserving further investigation, in particular for topics with discrepant regulations. The Report rightly underlines that such differences might lead “to a social taxonomy favouring companies located in jurisdictions with more stringent social legislation”, such effect is clearly undesirable. Conversely, companies should not either be “penalized” to operate in countries with demanding norms and practices.

In our view, taking national legislation (the Report mentions the national definition of social housing or the results of collective bargaining) as a starting point would not always be satisfactory. It would not allow to overcome national definition discrepancies (ex: on notice periods, parental leave, unionization). Criteria must be “cross-border” when feasible to be intelligible and usable. As an option, the Report mentions certification schemes such as fair-trade products or metals from certified mines.

The 2030 Agenda
The Sustainable Development Goals (SDGs), including their quantitative, timeframe and geographically bound features, could have been exploited to a fuller extent. This potential is largely untapped in the recommendations of the Platform.

The Report only indicates that “SDG indicators are also quantified, and they could be used for the corporate world by linking the SDG achievement (or lack of achievement) of a given country to its corporate contribution to SDG achievement”. Natixis Green & Sustainable Hub is carrying a consultancy mission for an international club of public development banks (the IDFC) on SDG alignment. As part of this work, we stress the importance of not using the SDG as a list of themes but rather as time-bound quantitative targets. Criteria around bridging the distance to these targets can be developed for both public and private entities (to get a glimpse on our work, see here).

Criteria scope of assessment across value chains
One wonders whether the DNSH on the second type of contribution (#2 minimizing negative impacts) and social minimum safeguards should be extended upstream and downstream along supply chains, in particular civil and political rights (e.g., the right to vote, the right to freedom of expression, the right to privacy, etc.).

Should such criteria cascade to the country or counterparts supplying raw materials? These countries are referred as “third countries” and products can be imported from them and distributed in Europe.

This question is topical considering the Russian case. The Platform asserts “it is important to consider working conditions in the supply chain”. Having the most comprehensive scope of criteria assessment is meaningful, although it is fraught with usability and accountability challenges (for instance, challenges to demonstrate or dismiss “involvement in violation” of the UNGC Principles in SFDR PAI Annex 1).

 

2. The socially harmful activities have been kicked into touch