To face the growing interest of investors for sustainable finance, the European Union has published over the past few months new directives to give to European financial institutions a common language and a clear definition of what is a sustainable investment.
Sustainability preferences assessment
First, financial firms will have to capture their clients’ sustainability preferences from the 2nd of August and recommend products which are in line with these preferences.
Investors should be asked about the percentage of their investments they want to dedicate to activities aligned with the EU taxonomy (see below) or with other sustainability objectives.
Product classification based on their sustainability objectives
Second, financial products will be classified based on their environmentally sustainable economic activities. Potential negative impacts of these activities will have to be documented (Principal Adverse Impacts (PAI)). Positive impacts will be classified according to a specific EU Taxonomy.
The objective of the EU Taxonomy will be to help financial market participants to classify their sustainable finance products with a common methodology.
So far, the Taxonomy Regulation covers 6 environmental objectives (climate change adaptation, climate change mitigation, pollution, circular economy, biodiversity, preservation of marine resources).
This Delegated Act supplementing Article 8 of the Taxonomy Regulation was adopted in July 2021.
The second step will be to extend this existing environmental taxonomy to a social taxonomy.
A first report on this future social taxonomy has been published at the beginning of March by the EU Sustainable Finance Platform.
We summarize below the key takeaways of this new publication on EU Taxonomy.
The challenges of the EU social taxonomy
If creating a green taxonomy at the European level was a challenge, creating a social taxonomy may be even more complex.
Most environmental objectives defined by the green taxonomy can be scientifically and quantiatively measured (ex: level of gas emission, ratio of hazardous waste…).
On the contrary, it is a real challenge to scientifically measure the substantial contribution of a company to social objectives like education, health or employee well-being.
Moreover, the social impact of an economic activity depends on the national context. For European firms with an international presence, this can go beyond the European Union power (ex: salary bargaining in a non-EU country).
Finally, economic activities defined in the existing green taxonomy tend to aim at reducing negative environmental impacts while economic activities in general tend to have inherent social benefits by creating jobs, providing training, contributing to taxes, bolstering social protection…
Given these challenges, the future social taxonomy is highly inspired by the current green taxonomy but presents some structural differences.
Environmental taxonomy and Social taxonomy, what are the differences and similarities?
The “Do not significantly harm” (DNSH) concept
In both taxonomies, an activity cannot be taxonomy-aligned if it does not respect the “Do not significantly harm” concept.
This means that if the activity pursues an activity that meets the criteria for sustainable development, then this activity cannot cause significant harm to the remaining taxonomy objectives.
A list of sustainable finance objectives
As for the green taxonomy, the social taxonomy defines a list of 3 social objectives and minimum social safeguards that should be pursued in order to be considered as a social taxonomy aligned product:
- Decent work (including value-chain workers)
- Adequate living standards and wellbeing for end-users
- Inclusive and sustainable communities and societies
Social taxonomy subgroups
While the green taxonomy is divided in 6 environmental objectives, the social taxonomy is divided in 3 social objectives but with sub-objectives for each of them.
Further work is needed on whether and how criteria for substantial contribution can be drawn up for the different sub-objectives.
For instance, for the social objective “decent work”, sub-objectives can be strengthening social dialogue, ensuring decent salaries, providing excellent health and safety to workers…
If both taxonomies use the concept of DNSH, they are only defined at the objective-level for the environmental taxonomy, while they are defined both at the social objective and at the sub-objective level for the social taxonomy.
The five next steps for developing a social taxonomy would be to:
1 clarify the minimum safeguards according to the scoping note;
2 conduct a study on the impacts of a social taxonomy considering different options for application and designs;
3 work out a rationale for prioritising objectives and sub-objectives;
4 prioritise objectives according to the rationale;
5 define substantial-contribution and DNSH criteria for the first objective(s) and sectors.