After publishing its sustainable finance taxonomy regulation in June 2020 on environmentally sustainable economic activities, the Commission has been developing a taxonomy to support socially sustainable finance initiatives. It released the Final Report on Social Taxonomy this February as a proposal to supplement the existing environmental taxonomy.
This social taxonomy will guide economic and financial activity and strategy, legislation, reporting and disclosure requirements, and corporate governance on the principles of social sustainability. It is predicated on the idea that economic activity is accountable for its social effects on a business’s workforce, consumers and the communities affected through its value chain.
The three main objectives outlined in the report are for businesses to facilitate:
- Decent work
- Adequate standards of living and wellbeing
- Inclusive and sustainable communities through their work for their stakeholders.
Alongside classifications of positive and substantial contributions to these objectives, the proposal outlines socially harmful activities.
Both taxonomies offer investors and financial institutions a framework to assess businesses and their operations on their compliance with ESG principles that have been standardised.
The evolution of the taxonomy
After the release of the first draft of the social taxonomy in September 2021, which highlighted the horizontal and vertical dimensions of business practices and products and services, BNP Paribas Asset Management advocated for linking the two aspects more closely to ensure a comprehensive stakeholder approach (see Exhibit 1).
A purely vertical dimension would limit the scope of the social impact to areas such as healthcare, education and social housing, and would overlook the effects in other sectors and their value chains.
The proposal published in February has set the tone for a formal social taxonomy in line with what BNP Paribas Asset Management advocated for. Beyond its three objectives, it links the two dimensions, practices and activities such ashealth and safety; healthcare; housing; wages; non-discrimination; consumer health; and communities’ livelihoods.
One area that will need further development is measuring how activities can meet thresholds for their social contribution. While the environmental taxonomy can reference and measure tangible impacts such as carbon emissions, social impacts are harder to quantify.
It is also challenging to come to a common threshold, even in the context of internationally agreed standards for human rights.
Social taxonomy metrics should allow for accessibility and ease-of-use for investors. The obvious use case is in social bonds where assessing the use of proceeds could be based on the taxonomy similar to the use of the environmental taxonomy for green bonds.
The social taxonomy also shows promise as the source of a common language to define what and how activities can contribute substantially to positive social outcomes and impacts.
A social framework for a green future
As a reminder, the EU’s Green Deal is designed to accomplish three key objectives:
- Reach net-zero greenhouse gas emissions by 2050
- Decouple economic growth from resource use
- Ensure the energy transition is experienced equally and that no person or place is left behind.
To that end, the EC integrated a ‘just transition mechanism’ into its European Green Deal Investment plan. This stipulates that projects must contribute to the goals of the Green Deal, supporting the development of new clean energy and circular economy industries and the creation of high-quality jobs.
Some 24% of the EU’s working-age population found itself below the at-risk-of-poverty threshold during the last four years. And while the green transition is crucial to the future of the planet, it could disrupt sectors such as mining, manufacturing, agriculture and forestry. Workers and communities tied to these industries may face negative impacts unless there are mechanisms in place to ensure minimal social fallout from such disruptions.
The Final Report on the Social Taxonomy is explicit on the importance of developing workers’ skills. We should note that people have been losing their jobs due to, for example, increased automation, and Covid-19 has put jobs in the services sector in jeopardy.
A number of funding schemes have been developed to facilitate access to retraining and green jobs.
A social taxonomy can support these objectives by requiring companies to identify how their activities affect society and what the future holds for their business model. It implies questioning the competencies and strategy for delivering a sustainable and inclusive economy.
This approach not only strengthens the workforce, but also improves stakeholder value for all, including external shareholders and the government.
It is important that the social taxonomy focuses on a broader suite of corporate metrics rather than just revenue, capital expenditure or operational spending. Such metrics could include employee training, community engagement, investment in better jobs and more support for all employees.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. The views expressed in this podcast do not in any way constitute investment advice.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.