In the Absence of a Social Taxonomy

The Social Taxonomy is not officially released. The non-binding guidance by the Platform on Sustainable Finance constitutes the most authoritative interpretation on how the SFDR applies to funds with a social objective. Since the standards for funds with an environmental objective are more thoroughly developed and with binding effect, they assist in interpreting the system for social funds. If the approach differs, it will be pointed out.

Step 1: Substantial Contribution Criteria

For a social taxonomy, we suggest the types of substantial contribution set out in the table below.

There are three aspects to the structure set out in the table above. Firstly, activities which address and avoid negative impacts for workers, consumers and/or communities can make a substantial contribution to these objectives (for example, by improving OHS). Secondly, there are activities with inherent social benefits for end-users, communities and societies, which by their very nature contribute to social objectives, such as providing affordable pharmaceuticals to certain groups of people. Thirdly, there are enabling activities for all three objectives, for example, social auditing services which help to reduce negative impacts on value-chain workers. All three of these aspects are crucial for a social taxonomy

Step 2: Do No Significant Harm

The DNSH criteria in a social taxonomy play a similar role to the one they play in the environmental taxonomy. They ensure that when an activity makes a substantial contribution to one social objective, it does not harm the other social objectives. In other words, an activity that makes a substantial contribution to the objective on decent work should not harm endusers (i.e. objective 2, See Section 4.1.), communities and societies (i.e. objective 3, see Section 4.1.). For example, an economic activity such as broadband expansion in underserved areas makes a substantial contribution to the objective on inclusive and sustainable communities and societies. However, broadband expansion should not harm the rights of workers building the broadband infrastructure and the living standards and well-being of consumers using the internet services. Similarly, lending activities to under-banked groups make a substantial contribution to the objective of inclusive societies, but must not harm the living standards and wellbeing of the end-users (for example, by using non-transparent and unfair lending practices).

There are three features of the DNSH criteria which require emphasis because they differ from the environmental taxonomy. These features are set out in the paragraphs below.

The first feature to emphasise is the need for more granular DNSH criteria at the level of the sub-objectives. Given that the substantial-contribution criteria in a social taxonomy will be developed and assessed at the level of sub-objectives, it would be most logical to also develop DNSH criteria at the level of sub-objectives, taking into the account the practical difficulties this approach entails. This means that an economic activity could be assessed for both substantial contribution and DNSH under the same headline objective. For example, an economic activity that makes a substantial contribution to living wages (thus promoting the decent-work objective) should not: (i) harm equal employment opportunities for women; (ii) undermine collective bargaining processes; or (iii) use child or forced labour in supply chains, etc. (all three of these are sub-objectives under the decent-work objective). Moreover, there might be cases where economic activities assessed for substantial contribution might also need to demonstrate DNSH for the very same sub-objective to which they make the substantial contribution. This should be further explored.

The second feature is that the DNSH criteria might also play an important role in some important social topics and sub-objectives for which it might be challenging to draw up substantial-contribution criteria. The reason it could be challenging to draw up substantial-contribution criteria could be either because it would be difficult to meaningfully prioritise sectors or because it is not possible to link turnover or expenditure to these activities. Examples of topics that we discussed where no sector-selection61 methodology was found to be meaningful include collective bargaining and workforce-diversity aspects. These topics are considered to be of great importance and further consultation with thematic experts is needed to understand whether and how to integrate these issues in the taxonomy through the development of substantial-contribution criteria. However, if a decision is reached that substantial-contribution criteria cannot be meaningfully drawn up, then the topics could still find a place in the taxonomy through the development of DNSH criteria. In that case, the social taxonomy would follow the example of the climate change-adaptation objective in the environmental taxonomy where DNSH criteria are drawn up for all sectors selected for the climate change-mitigation objective. In a similar way, all economic activities prioritised for the social taxonomy could be then assessed against these DNSH criteria. The second case arises where neither turnover nor expenditures can meaningfully be linked to sub-objectives like freedom of association and taxation, both topics closely related to measures at the entity level. In this case, we suggest developing criteria under the minimum-safeguards requirements (see Section 4.4 below). As these topics might not be considered anywhere else in the taxonomy, special care must be taken that they are adequately considered within the minimum safeguards.

The third feature is that it is challenging to build a meaningful case for a substantial contribution for objectives like ‘avoiding and addressing’ child labour or forced labour. This is because these issues are generally subject to zero-tolerance in law and are sometimes subject to import bans and exclusion criteria. In these cases, we suggest that experts be consulted to better understand if and how these objectives could be reasonably framed in substantial-contribution criteria.

Step 3: Minimum Environmental Safeguards

The Platform has released a report on Minimum Social Safeguards. As promised in the Social Taxonomy report, more indication on the Minimum Environmental Safeguards is included there.

One suggestion is that just as social and governance-related minimum safeguards (UNGPs and OECD guidelines on multinationals) are part of the environmental taxonomy, minimum environmental safeguards should be part of the future social taxonomy, for example, along the lines of the environmental part of the OECD guidelines for multinational enterprises (MNEs).

What should happen?

• reflecting on what environmental safeguards are required for socially sustainable activities, in particular the merits of: (i) using the existing DNSH criteria for environmental objectives; and (ii) drawing up additional minimum environmental safeguards

The Platform's suggestion:

The obvious structure for a looser relationship would be to draw up an independent social taxonomy with environmental safeguards. Mirroring the minimum safeguards for the environmental taxonomy, the environmental minimum safeguards for a social taxonomy in this model could be the environmental part of the OECD guidelines (see model 1 below).

Model 1: In this model, the social and the environmental taxonomy are related only by both having minimum safeguards for the respective other part. In this model, governance safeguards and entity-related social safeguards based on the UNGPs and the OECD guidelines for MNEs would be valid for both taxonomies. Basically, the UNGPs and all chapters of the OECD’s guidelines for MNEs (except for the chapter on environment) would serve as minimum safeguards for the environmental taxonomy, while the environmental chapter of the OECD’s guidelines for MNEs would serve as minimum safeguards for the social taxonomy. The respective social and environmental DNSH criteria would form the basis for detailed social and environmental criteria. The proposals are also made on the assumption that companies will report separately on their turnover/capital expenditures for social activities, and their operating expenses for environmental activities.

Model 2: The second model under consideration might solve this problem of companies focusing only on meeting whichever criteria are easier, but it may create new problems. In model 2, there is a closer relationship between the social and the environmental. An activity would have to meet either at least one substantial-contribution requirement, whether it be social or environmental. On top of that, all activities will have to meet all relevant environmental and social do no significant harm criteria. In this option, minimum safeguards would be partly replaced by more detailed social DNSH criteria for the environmental taxonomy, while the already existing DNSH criteria in the environmental taxonomy would also be valid for the social taxonomy. This second model might imply that some social DNSH criteria would be generic and similar to the DNSH criteria for climate adaptation in the present delegated act. In contrast to the existing minimum safeguards, these would address risks in more detail and might be sector-specific in some cases (see below). Replacing the minimum safeguards by DNSH criteria where advisable looks at first sight like a big change to the system. However, it might not necessarily be such a big change. The role model would be the generic DNSH criteria for climate adaptation in the green taxonomy (see Appendix 2). These DNSH criteria are generic for all sectors and for all environmental objectives, and demand that ‘climate risks that are material to the activity have been identified (…) by performing a robust climate risk and vulnerability assessment. The assessment is proportionate to the scale of the activity and its expected lifespan.’

Conclusion

In April, the EC confirmed that market participants are free to use their own methodologies to identify and disclose their share of sustainable investments. In other words, there are no prescriptive thresholds or approach to assess the three components of the "sustainable investment" definition (contribution to environmental/social objective, DNSH, or good governance). Thus, in light of the lack of regulatory guidance, funds are left with the freedom to patchwork their own methodologies.