EU: Platform on Sustainable Finance publishes final report on social taxonomy

On 28 February 2022, the Platform on Sustainable Finance ("PSF") published its final report on extension of the existing EU taxonomy to include a social taxonomy. This follows a consultation on a draft report in the summer of 2021 (see here). 

The European Commission had asked the PSF to advise it on whether the EU taxonomy should be extended to cover social issues and, if so, how. However, the PSF's final report does not include all the technical detail - its purpose is to suggest to the Commission a general approach to the creation of a social taxonomy and evaluate the pros and cons of different types of approach. 

The Commission now needs to decide if and how to take forward the PSF's suggestions. Although, it is not bound by the PSF's report, as the PSF is made up of well-regarded experts in their field, their final report carries substantial weight (see "Next steps" below). 

Purpose of a social taxonomy 

The purpose of a social taxonomy is to define more clearly what amounts to a social investment and what activities contribute substantially to achieving social objectives so that private capital can be directed towards socially valuable activities - in the same way that the existing green taxonomy provides a framework for assessing whether a particular activity is environmentally sustainable. It is a tool to help investors and end consumers make more informed choices.

The development of a social taxonomy is also an important step in furthering respect for human rights and better working conditions, as well as ensuring that the net zero transition is a "just transition" (e.g. where workers and communities particularly affected by the move away from a fossil-fuel reliant economy are not unfairly disadvantaged or "left behind"). 

Suggested structure for a social taxonomy

In response to feedback on its draft report, in particular to concerns about increased administrative burden on businesses, the PSF has tried to align the structure of the suggested social taxonomy more closely with the existing environmental taxonomy. 

So the suggested structure of the social taxonomy now involves: 

• the development of social objectives; 
• defining different types of substantial contributions; 
• "do no significant harm" ("DNSH)" criteria; and 
• minimum safeguards. 

The PSF has abandoned its previous suggestion of having a horizontal and vertical dimension and is now suggesting a single structure with three main objectives:

1. decent work (including value-chain workers);
2. adequate living standards and wellbeing for end-users ; and 
3. inclusive and sustainable communities and societies.

Each of the three main objectives will need to be supplemented by different sub-objectives. See Chapter 4.2 of the PSF report for a non-exhaustive list of sub-objectives. So for example:

• sub-objectives for decent work include ensuring pay levels for workers are set in a predictable and transparent way and that living wages should be paid that guarantee decent lives, as well carrying out risk-based due diligence to ensure respect of human rights and workers' rights in the value chain;
• sub-objectives for adequate living standards and wellbeing for end-users includes ensuring healthy and safe products and services, improving access to good-quality housing and  education;
• sub-objectives for inclusive and sustainable communities and societies includes improving access to transport, telecommunications, financial services and child care. 

Further work will be needed to establish criteria for substantial contribution for the different sub-objectives. However, an economic activity does not need to make a substantial contribution to all sub-objectives in order to qualify as socially sustainable. 

See: 

• Chapter 4.3 for the suggested approach to substantial contribution;
• Chapter 4.4 for a suggested approach to DNSH criteria; 
• Chapter 4.6 for a suggested approach to selecting and prioritising sectors (which like the green taxonomy uses the NACE industrial classification system as a starting point);
• Chapter 4.7.1 for the PSF's "first ideas" about disclosures for a social taxonomy;
• Chapter 5 for examples of sector selection, substantial contribution and DNSH for each of the three main objectives. 

On minimum safeguards, the PSF has been asked by the Commission to advise separately on how Article 18 of the Taxonomy Regulation works in practice. Article 18 requires businesses carrying out environmentally sustainable economic activities to uphold certain international labour standards and human rights. The PSF has said it will publish a separate report on this but has not said when. 

However, the PSF recognises that when developing a social taxonomy, the absence of detail on how Article 18 works in practice poses a problem, including whether there will be environmental minimum safeguards in parallel to social minimum safeguards. For more detail on the PSF's initial thinking on this, see Chapter 4.5. However, we will need to wait for more detail when the PSF's report on the application of Article 18 has been published. In the meantime, the PSF says it is important to track a company's actual performance on human rights - merely checking that they have made a commitment or have a human rights policy is not enough - which aligns with the new EU human rights due diligence regime proposed by the Commission last week (see here). 

The PSF also acknowledges that a social taxonomy will add to the reporting and disclosure requirements that companies and firms already face under the CSRD Proposal, the Taxonomy Regulation, SFDR and Corporate Sustainability Due Diligence Proposal and has called on the Commission to align the development of the social taxonomy with those initiatives, in particular with the CSRD proposal. Which is much easier said than done...

Governance and sustainability-linked pay

The Commission had also asked the PSF to advise on what other sustainability objectives, such as governance, could be covered in an environmental taxonomy and social taxonomy. Of course, the minimum safeguards in the Taxonomy Regulation already refer to the OECD Guidelines for Multinational Enterprises. 

The PSF has recommended that two governance objectives be added to the minimum safeguards for the environmental and social taxonomies (see Chapter 6): 

1. strengthening sustainability aspects of traditional corporate governance with sub-objectives such as sustainability assessment skills in the highest governance body and transparency on sustainability objectives and targets; and 
2. strengthening corporate governance aspects that are important for sustainability with sub-objectives such as anti-bribery and anti-corruption measures, responsible lobbying and political engagement, diversity of board members, and the option for employee representation on supervisory boards.

On sustainability competencies, it was expected that the Commission's proposal on sustainable corporate governance would cover this. However, that proposal has since morphed into a human rights and environmental due diligence proposal with only a small smattering of governance aspects (see here), which does not go as far as the PSF was expecting it to go on governance.

On linking executive pay to sustainability factors, the PSF recommends that this should be part of the EU taxonomy. It sees this as a "very effective way to steer a company towards achieving the sustainability targets it has set for itself" and a "reflection of what is happening in the real economy". It believes that concerns about interference with a company's autonomy can be addressed by ensuring this requirement is directional rather than prescriptive and is based on a company's own sustainability strategy and KPIs. 

Next steps 

The PSF report states that the Taxonomy Regulation could be amended to include a social taxonomy, with new articles mirroring Articles 10-15 of the existing Regulation and the technical screening criteria for a social taxonomy set out in delegated acts. For those of us only just getting to grips with the fiendish complexity of the environmental taxonomy, the thought of having to grapple with a parallel social taxonomy sounds rather ominous. 

As mentioned above, the PSF's suggestions are not binding on the Commission (although they do carry significant weight) so the Commission will have to decide if and how to develop a social taxonomy. The Commission was required by the Taxonomy Regulation to publish its own report on next steps on the social taxonomy by 31 December 2021. Clearly, that was not possible as the PSF has only just submitted its final report to the Commission. At the time of writing, it is not yet clear when the Commission is likely to publish its own report.

Separately, the PSF was also expected to publish its final report to the Commission on a significant harm and no significant impact (NSI) taxonomies by the end of Q1 2022 but that work has been delayed so it is not yet clear when that report will be published (see here).