Sustainable finance extends the taxonomy for green investments to social issues

The European Commission is pushing ahead the classification of the economic activities that are considered sustainable: with the publication of the Final Report on Social Taxonomy, a new Social Taxonomy is being proposed to integrate the objectives and criteria for eco-sustainable economic activities already provided for by EU Regulation 2020/852.

The proposal, published on 28 February 2022, gives completion to the draft submitted in July 2021 by the Platform on Sustainable Finance, a Permanent Group of Experts that assist the European Commission in achieving the objectives set by the European Action Plan for Sustainable Finance.

What is a Taxonomy? The members of the Platform on Sustainable Finance define it an «inventory for the future»: it provides clarity on economic activities that can be considered sustainable and provides the market with a useful tool to analyse the environmental, social and governance performances of a company or an investment product..

The members of the 4th Working Group of the Platform have been entrusted with the task of integrating the social dimension within the Taxonomy that, in the current version, focuses mainly on environmental aspects: the EC has identified activities and technical criteria for two out of six environmental objectives, mitigation and adaptation to climate change. To this date, fundamental issues such as human rights, governance, access to medical care, decent work, equality and combating discrimination have not yet been included. The absence of an extensive classification system might slow down the sustainable transition that the institutions want: the evaluation of social issues must go hand in hand with that of environmental issues.

In this context, it is important to stress that environmental taxonomy has strong scientific foundations that, on the contrary, cannot be applied to social issues. Therefore, the proposal made with the Final Report on Social Taxonomy intends to base the social classification on international norms, principles and objectives. The Platform’s experts have drawn on a variety of sources, including the Universal Declaration of Human Rights and the Sustainable Development Goals of the 2030 UN Agenda, as well as the OECD Guidelines for Multinational Enterprises.

However, the two Taxonomies must not be conceived as isolated systems, but rather as complementary ones. For example, both include the "Do Not Significant Harm" (DNSH) principle, whereby an activity is assessed not only on the basis of the substantial contribution it can make to one or more environmental and social objectives, but also on the basis of its ability to cause (or not) significant damage to the environment and community. The proposal that was published in February identifies three fundamental objectives, which every economic activity should pursue in order to be considered socially sustainable.

For each of these three objectives, more specific sub-objectives are then proposed, which evaluate the level of "substantial contribution" of a company, based on its ability to: avoid negative social impacts and address them efficiently; increase the positive impacts of goods and services and basic economic infrastructure; start activities with the potential to substantially reduce risk levels in other sectors. These aspects, together with the DNSH principle, will be further developed in the next stages of the work.

The work published by the Platform fully addresses the requests made recently by the financial sector, due to the lack of common criteria for measuring sustainability. The European Commission’s High-Level Expert Group on sustainable finance (HLEG) has repeatedly stressed the importance of considering social issues in the context of Sustainable and Responsible Investments (SRI), although their impacts are more difficult to measure and report than environmental impacts. More and more investors in Europe are looking for social investment opportunities: the "S" criteria of ESG (Environmental, Social, Governance) provides them with an additional element of assessment of the level of financial risk and a sorting tool that rewards companies driven by a social purpose.

In addition, the Covid-19 pandemic has led to a sharp acceleration of this trend, which has been made evident, for example, by the issuance of numerous Social Impact Bonds by financial institutions, peaking at €40 billion in Europe in 2020 alone. In Italy, these instruments have been complemented by state aid, which has supported the SMEs most affected by the pandemic.

Since January 2022, 6,000 large European companies already bound by legislation to report their sustainability performance have to disclose the alignment of their activities to the European Taxonomy for Sustainable Finance, reclassifying its assets in terms of turnover, capital expenditures and operating expenses. From 2023, the scope of these requirements will also extend to SMEs, involving more than 49,000 companies across Europe.

The Sustainability team at The European House - Ambrosetti supports companies on their path towards the adoption of sustainable business models. Among our various activities, ranging from training to reporting to developing medium and long-term sustainability strategies, we accompany companies in the processing of the information required by the European Taxonomy for Sustainable Finance.