SPI Journal, Summer 2022
Spotlight on social: the ‘S’ in ESG

Why do we need a social taxonomy?

Elia Trippel, policy analyst at the Organisation for Economic Co-operation and Development, spoke with Katerina Atkins, programme coordinator of OMFIF’s Sustainable Policy Institute, about the objectives and metrics of a social taxonomy and the process of its development in the European Union.

Katerina Atkins: The OECD estimated that further investments of $630bn a year worldwide for the next decade will be needed to have a 66% chance of limiting the temperature increase on the earth’s surface to below 2 degrees. But Covid-19 has clearly shown the importance of the ‘social’ element of sustainability. So, why there is a need for such a classification as social taxonomy? How can it help to prevent ‘social washing’ and what are its objectives?

Elia Trippel: There are broadly three main reasons for a social taxonomy. One of them is to prevent social washing. You really need to have a strong definition and measurement of social investment and a taxonomy is the right tool to do that. The same idea informed the green taxonomy, with the aim to define green investments and economic activities in order to limit greenwashing. In the market today there is a problem with social washing because ESG ratings can give you fundamentally different results depending on the provider, which makes them difficult to use by investors. A social taxonomy can help prevent social washing by harmonising how social sustainability is measured, and make it easier for investors to make informed and consistent decisions, and at the same time help to direct resources towards socially responsible activities and companies.

The second objective is to redirect capital. Government spending is going to be fundamental to ensure that welfare and social security systems are robust, but the Covid-19 pandemic has shown that private investment also has a role to play. The other aspect where we need investment is the just transition. We know that the green transition will require drastic changes in a number of different sectors in our economy, and that will have an effect on the lives of workers in these sectors and their communities. So, it’s important that a just transition is also considered by private investors and a social taxonomy can help with that.

Lastly, the third objective is to help investors consider risks and, by extension, opportunities related to social issues. Investors face a multitude of ESG risks, which can lead to reputational, regulatory, market, credit, operational and other types of risks. Social grievances and human rights violations of companies can increase these existing risks, for example, through reputational damage, liability issues and even supply chain disruptions. All of this translates into material risks for investors. A social taxonomy can help identify those risks and mitigate them, for example, through due diligence tools.

KA: Will these taxonomies that are being developed across different jurisdictions, including in the EU and China, become a blueprint for social taxonomies? And what will be the criteria given that social taxonomies cannot be based on science in the same way as green taxonomies?

ET: Unfortunately, we don’t have a lot of reference points for social taxonomies now, but the report on a social taxonomy by the EU Platform on Sustainable Finance can give us some indication. The report says that the overarching goal of the social taxonomy is to spell out what constitutes a social investment and what economic activities can provide a substantial contribution to social goals – as it has been done through the green taxonomy. On that basis, the report considers some of the same guiding principles as in the green taxonomy, namely, how to not do significant harm to other objectives, and what could be harmful activities under a social taxonomy. The substantial contribution is one of the key pillars of both green and social taxonomies. The report suggests that social activities should substantially contribute to three overarching social objectives: decent work, adequate living standards and wellbeing, and inclusive and sustainable communities and societies.

It is too early to tell whether social taxonomies will be based on the same type of logic as the green taxonomy. I think it’s important to remember that this is still a very nascent space, so we will have to see how it develops in the future. But I think it’s very good to remain flexible while leaning on some of the principles that are in the green taxonomy.

KA: What are the next steps in the development of a social taxonomy in the EU?

ET: The Platform on Sustainable Finance has published its report, which will now be considered by the European Commission. In line with the review clause of the taxonomy regulation, the Commission has to publish a report describing the provisions that would be required to extend the scope of the taxonomy regulation to cover other sustainability objectives, like social objectives.

KA: One of the challenging areas is tracking social risks across supply chains. There is also an issue of different standards and the accessibility of reliable data across various jurisdictions – a strain for multinational companies. How can the issue of complexity of supply chains be resolved and what is the role of the social taxonomy?

ET: This is a very important question because supply chains are really at the heart of this. About 70% of international trade involves global supply chains. And that means that raw materials, parts, components and services will cross borders several times in many cases, before being incorporated into a final product and shipped to consumers. Acute environmental and social risks like greenhouse gas emissions, hazardous waste, poor working conditions, child and forced labour, are most often found deep down in supply chains. This of course raises concerns over the potential role of supply chains in exacerbating these risks.

One way to address the complexity of supply chains and enhance visibility is through risk-based due diligence. It has become an important tool to mitigate the actual and potential adverse environmental and social impacts from business, including in their supply chains. That’s why it has become more and more integrated in policies and regulations.

Once companies have more visibility over their supply chain, they can more comprehensively collect data, and that can inform their risk management and decision-making process. If done correctly, this can lead to more sustainable outcomes. During Covid-19, companies that had sound due diligence management practices and greater visibility over their supply chains in place ended up being more resilient than their counterparts that had irresponsible business practices. Conducting this kind of due diligence can help businesses respond to shocks better, which minimises the severity of the shock.

The platform’s report on the social taxonomy recognises that conducting risk-based due diligence to protect worker and community rights in global supply chains should be rewarded and recognised as a substantial contribution. That goes beyond the do-no-harm or minimum safeguard aspect that due diligence is normally about, but instead really recognises the transformative impacts that risk-based due diligence can have if implemented correctly and according to international standards.

KA: What from your point of view needs to be done to have comparable, reliable data on social factors across jurisdictions?

ET: Given that more and more jurisdictions are developing frameworks on sustainable finance, like taxonomies, for instance, the topic of interoperability, comparability and reliability of ESG data – including social factors – is high on the agenda. It’s true that the focus has been on climate metrics, but the G20 Sustainable Finance Working Group has also flagged general concerns over the lack of consistency of ESG data, lack of comparability of metrics and methodologies and a range of approaches that undermines the meaningfulness of ESG. Having a social taxonomy is a first step to creating a common framework on what constitutes socially beneficial economic activities and better direct financial flows towards those activities.

That’s why a Taskforce on Social-related Financing Disclosures is currently under discussion – as a natural next step to the Task Force on Climate-related Financial Disclosures and Taskforce on Nature-related Financial Disclosures. As social taxonomy is heavily reliant on national policies and national regulations, having a taskforce that can come up with a baseline would be a very good first step to help with bringing comparable and reliable data out across different jurisdictions.

This article is an abridged version of a Sustainable Policy Institute podcast. The full conversation can be accessed next week.

‘Government spending is going to be fundamental to ensure that welfare and social security systems are robust, but the Covid-19 pandemic has shown that private investment also has a role to play.’

‘A Taskforce on Social-related Financing Disclosures is currently under discussion – as a natural next step to the TCFD and TNFD.

70%

‘About 70% of international trade involves global supply chains. And that means that raw materials, parts, components and services will cross borders several times in many cases, before being incorporated into a final product and shipped to consumers.’