What is the social taxonomy?

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Proposals for a social taxonomy by the European Commission’s Platform on Sustainable Finance group have been welcomed by some in the industry who hope that social factors will finally receive greater attention.  
  
As climate change manifests itself ever more violently, governments the world over are scrambling to deliver a policy framework including disclosure requirements and carbon allowances, as well as green taxonomies.   
  
Social factors, however, have not received the same attention so far, despite attempts to change this. In the UK, the Department for Work and Pensions sought views on the issue in March this year, to little effect; asset owners are currently heavily focused on climate risk disclosure rules. Aside from the workload, a lack of guidelines for what can be designated and measured as ‘social’ has also been cited as a factor in the muted response.  
 
Now, the EC is trying to spur the private sector into action. Its Platform on Sustainable Finance has produced a draft report for a social taxonomy, which could well find its way into EU legislation such as the Non-Financial Reporting Directive and the Sustainable Finance Disclosure Regulation.   
    

Inequality could undermine economic growth  

   
Part of the drive for more social investments is the – albeit not universal – view that a growing gap between rich and poor impedes growth, as well as creating political and social instability which could deter investment and make it harder to find consensus to address societal issues.  
  
"Apart from these negative effects for society as a whole, this would have detrimental effects, especially for long-term investors such as pension funds,” the taxonomy report authors write, adding: “But companies can help to mitigate these risks. A taxonomy is needed to identify credible approaches to doing so.”  
  
They note that among providers of ESG scores, there is particularly large divergence for human rights and product safety ratings, and argue that “a social taxonomy has the potential to address these issues and harmonise how social aspects are measured. It would 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.”  
  

Vertical and horizontal dimension to taxonomy  

  
The social taxonomy is proposed to build on the principle of doing no significant harm and would consist of a vertical and a horizontal axis.   
  
The vertical would focus on products and services required for adequate living standards and basic human needs like water, food, housing, healthcare, education, as well as basic infrastructure like transport, electricity, telecoms, internet and financial inclusion.  
  
The horizontal dimension encompasses activities across the value chain that have positive impacts and avoid and address negative impacts, such as opportunities for decent work, promoting consumer interests, enabling inclusive and sustainable communities, good corporate governance and tax transparency.  
  

Politicians give mixed signals  

  
Compared with the green taxonomy, the social taxonomy faces a number of additional challenges, the first being that it is starting from lower base in terms of evidence, says Karin Pasha, head of sustainability at fiduciary manager Cardano. “We have a more established science-based evidence on climate change than on a number of social issues,” she says.  
  
The second issue is that there is less political clarity, she notes, compared with the clear direction on emissions reductions, for example, as social issues are more personal, difficult to quantify and generally more aligned with philosophy or politics. For example, while the DWP has consulted on social risks and opportunities for investors, the government has also decided on a controversial cut to overseas aid among others.  
  
“The market gets mixed signals,” she says, and unlike with climate change, for social issues there are still big debates to be had on whether inequality is a problem, and how and when to tackle it.   
  
Cardano advocates for place-based investments, arguing that the social value of a product or activity is contextual. “When it comes to social issues, upholding strong labour rights in the Congo is more of a contribution to social goals than complying with [labour] law in the UK,” says Pasha, stressing that a social taxonomy and resultant ESG scores should avoid leading to capital outflows from less developed countries.  
  

Squaring the ESG circle: A just transition  

  
One major challenge for a social taxonomy – which could become part of an overarching sustainable taxonomy in the future – will be balancing environmental and social issues where these conflict with each other, such as the dismantling of emissions-heavy industries leading to higher unemployment.  
  
“From a ‘do no significant harm’ perspective we shouldn’t be seeing investors allocate to activities that are seeking to do environmental contribution but do significant harm to social issues. That shouldn’t happen,” says Pasha, adding that there should be minimum safeguards. However, “when it comes to more jobs or better environmental performance, I expect there probably will be trade-offs", she admits.  
  
For investors, the key might be to look at a company’s trajectory and relative performance, looking at whether it has plans to improve on social matters.  
  

Hope that the ball is now rolling  

  
The draft social taxonomy report is also considered a positive step by Scottish Widows. Investments stewardship lead Shipra Gupta says the report is not only critical to the ‘just’ aspect of the low carbon transition but should also facilitate fund flows into socially-oriented investments that are critical to achieving the UN’s Sustainable Development Goals.  
   
“Despite growing recognition amongst investors around material social factors, the varied sub-factors and lack of standardised definitions – let alone adequate disclosures and comparable data – [have meant that] integrating ‘social’ in investment processes has always been challenging,” she says.  
   
With a taxonomy framework based on factors including human rights and living standards and covering workers, communities and consumers, “we hope that the ‘S’ in ESG will get the greater focus it deserves”, says Gupta.  
  

Would you welcome a social taxonomy for use by UK institutions?  

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