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EU drops social taxonomy as inflation soars

© Shutterstock / Ugis RibaPost Thumbnail

Ongoing inflationary pressures have taken priority, as the European Commission suspends plans for the development of a social taxonomy.

  • The European Commission has shelved its plans to develop a social taxonomy, prompting a wider debate on whether other regulatory initiatives will be sufficient in ensuring a just transition. 
  • A social taxonomy would impact investor decisions by providing an overarching framework through which to assess the social category of ESG risks and opportunities. 
  • Other regulatory mechanisms will provide similar benefits until new approaches emerge for the mobilisation of capital towards social activities that drive long-term impact. 

The European Commission has suspended its plans to develop a social taxonomy, with some suggesting the project may have been fully abandoned.

Its decision has likely been prompted by the need to prioritise other issues, such as the ongoing energy crisis, Russia’s invasion of Ukraine, and extreme weather contributing to further supply chain and inflationary pressures. Another factor could be the short timeframe within which the current European Commission has to operate as it nears the end of its five-year term. 

What would the social taxonomy look like? 

The original idea behind the social taxonomy was to complement the existing EU Taxonomy Regulation, which serves as a classification system for environmentally sustainable economic activities.  

A social taxonomy would provide a similar mechanism, laying out a clear set of rules under which different companies or economic activities could be classified by their alignment with the EU’s social goals. Examples of such goals include an improvement in living standards, the provision of decent wages, or the reduction of bribery and corruption. 

Some progress had already been made in the taxonomy’s development, painting a clearer picture of how it might look in reality. The Platform for Sustainable Finance, a group of experts assembled to advise the European Commission on its taxonomies, submitted a report in February 2022, outlining how the social taxonomy might proceed. 

The report’s recommendations are not binding, and it is yet to receive a response from the Commission. Nevertheless, it is currently the only resource available to determine how the taxonomy might be designed. 

First and foremost, the report recognises that the EU’s social objectives, as well as the specific types of contribution that could be made towards them, must be clearly defined. Using the Do-No-Significant Harm-Principle (DNSH), the taxonomy should also be clear on what activities cause no significant social harm under any circumstance. 

Although the report largely recommends following the approach taken to develop the existing environmental taxonomy, it acknowledges that there would have to be some key differences. 

It explains: “While most economic activities have detrimental impacts on the environment, most economic activities such as the creation of decent jobs, paying taxes and production of socially beneficial goods and services can be considered inherently socially beneficial. A social taxonomy has to distinguish between such inherent benefits and additional social benefits that directly contribute to the realisation of human rights such as improving access to quality healthcare or ensuring decent jobs.” 

Furthermore, where environmental classifications are based largely on science, the more subjective issues addressed by a social taxonomy would have to be based on existing international standards such as the International Convention on Human Rights.  

Why might a social taxonomy be useful? 

The social taxonomy would serve as a common code for investors, businesses and regulators to determine what is, or is not, sustainable from a social perspective. Such a classification system would fundamentally alter how investors assess the social category of ESG risks and opportunities by standardising how social sustainability is measured. 

As investors are growing more aware of the material risks associated with social problems, there comes a greater demand for a standardised approach to their identification and mitigation. 

Meeting this demand would allow capital flows to be redirected towards socially responsible activities and companies, supporting the EU’s goals of enabling an inclusive transition to a more sustainable economy. 

Investments in support of this transition cannot be focused entirely on promoting environmental values while avoiding environmental risks. Healthy societies must also address rising levels of inequality, ensuring that the poorest and most vulnerable communities are included in the benefits brought by environmental sustainability and not exploited during its creation. 

Investing in the creation of social value allows businesses to improve the communities within which they operate, creating long-term benefits throughout society. Being able to demonstrate these benefits through the standardised language of a clearly defined taxonomy could prove crucial in appealing to investors who are assessing their decisions through an ESG lens.  

Alternative approaches to demonstrating social value 

Even without a social taxonomy, the EU is developing several other pieces of regulation that could provide alternative frameworks for auditing the social impact of economic activities. 

The minimum social safeguards project, for example, will require companies to comply with both the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human rights. New legislation on corporate sustainability due diligence, meanwhile, integrates both human rights and environmental concerns. 

Although these frameworks are not as broad as a social taxonomy promised to be, they could prove more effective by creating legal liability. Mandatory regulation increases the financial materiality of social ESG risks, providing a greater incentive for companies to eliminate such concerns from their operations. 

It could also be argued that, while a social taxonomy would facilitate investment decision-making based on ESG criteria, it still would not provide a suitable framework for assessing future impact.

With the ESG approach facing increasing levels of backlash, largely due to a widespread misunderstandings of what ESG is intended to do, alternative frameworks will be needed to highlight which companies and activities are actually delivering long-term solutions. 

The delivery of a truly sustainable future will undoubtedly require an overhaul of economic activity, with social value redefined as an underpinning component. How this is enacted, however, is unlikely to rest solely on the development of a social taxonomy. 

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