What is the European Union’s social taxonomy for sustainable finance?
Social taxonomy is the classification of economic activities that significantly contribute to social goals in the EU and represent a common code for investors, businesses and regulators regarding what is sustainable from a social perspective and what is not.
It represents a change of course for sustainable finance. This change is marked by the publication of the final report of the European Commission technical expert group on sustainable finance with the classification of activities that would encourage compliance with the social objectives of the European Union and contribute to the development of a green and more inclusive society. For example, improving the impact of sectors like education, health, and housing, among others.
“It is very expected and just as relevant - if not more than the green taxonomy,” Spainsif Chair Joaquín Garralda said at the meeting ‘The Social Taxonomy of the European Union’, which the organization held at the end of January this year. However, “As it is based on international principles, standards and criteria related to cultural aspects, the social taxonomy may develop more slowly than the one for environmental objectives.”
The European Commission technical expert group on sustainable finance presented the first draft of social taxonomy in July 2021, and the second version was expected by the end of 2021. The report was finally released in February 2022 and will serve to promote sustainable investment in Europe, putting the focus on the protection of human rights and on the social impact on the main stakeholder groups of businesses: employees, customers and communities.
According to the EU proposal, the classification has a structure that is similar to the environmental taxonomy, but focuses on establishing criteria geared toward financial organizations on the one hand, and the products and services they generate on the other. “The idea of incorporating social aspects was taken into account from the moment the green taxonomy emerged, but the social taxonomy relies more heavily on international standards and values than on science,” explained Hugo Gallagher, Senior Policy Adviser at Eurosif, at the Spainsif meeting. “In addition, the EU has more limited competency for social issues,” he added.
Why is a social taxonomy needed?
There are several reasons that this classification is fundamental. “The introduction of a social taxonomy would be an important step toward advancing Europe’s regulatory framework of sustainability,” said Ana Rubio of BBVA’s Financial Regulation area. In this sense, banks have been working with social and financial inclusion objectives for a long time “and this taxonomy would make it easier to have common criteria to promote it. In any case, the taxonomy should be simple and easy to implement and should converge with similar international initiatives to facilitate its application in global groups,” she added.
“Clarifying what can be considered to have a positive environmental or social impact in the market is an important step that benefits everyone - investors, businesses and society,” explains Fernando Varela de Ugarte, the Director of Social Gob and Co-Director of Entidades Financieras Sostenibles (Sustainable Financial Entities) in this article for Ibercampus. “It transmits transparency to the market and reduces the possibilities of greenwashing.” Second, “the promotion of just one taxonomy from a green angle would be incomplete, as the social aspect is a relevant field, which is complementary and intimately linked to the environmental dimension,” Varela added.
Meanwhile, the EU report underscores the following main factors which make a social taxonomy necessary:
- The need for social investments in sectors like affordable housing, medical care, education and respect for the human rights of workers, consumers and communities.
- Connection with the environment: need for socially inclusive measures to accompany the green, just transition.
- Opportunities: investors are increasingly looking for more social investment opportunities. For example, the rise of social bonds due to the pandemic and post-pandemic recovery demonstrate the demand in the market.
- Risks: the absence of considerations regarding social issues comes with risks - especially reputational risks - for investors.
- Complexity of measuring social aspects: the lack of definitions and of a classification system is an obstacle to direct capital toward socially sustainable activities and to measure its impact. In addition, ‘social-washing’ must be avoided.
What is the proposed structure for the social taxonomy?
The social taxonomy is geared toward banks, businesses and regulators in order to classify and guide sustainable investments. The report for this EU taxonomy proposes three social objectives. Each objective contains three specific sub-objectives designed to have a direct, positive impact on businesses’ three main stakeholder groups: employees, customers and communities.
Objective 1: Employees:
- To promote equality and human rights throughout the value chain through equal pay, social protections, the elimination of job instability, etc.
- To promote equality and non-discrimination in the workplace: salary gap, employment for women, employment for disadvantaged groups, etc.
- To guarantee the human rights of employees in the entire value chain.
Objective 2: Customers. Suitable quality of life and well-being for end users
- Data protection and cybersecurity for users
- Clear and responsible marketing and communications practices.
- Accessibility to quality products and basic services, such as food, healthcare, housing, education, water and support services.
- Design of durable, safe and repairable products.
Objective 3: Sustainable and inclusive communities
- Basic economic infrastructure: transportation, telecommunications (including Internet), financial services, electricity and waste removal.
- Creation and preservation of decent jobs, particularly in the context of digital transition, and a green and just environment.
- Promotion of gender equality.
According to the report, the activities that could be considered sustainable from a social perspective, should be make some type of “substantial contribution” to one of the three objectives that the taxonomy proposes. The contribution could be made through investments that avoid or mitigate the risks of failing to protect human rights in high risk sectors (textile or agriculture) or, with investments that improve the inherent positive social impact of certain economic activities; mainly in basic sectors related to basic services, education, health, housing and digital infrastructure.
On this point, the role of the “do no significant harm” principle is critical. This criterion ensures that an activity makes a substantial contribution to a social objective, without undermining other social objectives.
BBVA, aligned with the social taxonomy
“The methodology that we have been using at BBVA to define sustainable finance in inclusive growth is in alignment with the social taxonomy proposal that has been presented,” explained Antoni Ballabriga, Global Head of Responsible Business. “In a complementary manner, BBVA also has an environmental and social framework for financing, primarily at Corporate Investment Banking, to cover the Minimum Safeguards,” he concluded.
The BBVA standards exclude economic activities that under no circumstances could be considered socially sustainable, such as: nuclear power, defense, mining, firearms, gambling, pornography and tobacco. The social taxonomy defines them as “harmful activities”.
In its purpose to bring the age of opportunity to everyone, BBVA has incorporated climate action and inclusive growth as one of the pillars that uphold its sustainability strategy. Its aim is to mobilize adequate resources to manage the challenge of climate change and tackle the SDGs related to this challenge. For this reason, it has developed an internal taxonomy of transition risks that classify sectors based on their sensitivity to transition risks, thus identifying metrics on a customer level. For inclusive growth, BBVA’s efforts focus on promoting financial inclusion, inclusive infrastructure and support for entrepreneurs and micro-enterprises.
Furthermore, the bank collaborated with 26 banks in 2020 as part of an initiative to determine how the European Union taxonomy on sustainable activities could be applied to basic banking products, and thus ensure that common criteria exist to determine what products are sustainable and allow banks to promote sustainable finance in the entire economy.