EU taxonomy: How do you measure the “S” in ESG?

 The Platform on Sustainable Finance presents social taxonomy recommendations.

EU taxonomy: How do you measure the “S” in ESG?

In the future, the European Union intends to classify more than just ecologically sustainable economic activities. Companies shall also be measured on the basis of social criteria. An Expert Group from the European Commission published recommendations for the implementation in mid-October. However, these recommendations have their own pitfalls.

The EU Taxonomy for Ecological Management represents the European Union’s criteria for sustainable financial investments which encourage climate protection. These include investments in renewable energies or in the circular economy, for example. This will be followed by a taxonomy that can be used to measure socially sustainable investments. The aim is also to steer financial flows utilizing criteria such as Environment Social and Governance (ESG) with a focus on social aspects in this case. The experts from the EU Commission’s Platform on Sustainable Finance presented initial proposals for developing a social taxonomy at the end of February. Oriented on the Corporate Sustainability Reporting Directive, the taxonomy differentiates between diverse stakeholders: employees, consumers, municipalities, and society. The proposals pursue three primary goals: Good working conditions for employees, adequate living standards for consumers, and a society which acts in accordance with the principles of inclusion and sustainability. Human and labor rights shall have better protection while bribery and corruption are curbed.

Ecological issues can collide with social sustainability

In the process, Brussels is now turning its attention to an even more disputed issue. Creating a general definition of “social” is exceptionally difficult. Furthermore, such a definition may contradict environmental sustainability: For example, the transformation towards electromobility to achieve greater climate protection can also result in job losses. Automotive suppliers which previously manufactured the gearboxes for internal combustion engines are one example.

However, almost no reliable data currently exists regarding a social taxonomy. Therefore, it is very difficult to derive specific measures. Quantitative benchmarks are missing for many areas. Unlike environmental taxonomy, few scientifically based sustainability goals and criteria exist. Essentially, most economic activities can be regarded as socially useful because they create decent jobs, taxes are paid, and goods useful to consumers are produced. In view of this, a social taxonomy has to distinguish between the inherent benefits of economic activity and the additional social benefits such as better access to good health care throughout the supply chain or measures to include people with disabilities.

The EU expert group’s implementation proposals

The Platform on Sustainable Finance published proposals for implementation by companies and financial markets on October 11. The proposals provide guidance regarding how to comply with a minimum level of protection. In particular, these proposals are intended to bridge the period during which the EU’s Corporate Sustainability Reporting Directive (CSRD) and Corporate Sustainability Due Diligence Directive (CSDD) have yetto be applied.

Four key topics for minimum measures

Art. 18 of the EU Taxonomy Regulation states that the minimum protection shall be oriented on standards such as the OECD Guidelines for Multinational Enterprises, the United Nations Guiding Principles on Business and Human Rights, the Conventions of the International Labor Organization as well as fundamental labor principles and rights, and the international Fazio Human Rights Charter. The Platform on Sustainable Finance identifies four key issues for minimum compliance:
• Human rights, including workers’ rights,

  • Bribery and corruption,
  • Taxation,
  • Fair competition.

Until the new reporting requirements stipulated by the Corporate Sustainability Reporting Directive and the more stringent due diligence requirements stipulated by the Corporate Sustainability Due Diligence Directive become applicable, the experts suggest the following approach: The Member States should base the requirements for compliance with the minimum measures on the international standards specified in Article 18, in particular the UN/OECD guidelines. Moreover, these also aim to provide companies with independent information sources regarding specific aspects of how to implement the minimum protection for external performance audits. The examples provided serve to illustrate when companies risk failing to comply with the minimum standards.

Human Resources departments need to take action

The experts do not define any specific obligations for companies. Instead, they only provide proposals for how to implement a social taxonomy.
Nevertheless, looking at the platform’s report is worthwhile, particularly for HR departments, when companies establish new due diligence processes or review existing procedures to determine whether these will meet the minimum protection requirement specified by above-mentioned standards in the four key areas in the future. The expert group places particular importance in compliance with the minimum standards being understood as a permanent process with the aim of achieving constant monitoring and improvement.

According to the latest World Bank report, poverty will continue to increase worldwide as a result of the Covid pandemic. Despite the practical pitfalls, the EU Commission is not expected to abandon its social taxonomy plans. In view of this, companies need to keep an eye on the ongoing developments regarding social taxonomy. Human and employee rights issues will also become increasingly important factors affecting financing conditions in the future. The social and health economy has even gone as far as to explicitly demand progress with social taxonomy in order to remain attractive for investors and to compensate for the lack of potential for improvement with regard to its environmental impact given the focus on the common good.

HR departments are coming under increasing pressure to implement ESG compliance. This is also why it is so important to avoid duplicating work and incurring additional expenses by taking an integrated approach which considers both the social taxonomy and the new CSRD reporting requirements as well as the planned EU supply chain due diligence law (CSDD), which will place even stricter requirements on companies than the German supply chain due diligence law.