Promoting Capital Flows for Social Investments via a Social Taxonomy

February 2023

Christiane-Conrads Christiane Conrads
Director, Global Real Estate ESG Leader, PwC Germany
José Amérigo José Amérigo
Partner, Tax and Legal, ESG PwC Spain
Allard Knook Allard Knook
Partner, Head of Public Sector Legal, PwC Netherlands

Environmental protection and social standards are becoming increasingly important in terms of regulatory obligations and stakeholder expectations. Both aspects are an integral part of the EU’s sustainable finance strategy. Further, in order to achieve the sustainable development goals (SDGs) of the UN’s 2030 agenda, social standards must be invested in.

With the EU Taxonomy Regulation[1], the EU is establishing a comprehensive framework for the protection of six environmental objectives (i.e. (i) climate change mitigation, (ii) climate change adaptation, (iii) protection of water and marine resources, (iv) transition to a circular economy, (v) protection of biodiversity and ecosystems as well as (vi) pollution prevention). Within this framework human rights and labor protection issues are only considered in the form of minimum safeguards. However, social aspects are now also emerging in the foreground of European regulation. This is particularly evident in the proposal for a directive on corporate sustainability due diligence and the final report on a possible structure of a Social Taxonomy. Whereas the first focuses on due-diligence duties of a company and its impact on human rights including workers’ rights, health, the climate as well as the environment, the latter shall provide for a framework promoting capital flows into investments with a main social objective so that private capital can be directed towards socially valuable activities. In this sense, Social Taxonomy is defined as the set of objective criteria and parameters aimed at classifying in a transparent and reliable manner, the activities and companies that contribute substantially to achieving certain objectives on the social level.

The following article introduces the recently published Social Taxonomy and provides an overview as to its key points.

Legislative process and next steps

On 28 February 2022, the Platform on Sustainable Finance (PSF, advisory body made up of commissioned experts who advise the Commission on issues related to the development of the European taxonomy) published its final report on a possible structure of an EU Social Taxonomy, following the publication of a preliminary report in July 2021. The report recommends taking national legislation as a minimum standard and, in addition, using as a reference framework international rules recognized by all member states, such as the UN Guiding Principles on Business and Human Rights. In terms of congruence with other EU regulations, there is also an overlap with the EU Disclosure Regulation on negative sustainability impacts in terms of the data to be reported.

The final report continues with the two options of either designing the interaction between two taxonomies, environmental and social, or merging both dimensions into one taxonomy. The next steps announced include a clarification of the minimum safeguards, conducting a study on the impacts of a social taxonomy considering different options for application and designs and working out a rationale for prioritizing objectives and sub-objectives. Although the PFS report does not contain obligations for the European Commission, it certainly points the way. Indeed, the European Commission has not yet decided what the next step in the development of social taxonomy will be. It is well expected that what is included in the report is taken into account by the Commission, whose proposal in this area seems that it will not be promoted in 2022 as expected, but later.

Social objectives

According to the PSF, while environmental objectives and criteria can be based on science, a social taxonomy must be based on international authoritative standards of topical relevance, such as the International Bill of Human Rights.

The Social Taxonomy shall promote three main targets for three different stakeholder groups:

  1. Decent work (including value-chain workers);
  2. Adequate living standards and well-being for end-users; and
  3. Inclusive and sustainable communities and societies.

These three groups of stakeholders to whose lives and livelihoods economic activities can make a positive contribution shall be in the center of the new regulation. This approach is to be welcomed from a methodological perspective and does also align with the recommendation of the EFRAG’s European Lab Project Task Force on preparatory work for developing EU sustainability-reporting standards. They already proposed a stakeholder-centric approach in their final report of February 2021.

To ensure that the various aspects integral to these objectives are considered, a non-exhaustive list of sub-objectives for each objective have been defined. These include, among others: health and safety; healthcare; housing; wages; non-discrimination; consumer health; and communities’ livelihoods.

Proposed structure

According to the final report the structure of the Social Taxonomy shall borrow various aspects of the environmental taxonomy. These include

  • the development of social objectives,
  • substantial contribution criteria,
  • "do no significant harm" (DNSH) criteria, and
  • minimum safeguards.

Therefore, to qualify as “socially sustainable” an economic activity must meet the (i) substantial contribution criteria, (ii) DNSH-requirements (iii) and the criteria on minimum safeguards.

There are three types of substantial contribution criteria for eligible economic activities proposed:

  1. Avoidance and management of negative impacts on the three objectives: Avoid high-risk sectors with proven human and labor rights violations or sectors that are less likely to contribute to the objectives of the European social pillar (e.g. fair working conditions and social protection and inclusion);
  2. Enhancing inherently positive impacts on social goods and services and basic infrastructure: focusing on social goods and services sectors that include products and services for basic human needs and basic economic infrastructure to meet the right to an adequate standard of living (e.g. adequate, safe, and healthy food, water, housing and clothing, but also the right to ‘the highest attainable standard of physical and mental health’ and the ‘right to education)
  3. Enabling activities: Economic activities that offer the potential to bring substantial risk reductions in other sectors (e.g. to ensure decent working conditions in a value chain; social audits can be implemented to highlight deficiencies and recommend improvements).

As in the Environmental Taxonomy, the Social Taxonomy will capture so-called DNSH-criteria, which means that activities making a substantial contribution to one social objective should not significantly harm other social objectives.

The PSF has been asked by the Commission to advise separately on the application and functioning of the minimum safeguards as set out in Article 18 of the Environmental Taxonomy. Article 18 describes them as minimum safeguard ‘procedures’ that the entity implementing a sustainable economic activity must follow and must be aligned with the relevant international instruments[2]. However, the report on the minimum safeguards is still to be published by the PSF and will then provide further clarity on how to apply Article 18.

“Just transition”

For an equitable ecological transformation of the economy (“just transition”), it is important to take social and labor standards into account. This is of particular importance because the social consequences of ecological actions are often unrecognized. The final draft by the PSF highlights that mostly all ecological measures not only have an environmental impact, but also a social one. According to the PSF, a social taxonomy must distinguish between the inherent benefits and any additional social benefits that directly contribute to the realization of human rights, such as improving access to quality healthcare or ensuring decent jobs. Without such an approach, pure social added value cannot be clearly determined and targeted.

Impact on the real estate industry

As one of the largest economic sectors, the real estate industry plays an outstanding role in people's everyday lives and in the development of society as a whole and, therefore, bears a high level of responsibility to the society. The introduction of a Social Taxonomy would not only give the industry the opportunity to position itself in its responsibility as one of the most important sectors, but also to improve its image, and provide companies the chance to develop competitive advantages. Issues such as creating livable urban neighborhoods, social justice, living together in the social space, and further improving diversity, should be addressed and, hopefully, these issues will be given greater focus with a Social Taxonomy. Precisely the fact that one of the objectives is to promote adequate living standards and well-being for end users and consumers, puts the focus on social rights such as housing, which makes the real estate sector one of the most important for the achievement of the ends to which the Social Taxonomy is oriented. Uniformity across the EU regarding labor and social standards is a goal to be pursued at its best. Achieving this will be a major challenge in the future, which needs to be overcome to push forward the “S” in the ESG.

For this to happen, it is to be hoped that the European Commission will speed up work so that Social Taxonomy is a legal reality as soon as possible.

[1] Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088.

[2] “the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights, including the principles and rights set out in the eight fundamental conventions identified in the Declaration of the International Labour Organisation on Fundamental Principles and Rights at Work and the International Bill of Human Rights”.