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Social Taxonomy Poses Data Challenges Say Experts

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The European Union’s plans to create a Social Taxonomy will pose even greater data challenges than the framework created for financial institutions and companies to report on their environmental impacts.

Experts warn that the lack of concrete data on issues such as diversity and modern slavery will make the process of formulating the regulation slow and difficult. It also could run into enforcement challenges if the legislation’s draughtsmen don’t tighten the definitions of some important social measures or if they over-extend the boundaries of its scope.

“There will be certain challenges because nobody is used to the taxonomy – nobody is used to properly collecting those metrics and analysing them,” said Meghna Mehta, Vice President for ESG Impact & Screening Research at MSCI.

The comments came in a panel meeting of representatives of data and asset managers hosted by the United Nations’ Principles for Responsible Investment (PRI). The gathering was convened a few weeks after the EU published its Final Report on Social Taxonomy in February.

The document, written by the EU’s Platform on Sustainable Finance (PSF) expert group, lays out the case for creating a template for reporting on social impact in a similar way to the EU Taxonomy. The framework is intended to guide investment and corporate decisions to achieve three objectives; create good work for populations; provide adequate living standards; and, ensure sustainable and inclusive communities.

Do No Harm

Like the green Taxonomy, it seeks to ensure activities avoid negative impact on society. However, it adds another provision, that decisions enhance the positive impacts inherent in economic activity. It also departs from the green Taxonomy in that it is unlikely to set scientific targets. Instead the Social Taxonomy will be based on minimum standards on a range of issues including gender parity and healthcare provisions.

The European Commission is expected to publish its observations on the blueprint by the end of the year and legislation isn’t expected for many years yet.

Nevertheless, experts fear there may be some shortcomings in the application of the Social Taxonomy, especially when it comes to companies gathering the necessary compliance data. One important observation offered by the PRI panel was that the proposal provides few details on key reporting parameters.

“We have no definitions and standardised classifications for social topics,” said Antje Schneeweiß, General Secretary of the Working Group of Church Investors in Germany, and a rapporteur for one of the sub-groups within the PSF. “When we have a look at ESG ratings, we see that the ratings on social topics diverge even more than the ratings on the environmental topics.”

Amid questions over whether the S and G in ESG had been overlooked in the face of the need to rapidly address E through climate-change mitigation funding, there is wide acceptance of the need for a Social Taxonomy within the financial services industry.

Laurene Chevenat, Policy and Advocacy Lead at asset manager Mirova said the framework filled a hole in the EU’s sustainable finance programme.

“There are no EU policies on social issues that can set mutually agreed objectives,” Chevenat said. “And so this makes it even more complex – having a taxonomy in this regard would be very helpful for investors, so we support very much the concept and the idea.”

Maria Teresa Zappia, Deputy CEO and Chief Impact and Blended Finance Officer at BlueOrchard Finance said the Taxonomy would help bring smaller businesses within the broader ESG fold.

“If we want private investment to really be channelled into having a positive social contribution, we certainly have to build a framework,” Zappia said.

Complexity Concern

Nevertheless, the complexity of the regulation’s aims would make compliance difficult. Within each objective are a multitude of other sub-objectives, which could be tricky to measure and address. And its links to the green Taxonomy need to be strengthened, others have argued. They cite as an example the need to address the expectation that poorer communities will bear the greatest cost of the global decarbonisation transition.

But the gaps in the data record would be likely to occupy most time. MSCI’s Mehta said the absence of clear definitions of such issues as poverty and even what constitutes a small business would make gathering data a challenge.

“We don’t really find very concrete data on some complex issues like diversity, like modern slavery, those are data that we don’t find very easily,” she said.

She also warned that companies have shown little appetite for reporting on controversies, which would be required to satisfy the Taxonomy’s “do no wrong” test.

Its application across Europe – and to companies from overseas that trade in the regions – could also be hampered by cultural differences, Mehta argued. She cited problems that could come with promoting vegan diets, which “may really be problematic in another” cultural context.

More broadly, without tight guidance on the metrics to be included, the Taxonomy’s aims may be too great for some companies and economies to bear, said Zappia. That, she warned, could undermine the ambitions of the regulation.

“The environmental Taxonomy has been pretty prescriptive and is in some cases very limiting for its application in emerging markets, where some of these data points are simply not there,” she said.

“The social taxonomy – if it wants to cover smaller companies and their activities in emerging and frontier markets – will have to write in some some flexibility and room for manoeuvre. Otherwise it would not be fulfilling its initial objective of transparency in disclosure.”

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