Towards a European Social Taxonomy: A Scorecard Approach

Abstract

This paper analyzes the EU’s efforts in designing a social taxonomy for sustainable investments. Examining the draft Social Taxonomy proposed by the Platform for Sustainable Finance in early 2022, we challenge the decision to follow the methodology provided by the EU’s environmental taxonomy detailed in the Taxonomy Regulation. We criticize in particular its “winner takes all” character whereby only economic activities meeting both furthering and facilitating characteristics and the do-no-significant-harm (DNSH) principle – as narrowly defined by a set of Technical Screening Criteria adopted in Level 2 legislation – can be classified as sustainable. Furthermore, the environmental taxonomy methodology seems to fail to properly incentivize transitional and mitigating economic activities, prompting the need to adopt an additional classification system for that purpose. Despite countless words, taxonomy rules remain incomplete and occasionally vague. This regulatory complexity carries enormous transaction costs for issuers, advisors and financial institutions. This observation casts doubt on the ability of the taxonomy framework to support the transition into a sustainable EU economy.

Contemplating these deficiencies, we propose an alternative scorecard approach assigning lower scores for transitional and mitigating activities and higher scores for activities meeting stricter taxonomy system criteria. While we admit that this might lessen accuracy for some aspects, the advantage of a scorecard approach lies in its adaptability and indicative effect, putting an emphasis on economic activity’s transition towards sustainability.

Keywords: Social taxonomy, environmental taxonomy, sustainability, ESG, sustainable finance, finance regulation

JEL Classification: K00, K1, K2, K10, K22, K23, K32, G23, G41, Q2