Social investing took a setback when the European Commission decided to put aside its social taxonomy as the political hurdles were too great. The ‘S’ in ESG will soldier on, but there is now more pressure on the market to come up with its own standards. By Justin Pugsley.

What is happening?

The social taxonomy has turned out to be a bridge too far for an exhausted European Commission (EC), following the passing of the contentious green taxonomy, and has been left parked on the sidelines indefinitely. 

Investors expressed disappointment, but do not see this news as a mortal blow. After all, it focused heavily on the fixed income market and it did not quite cover all the bases in terms of granular detail.  

Reg rage – acceptance

That means individual jurisdictions and various global initiatives will continue as the torch bearers for crafting widely accepted standards for social lending and investing. 

But despite the possibility of not having a global set of EU standards for social lending and investing, financial innovation around the ‘social’ aspect of environmental, social and governance (ESG) is still happening.

Why is it happening? 

It is fair to say that ‘S’ is currently the poor cousin of ‘E’, when it comes to ESG. The latter, for all its problems, is far more developed, has well-established markets and the leaders in the financial space are enthusiastically supporting climate change policies. 

The trouble with the ‘S’ in ESG is that it is fiendishly complicated to agree on standards. Environmental issues at least have the benefit of being backed by science, and even then it can prove difficult to find common standards. 

Social issues, on the other hand, are embroiled in ethical and moral quandaries, which vary considerably not just by culture and country, but even within societies themselves. Look, for example, at the chasm between Trump and Biden supporters in the US over what is considered moral or ethical. 

This makes it very difficult to establish workable global guidelines beyond clear-cut issues such as not supporting slavery. But when it gets down to definitions and measurement, fragmentation is almost inevitable. 

There are frameworks, such as the Organisation for Economic Co-operation and Development guidelines for multinational enterprises and the UN Principles for Responsible Investment, but these only cover certain social aspects and lack granularity.

What do the bankers say? 

Bankers, especially those that operate across borders, nearly always favour global standards to create those fabled level playing fields.  

However, most are taking a ‘wait and see’ attitude to see how the ‘S’ sector develops. Few have truly devised lending criteria to support diversity, social justice or gender equality. Their counterparts in asset management are currently taking the lead in that area — and even there, the ‘S’ lags far behind the ‘E’. 

Indeed, until there is a more definitive consensus and public momentum behind what constitutes ‘S’, it is likely that adoption in banking will be relatively hesitant. For instance, a lack of definitions has seen some corporates back-off from issuing social or sustainability-linked bonds (SLBs) for fear of being accused of ‘rainbow washing’. 

Will it provide the incentives?  

The EC is not done with ‘S’ just yet. The great library of EU regulation is replete with references to rules on labour relations, practices, management and equality — all of which the commission intends to continue enhancing. Even the green taxonomy makes some references to social issues. 

With the social taxonomy in limbo, many industry sources see the US as potentially being able to take the lead in this area. It has several strong federal programmes and detailed definitions around social housing, which is enabling the development of a social bond market.

There are even numerous specialist boutique investment banks in the US focused on minorities, veterans and women. Late last year, the Canadian bank Toronto Dominion worked with four of these banks as joint book runners on a $500m green bond deal that was described as groundbreaking by many in the industry. This is where the US has a very strong edge, as its capital markets are considerably more developed than European ones.  

In the short term at least, the likely biggest hurdle to social finance might be rapidly rising interest rates and the likely slide towards recession. Indeed, issuance of social and SLBs has slipped back somewhat, as credit quality rises up the list of priorities for many investors. 

In the longer term, investors may well be the standard setters for definitions in social finance.

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