Taxonomy should link ESG and executive pay, say EU advisors

Europe’s Platform on Sustainable Finance is consulting on recommendations including framework for harmful activities and social taxonomy

The European Commission’s advisory group has concluded that the inclusion of ESG-linked executive pay and polluting activities in the taxonomy would help the EU’s flagship sustainable finance project generate real-world impact. 

The Platform on Sustainable Finance – a group of 57 market participants, sustainability experts and public agencies convened last year to steer the evolution of the taxonomy – has released a draft of its latest recommendations this week. 

In the recommendations, the Platform notes the growing trend for companies to link executive pay to ESG goals such as carbon emissions reductions or diversity at senior levels. 

“Having executive remuneration linked to ESG should be part of the EU taxonomy as it is a reflection of what is happening in the real economy,” it recommends, but acknowledges concerns about “how such requirements may interfere with the culture and autonomy of a company”. 

The Platform also addresses the prospect of a taxonomy that identifies business activities that are at odds with the EU’s environmental objectives, as well as those that contribute to a climate transition, and those that don’t have any impact at all. 

“Whilst acknowledging that there are arguments for and against extending the EU Taxonomy beyond green, the Platform considers the balance of evidence is that sustainable finance initiatives to date have neither significantly increased transition finance nor driven sufficiently ambitious environmental transitions,” says the report. “Alongside the growth in finance labelled as ‘green’, investments in and subsidies to fossil fuel industries and other environmentally harmful economic activities continue.” 

As a result, the expert group has proposed the EU Taxonomy be extended rapidly to cover activities causing significant harm (SH) to climate, waste, water, biodiversity and the circular economy – identifying activities for which “no technological possibility of improving their environmental performance to avoid significant harm exists”. 

It recommends that the first reporting requirements under such a framework are implemented by 2023. 

The report reiterates the need, as reported by RI in May, for an Intermediate Performance (IP) category in the EU Taxonomy to capture activities that fall in between significantly contributing to one of the six taxonomy objectives and causing significant harm to them. 

It recommends that the Commission issues non-binding guidance to taxonomy users on the use of SH and IP performance levels. 

In a second report from the Platform, this time dedicated to social issues, the experts call out data providers for their “concerning application” of the taxonomy rules – particularly for the ‘social safeguards’ pillar, which requires eligible green business activities to fulfil basic human rights protections in order to be fully taxonomy-aligned. 

“For example, an ESG rating provider indicated using the following indicator for compliance with the minimum safeguards: ‘It must be verified that the company has not been subject to (allegations of) failing to meet minimum social safeguards in their operations.’ It is indeed important to track a company’s actual performance on human rights – merely checking commitments and policies does not ensure actual implementation and safeguard human rights. However, this must be accompanied by pro-active alignment with the minimum safeguards’ requirements,” the report stated. 

The company cited in the example is Institutional Shareholder Services (ISS) – one of the main providers of taxonomy-based data and services in the market. 

Antje Schneeweiß, Managing Director at German church investment group Arbeitskreis Kirchliche Investoren and head of the group that produced the report, told RI that ISS was highlighted because “the subgroup was provided with this information” as opposed to information on other major providers. 

“Their [ISS’] inclusion was just meant as an example of how the subgroup doesn’t think verification should be done,” she explained. 

ISS declined to provide comment on the criticism, but said it welcomed the Commission's interest in social issues. 

The document also addresses the potential to extend the EU taxonomy to cover economic activities that support the bloc’s social objectives. 

The authors note that not all members of the Platform are convinced such a dedicated ‘social taxonomy’ is feasible or necessary. It also notes that current efforts on social issues are being “carried out in separate workstreams which carries the danger that investors and companies are faced with different reporting requirements for different legislative acts”. 

It adds that “present social reporting requirements in the SFDR might not be sufficient once the social taxonomy has been fully developed”, referring to the EU’s new Sustainable Finance Disclosure Regulation for financial product providers, which came into force this year. 

Schneeweiß acknowledged the concerns, but told RI: “We don't think that these obstacles can’t be overcome.”

She said the subgroup will review responses and issue final recommendations in October, to enable the Commission to adopt a position on the extension of the taxonomy before the end of 2021.

The Platform will then turn its attention to fleshing out the social safeguards requirements in the green taxonomy. 

Both reports are open for feedback until August.