What is social finance? Definitions by market participants, the EU taxonomy for sustainable activities, and implications for development policy

Hilbrich, Sören Working Paper What is social finance? Definitions by market participants, the EU taxonomy for sustainable activities, and implications for development policy Discussion Paper, No. 29/2021 Provided in Cooperation with: German Institute of Development and Sustainability (IDOS), Bonn Suggested Citation: Hilbrich, Sören (2021) : What is social finance? Definitions by market participants, the EU taxonomy for sustainable activities, and implications for development policy, Discussion Paper, No. 29/2021, ISBN 978-3-96021-172-3, Deutsches Institut für Entwicklungspolitik (DIE), Bonn, https://doi.org/10.23661/dp29.2021 This Version is available at: https://hdl.handle.net/10419/247789 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ Discussion Paper 29/2021 What is Social Finance? Definitions by Market Participants, the EU Taxonomy for Sustainable Activities, and Implications for Development Policy Sören Hilbrich What is social finance? Definitions by market participants, the EU taxonomy for sustainable activities, and implications for development policy Sören Hilbrich Bonn 2021 Discussion Paper / Deutsches Institut für Entwicklungspolitik ISSN (Print) 1860-0441 ISSN (Online) 2512-8698 Except as otherwise noted, this Open Access publication is free to read, share and adapt under the terms of the CC BY 4.0 license. Die Deutsche Nationalbibliothek verzeichnet diese Publikation in der Deutschen Nationalbibliografie; detaillierte bibliografische Daten sind im Internet über http://dnb.d-nb.de abrufbar. The Deutsche Nationalbibliothek lists this publication in the Deutsche Nationalbibliografie; detailed bibliographic data is available on the Internet at http://dnb.d-nb.de. ISBN 978-3-96021-172-3 (printed edition) DOI:10.23661/dp29.2021 Printed on eco-friendly, certified paper Sören Hilbrich is a researcher at the German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) in the Programme “Transformation of Economic and Social Systems”. Email: [email protected] Published with financial support from the Federal Ministry for Economic Cooperation and Development (BMZ) © Deutsches Institut für Entwicklungspolitik gGmbH Tulpenfeld 6, 53113 Bonn  +49 (0)228 94927-0  +49 (0)228 94927-130 Email: [email protected] http://www.die-gdi.de Contents Acknowledgements Abbreviations Executive summary 1 1 Introduction 3 2 The relevance of social finance 4 3 Definitions of social finance by market participants 6 3.1 Social bonds 7 3.2 Social equity and sustainability ratings 9 4 The importance of common definitions 10 5 The need for public governance and the EU taxonomy for sustainable activities 11 6 Implications for development policy 14 References 17 Annex 20 Table A 1: Overview of eligible activities and target populations specified in social taxonomies and social bond principles 20 Tables Table 1: Eligible investment projects of 71 social bonds (projects categories most often mentioned) 8 Table 2: Social categories taken into account in ESG ratings by exemplary providers 10 Table 3: Overview of approaches used in the EU Social Taxonomy, the ICMA Social Bonds Principles, and definitions of social investments that build on ratings of sustainability rating agencies 14 Acknowledgements I am very grateful to Kathrin Berensmann, Clara Brandi, Paul Marschall und Ulrich Volz for comments on earlier versions of this paper. Adrian Glaz and Monja Rinderle provided valuable research assistance. Abbreviations ADB Asian Development Bank ACMF ASEAN Capital Markets Forum ASEAN Association of Southeast Asian Nations CICETE China International Center for Economic and Technical Exchanges DNSH do no significant harm ESG environmental, social and governance ETF exchange-traded funds EU European Union FfD Financing for Development GDP gross domestic product ICMA International Capital Market Association ILO International Labour Organization IMF International Monetary Fund IOSCO International Organization of Securities Commissions IPSF International Platform on Sustainable Finance MSME micro, small and medium enterprises NFRD Non-Financial Reporting Directive NGO non-governmental organization OECD Organisation for Economic Co-operation and Development SDG Sustainable Development Goal UN United Nations UNDP United Nations Development Programme USA United States of America WWF World Wide Fund for Nature What is social finance? German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 1 Executive summary The market for social financial instruments is rapidly growing. The issuance of social bonds, for instance, reached $149.4 billion in 2020, showing an extraordinary growth of 720% compared to 2019 (ADB, 2021, p. 14). By providing capital for certain types of investments associated with positive social impacts, these instruments are intended to close funding gaps that hamper the realisation of social goals, as laid down, for instance, in the 2030 Agenda for Sustainable Development. In addition, social finance might set incentives for enterprises to engage in more sustainable business models that would give them access to social financial instruments potentially associated with a lower cost of capital. However, the magnitude of the potential contribution to society of social finance is a matter of debate. One reason for this is that, due to the fungibility of money, it usually cannot be ensured that social financial products mobilise additional resources. This paper focuses on another important challenge for social finance – one that concerns the plurality of existing definitions of social investments. It provides an overview of the definitions followed by market participants, describes the European Union (EU) taxonomy for sustainable activities as a potential standard in this context, and discusses implications for development policy. Until now, market participants have worked with very different definitions of social investments. Some agents have focused on the social impacts of goods or services. Others have focused on process-related impacts, such as those related to working conditions of employees. There is also considerable variety in the procedure for selecting eligible investments. Some issuers of social financial products positively identify specific sectors as being eligible; others merely exclude some sectors. Other agents use so-called best-in-class procedures and consider a fixed share of firms in each industry that score highest in respect of social indicators as eligible. Finally, minimum criteria that all eligible firms have to meet are also often used in identifying potential investment projects. Partly depending on the different foci and selection procedures, there are also great differences in the level of ambition of the various definitions. The plethora of definitions of social investments in economic practice is detrimental to positive societal impacts. Heterogeneous definitions increase transaction costs because investors have to spend resources on researching what definition is being applied by the issuer of a specific social financial product, and they can facilitate deceptive practices and even lead to adverse selection. Social finance can thus only realise its full potential if common definitions for social financial products are established. While, many efforts to develop standards for definitions of social investments have been made by private agents such as the International Capital Market Association (ICMA), the European Union (EU) is currently preparing a comprehensive taxonomy for sustainable activities. A proposal for this taxonomy, developed by the EU Platform on Sustainable Finance, suggests that the taxonomy should combine a number of the different approaches used by market participants to identify social activities. The details of this classification system with respect to the social dimension and its level of ambition have not yet been Sören Hilbrich 2 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) determined. In developing the taxonomy, it will be important to ensure that economic activities have to meet sufficiently demanding criteria to be considered sustainable. The EU taxonomy will probably exert a major influence on the global sustainable finance markets as, for instance, all agents wanting to sell financial products in the EU will have to disclose the extent to which the proceeds of these products finance activities that are aligned with the taxonomy. Because of the likely global repercussions, impacts on non- EU and, in particular, poorer countries should be carefully assessed and taken into account in the development of the taxonomy. Of direct relevance to these countries is, for instance, how working conditions and local externalities in global supply chains will be taken into account. International efforts to further develop the governance of social finance (and more generally sustainable finance) as they are currently undertaken by, for instance, the G20, will remain important (in spite of the influence exerted by the EU taxonomy). It is crucial that representatives from poorer and smaller countries are able to participate in shaping the governance of social finance to improve the chance that future rules will meet the interests of the population of these countries. Social finance should thus also be on the agenda of more inclusive processes, such as that of the United Nation’s Financing for Development process. What is social finance? German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 9 bonds, the ICMA has developed voluntary process guidelines for sustainability-linked bonds (ICMA, 2020b). However, the guidelines leave much room for different sustainability targets, allowing for different understandings of social (or environmental) investment. 3.2 Social equity and sustainability ratings Social finance is increasingly playing a role on equity markets. For instance, equity funds – taking the form either of actively managed funds or of exchange-traded funds (ETFs) – that claim to offer the opportunity of a social investment have rapidly increased in number in recent years. Sustainable ETFs replicate sustainable business indices, such as one of the MSCI SRI Indexes or the Dow Jones Sustainability Indices. Such indices cover a subset of the companies of a parent index that are selected for their sustainability performance.11 Various combinations of the approaches distinguished above are used in the selection procedures of actively managed funds or the compilation of sustainable business indices. For instance, many sustainable equity funds exclude some sectors, such as the production of military weapons, due to the kind of goods produced from their investment universe. This is often combined with a best-in-class procedure, or the application of minimum criteria that might also concern process-related impacts. Other funds use a positive selection of social sectors. The definitions of social sustainability employed by sustainable equity funds have very different levels of ambition. In addition, many funds are not very transparent about the exact selection procedure of stocks and the sustainability criteria employed in these procedures. In general, in spite of the great number of financial products in this area, so far no common definitions or standards for social equity have emerged. Sustainable equity funds often rely in their investment decisions at least partly on ESG data provided by sustainability rating agencies. Agencies such as MSCI, Refinitiv, or ISS-oekom assign corporations a rating according to sustainability criteria, and often provide additional ESG data. ESG ratings are typically relative to industry peers (MSCI, 2020, p. 4). Therefore, investment decisions based on sustainability ratings can be described as employing a kind of best-in-class procedure. Rating agencies usually focus predominantly on process-related issues, but often also consider to some extent the impacts of the goods and services produced. Criteria related to the social dimension of sustainability that are part of the rating processes often concern, for instance, the situation of the workforce, product liability and engagement with local communities. Table 2 summarises what social categories are taken into account by four exemplary rating providers. On the level of general categories there is a rather high degree of overlap among different rating providers. However, as detailed methodologies of rating agencies are not always made publicly available, the precise understanding of the social dimension of sustainable finance implicit in their ratings is often unclear. In addition, sustainability ratings of different agencies have been shown to diverge to a substantial extent (Dorfleitner, Halbritter, & Nguyen, 2015). In general, the meaning and trustworthiness of 11 For an analysis of a number of sustainable business indices, see Fowler and Hope (2007). Sören Hilbrich 10 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) ESG data provided by these agencies is subject to debate (Berg, Koelbel, & Rigobon, 2019; Busch, Bauer, & Orlitzky, 2016; Cash, 2018; Widyawati, 2020). Table 2: Social categories taken into account in ESG ratings by exemplary providers FTSE Russell MSCI Refinitiv S&P Global Social categories (terms used by the respective rating agency) • Labour standards • Human rights and community • Health and safety • Costumer responsibility • Human capital • Product liability • Stakeholder opposition • Social opportunities • Workforce • Human rights • Community • Product responsibility • Workforce and diversity • Safety management • Customer engagement • Community Author’s compilation based on FTSE Russell (2020), MSCI (2020), Refinitiv (2021), and S&P Global (2020) 4 The importance of common definitions The discussion of definitions of social investments widespread on financial markets in the previous section revealed how heterogeneous understandings of social finance are. Great differences exist with respect to foci, selection procedures, and how demanding the criteria are. In principle, there might be nothing wrong with having social financial products that follow different definitions. A diversified market can, for instance, allow investors who put much weight on social concerns to purchase products that are meant to make a clear positive contribution. Other investors who are less motivated by social concerns might at least be motivated to purchase financial products that take some minimal social criteria into account. In addition, financial products can be designed to align with values of specific population groups, such as certain religious communities. However, if all providers can label financial products as social according to their own definition, this opens up opportunities for deceptive practices, such as “social washing”. Social washing can be understood as analogous to greenwashing, which refers to exaggerated (or false) claims made by firms that mislead customers or investors about the impact of their business practices on the environment (Gregory, 2021, p. 1). The consequences of social washing are twofold: financial products that are labelled as “social” but are little different from conventional financial products cannot have a positive societal impact (or rather no impact that is different from the impact of other financial products) and potential investors are likely to be deterred from investing in social financial products (Migliorelli, 2021). More generally, as is often argued with respect to standards and definitions concerning green bonds (Berensmann, 2017; Shishlov, Morel, & Cochran, 2016), a lack of harmonisation increases transaction costs because investors have to assess, in each case, what approaches are applied by the respective providers in the selection of social investment projects. Increased transaction costs lower the financial returns of social financial products compared to other products, and can thereby reduce market size. What is social finance? German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 11 A lack of common definitions and transparency could even lead to adverse selection due to asymmetric information. If consumers of sustainable financial products cannot easily distinguish between financial products that meet ambitious social standards and products that apply only loose standards or are even merely advertised as social but do not differ from conventional financial products, this can drive suppliers of financial products that conform to ambitious standards out of the market. If the level of ambition cannot easily be identified by investors, they might set their reservation price (i.e. the maximum price they would be willing to pay) lower than the price they would be willing to pay for products that meet high social standards. Suppliers that are only willing to provide their financial products at a higher price leave the market. Common standards are thus crucial to enable social finance to realise its potential in supporting the transformation of the economy towards sustainability. This holds true not only for standards on the definition of social investments but also for other kinds of standards for social financial products, such as standards on reporting or monitoring. In this paper, though, I focus exclusively on issues associated with defining what counts as a social investment. 5 The need for public governance and the EU taxonomy for sustainable activities As a lack of common definitions can lead to social washing, increased transaction costs and adverse selection, social finance can only make a substantial contribution to the transformation towards sustainability if standards on definitions are developed. Such standards can, in principle, be established by private agents, such as associations of market participants and multi-stakeholder organisations, and by public agents, such as national governments and international organisations. In general, private governance is sometimes able to achieve some harmonisation without issuing legally binding rules (Kawabata, 2020; Thistlethwaite, 2014). As described above, the ICMA as a private agent has established guidelines that are followed by many issuers of social and green bonds (and even by public institutions that issue such bonds). However, these guidelines remain on a very general level and do not include a sufficiently concrete definition of social investments. Moreover, to establish any common definition is, obviously, not sufficient. Adequate definitions that ensure that social finance realises its potential in contributing to the transformation towards sustainability need to set, for instance, sufficiently ambitious criteria. The commercial interests of market participants, as they are organised in associations such as the ICMA, do not necessarily favour the definitions that would do best in terms of sustainability goals. In addition, the systematic exclusion of affected groups in decision-making raises issues of legitimacy if rules made by private agents become prevalent.12 12 For instance, the ICMA, in common with many institutions that provide private governance in the global sphere (Dingwerth, 2008), is dominated by agents from high-income countries. For a discussion of the shortcomings that can be associated with a strong role of private actors in global monetary and financial governance – focusing on the Basel Committee on Banking Supervision and the International Organization of Securities Commissions (IOSCO) – see Underhill and Zhang (2008). Sören Hilbrich 12 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) Despite these shortcomings, private governance might still have a role to play in establishing standards for social finance. In the absence of public regulations, guidelines and principles of private association can constitute second-best solutions. In addition, private governance can provide opportunities for experimentation and serve as an “idea incubator” (Green & Auld, 2017, p. 271) for public actors. However, due to the described deficits, efforts of public institutions to develop common standards on the definition of social investments that, at least, complement forms of private governance in this area, are to be welcomed. One of the first comprehensive efforts by a public institution to define sustainable economic activities is currently undertaken by the EU in developing a taxonomy for sustainable activities. The EU taxonomy is not the first effort to establish a public definition of social investments. However, attempts such as the ASEAN Social Bond Standards (ACMF, 2018) or the SDG Finance Taxonomy (Qing & Nedopil Wang, 2020) developed by United Nations Development Programme (UNDP) China and the China International Center for Economic and Technical Exchanges (CICETE) have remained rather general and have not exercised the same degree of influence on the markets as can be expected with respect to the EU taxonomy.13 The EU taxonomy should be used in a number of ways. Financial market participants will probably be obliged to disclose to what extent the proceeds of their financial products finance activities that are in line with the EU taxonomy. This disclosure requirement will apply to all agents that sell financial products in the EU, irrespective of where they are based. The EU taxonomy will thus also be of considerable importance to global markets and definitions of social investment followed by financial market participants from non-EU countries. Not only financial market participants, but also large companies of all sectors that fall under the scope of the Non-Financial Reporting Directive (NFRD) will probably have to report on the proportion of their turnover, capital expenditure, and operating expenditure that is associated with economic activities that are sustainable in the sense laid out by the taxonomies.14 In addition, the EU sustainable taxonomies should be used as definition of sustainable economic activities for all public labels for sustainable financial products that might be developed by the EU or the member states. This is relevant, for instance, to the EU Green Bonds Standard or the EU Eco Label for financial products currently being developed. A green taxonomy has already been presented, in 2020. Green economic activities have to substantially contribute to at least one of six environmental objectives defined in the taxonomy (positive selection) and to do no significant harm (DNSH) to the realisation of 13 The ASEAN Social Bond Standards and the SDG Finance Taxonomy are included in the overview in the Annex (table A1). Public taxonomies that focus on the green dimension are somewhat further developed. For an overview of green finance definitions and taxonomies, see OECD (2020). 14 However, the members of the Platform on Sustainable Finance that is preparing the EU taxonomies voice scepticism over whether it will be possible to calculate the proportion of turnover, capital expenditure, and operating expenditure for all objectives that are suggested for inclusion in the social taxonomy (Platform on Sustainable Finance, 2021, p. 33). What is social finance? German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 13 the other five.15 Delegated Acts by the European Commission establish technical screening criteria for these objectives. In addition, the green taxonomy includes minimum social safeguards (minimum criteria). A taxonomy of social activities that will probably have a rather similar structure is currently under development.16 In preparing the sustainability taxonomies, the EU Commission is advised by the Platform on Sustainable Finance, a group of experts from private sector, civil society, and public institutions. In July 2021, the Platform published a draft report on the social taxonomy (Platform on Sustainable Finance, 2021).17 The recommendations included in the report are interesting because they might provide a foretaste of what the prospective social taxonomy of the EU will look like. The report emphasises that the social taxonomy should refer in its criteria to international agreements, such as the International Bill of Human Rights and the International Labour Organization (ILO) core labour norms. The members of the platform believe that, unlike in the case of the green taxonomy, it is often not possible to derive social criteria directly from scientific knowledge. The reference to “international authoritative standards” (Platform on Sustainable Finance, 2021, p. 4) is seen as a suitable alternative basis for the social taxonomy. In addition, the reference to international agreements is meant to avoid infringing on national sovereignty if these agreements are accepted by all EU member states. The report suggests including five social objectives in the social taxonomy: improving accessibility of products and services for basic human needs, improving accessibility to basic economic infrastructure, ensuring decent work, promoting consumer interests, and enabling inclusive and sustainable communities. For each of these topics the fully worked out taxonomy would have to specify criteria for a “substantial contribution” and for “doing no significant harm” (the current report of the Platform on Sustainable Finance includes only examples of potential criteria). An economic activity would have to make a substantial contribution to one of the five objectives (positive selection) and to do no significant harm to the other four (minimum criteria) to count as socially sustainable.18 The first two objectives – referred to in the report as “vertical objectives” – relate to the impacts of goods and services on the realisation of social goals. The other three, 15 The six environmental objectives are: climate change mitigation, climate change adaptation, the sustainable use and protection of water and marine resources, the transition to a circular economy, pollution prevention and control, and the protection and restoration of biodiversity and ecosystems. 16 How the green and social taxonomy will be related to each other is not yet clear. The Platform on Sustainable Finance describes two models in this regard. According to the first model, sustainable economic activities have to conform either to the green or to the social taxonomy and meet only some minimum safeguards with respect to the other dimension. According to the second model, there will basically be only one taxonomy. Sustainable activities would then have to make a substantial contribution to one of the objectives (green or social) and meet all green and social DNSH-criteria (Platform on Sustainable Finance, 2021, pp. 52-57). 17 For an earlier comprehensive proposal for the EU social taxonomy by a representative of a German NGO that is also member of the Platform on Sustainable Finance, see Schneeweiß (2020). 18 The EU green taxonomy is applied to economic activities. The report of the Platform on Sustainable Finance on the social taxonomy states, though, that it might not be possible to link social issues in all cases to economic activities. Instead, for some issues, such as tax transparency, it might make more sense to focus on economic entities (Platform on Sustainable Finance, 2021, p. 4). Sören Hilbrich 14 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) “horizontal”, objectives are process-related and can, in principle, be met by economic activities that produce all kinds of goods or services. The report suggests, though, excluding some economic activities as “significantly harmful activities”, such as the production of tobacco and of certain kinds of weapons, because of the negative impacts of the goods produced (exclusion). According to the proposal of the Platform on Sustainable Finance, the EU social taxonomy would thus combine many of the approaches to identifying social economic activities described above (see Table 3). Table 3: Overview of approaches used in the EU Social Taxonomy, the ICMA Social Bonds Principles, and definitions of social investments that build on ratings of sustainability rating agencies Impact of goods or services produced on social goals Process-related impacts on social goals (e.g. working conditions) Positive selection of sectors (or certain types of activities) EU Social Taxonomy ICMA Social Bonds Principles EU Social Taxonomy ICMA Social Bonds Principles Exclusion of sectors (or certain types of activities) EU Social Taxonomy Best-in-class procedures Sustainability rating agencies Sustainability rating agencies Minimum criteria EU Social Taxonomy EU Social Taxonomy Author’s compilation, based on Platform on Sustainable Finance (2021) and ICMA (2020a) 6 Implications for development policy In the previous sections, I argued that social finance could contribute to closing the funding gaps for social investments and setting incentives for the transformation of the economy towards sustainability (although the magnitude of its potential contribution is unclear). I also described the plethora of definitions of social investments on the markets, and explained how this plurality of definitions increases transaction costs and facilitates deceptive practices. For this reason, I argued that standards for the definition of social investments are necessary to allow social finance to realise its potential. The EU taxonomy for sustainable activities as a comprehensive classification system may well set such a standard. The efforts of the EU to establish a comprehensive taxonomy for sustainable activities could, thus, in principle, be highly beneficial. In accompanying the process of developing the taxonomy, the German governments should seek to ensure that the taxonomy has a sufficient level of ambition and is not subsequently watered down in response to lobbying activities. As business actors are strongly represented in the Platform, this might be a real threat. Several NGOs, including the World Wide Fund for Nature (WWF), have also reported experiencing lobbying by EU member states in favour of specific commercial interests in the development of the green taxonomy. They suspended their participation in the Platform for Sustainable Development in April 2021 because they considered the taxonomy rules concerning bioenergy and forestry as being too weak, and were critical of lobbying activities that had led to these rules (WWF, 2021a), only resuming their work after What is social finance? German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 15 the EU Commission proposed steps to increase the independence of the Platform (WWF, 2021b). As described in the previous section, the adoption of the EU taxonomy for sustainable activities will have a great influence on global financial markets and the further development of standards for social financial products. Due to these global impacts, it is necessary to carefully assess consequences of the taxonomy regulation for non-EU countries, consult with representatives of these countries on potential impacts, and take these impacts into account in the design of the taxonomy. The EU taxonomy could have impacts on poorer countries even if the amount of capital that is channelled to these countries in the near term through taxonomy-aligned dedicated sustainable financial products remains limited.19 After all, the report of the Platform on Sustainable Finance on social taxonomy emphasises the importance of human rights due diligence that encompasses the entire value chain (Platform on Sustainable Finance, 2021, p. 32). Ambitious criteria with respect to international supply chains could potentially provide additional incentives for large companies to implement measures that improve working conditions and address local externalities of production processes abroad. However, the report does not yet specify exactly how requirements with respect to supply chains should be reflected in the taxonomy. Supply chains are relevant for two of the social objectives included in the current proposal for the taxonomy, namely “ensuring decent work” and “ensuring inclusive and sustainable communities”. To be able to set effective incentives, criteria for these objectives with respect to supply chains (in particular the criteria for “substantial contributions”) must go much further than the legal obligations that are already enacted by national legislation or will be included in the EU due diligence law currently being prepared. Criteria should, for instance, not only concern immediate suppliers but the entire supply chain, and should go beyond requiring merely risk analyses. While the EU taxonomy will arguably play a crucial role in setting standards for social finance and sustainable finance in general, activities of international organisations to monitor developments and work towards harmonisation in the area of social finance will remain relevant. Countries such as China or Mexico have, in the past, to some degree established their own standards in the area of sustainable finance, for instance with respect to green bonds. It is questionable whether they will simply adopt the definition of social activities set by the EU taxonomy for sustainable activities. While it can be beneficial if definitions are adapted to national circumstances, different standards will, as described above for the definitions of social investments followed until now by market participants, increase transactions costs. International cooperation on sustainable finance regulations has, in the past, been facilitated, for instance, by the OECD, the World Bank and the G20. It is crucial, though, that regulatory questions concerning sustainable finance are also discussed in more 19 Until now, markets for sustainable financial products have developed rather slowly in many economically poor countries. It has been argued that barriers to the development of, for instance, green bond markets in these countries include currency risks, requirements of international institutional investors to purchase only financial products with high credit ratings, minimum size requirements, limited technical capacity, and high transaction costs (Banga, 2019; Jones et al., 2020). It is plausible that these barriers also apply to markets for social financial products. Sören Hilbrich 16 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) inclusive processes, such as the Financing for Development (FfD) process of the United Nations (UN). In 2018, the EU launched, together with a number of relevant authorities from non-EU countries, the International Platform on Sustainable Finance (IPSF).20 Today, the platform includes 17 members, including countries such as China, India, Japan and Kenya. It is meant to facilitate the exchange between its members and promote best practices with respect to sustainable finance policies.21 For instance, the platform is working “toward a ‘Common Ground Taxonomy’ highlighting the commonalities between existing taxonomies” (International Platform on Sustainable Finance, 2020, p. 6). In general, the German government and the EU should encourage discussion of issues related to social finance in inclusive fora, and support poorer or smaller countries in actively participating in decisionmaking with respect to the governance of sustainable finance. 20 The IPSF should not be confused with the Platform on Sustainable Finance mentioned above, which is an expert group that advises the EU with respect to its sustainable finance policies. 21 However, the IPSF seems to have focused until now mainly on the green dimension of sustainable finance. What is social finance? German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 17 References ADB (Asian Development Bank). (2021). Primer on social bonds and recent developments in Asia. Retrieved from https://www.adb.org/sites/default/files/publication/677671/social-bonds-recent-developments- asia.pdf ACMF (ASEAN Capital Markets Forum) (2018). ASEAN Social bond standards. Retrieved from https://www.theacmf.org/initiatives/sustainable-finance/asean-social-bond-standards Banga, J. (2019). The green bond market: A potential source of climate finance for developing countries. Journal of Sustainable Finance & Investment, 9(1), 17-32. Berensmann, K. (2017). Upscaling green bond markets: The need for harmonised green bond standards (Briefing Paper 12/2017). German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE). Retrieved from https://www.die-gdi.de/uploads/media/BP_12.2017.pdf Berg, F., Koelbel, J. F., & Rigobon, R. (2019). Aggregate confusion: The divergence of ESG ratings (MIT Sloan School Working Paper 5822-19). Retrieved from https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3438533 Bracking, S. (2015). Performativity in the Green Economy: How far does climate finance create a fictive economy? Third World Quarterly, 36(12), 2337-2357. Busch, T., Bauer, R., & Orlitzky, M. (2016). Sustainable development and financial markets: Old paths and new avenues. Business & Society, 55(3), 303-329. Cash, D. (2018). Sustainable finance ratings as the latest symptom of ‘rating addiction’. Journal of Sustainable Finance & Investment, 8(3), 242-258. Cripps, P. (2018). Green bond comment, January 2018: What has the green bond market ever done for us? Environmental Finance. Retrieved from https://www.environmental-finance.com/content/analysis/greenbond-comment-january-2018-what-has-the-green-bond-market-ever-done-for-us.html Dingwerth, K. (2008). Private transnational governance and the developing world: A comparative perspective. International Studies Quarterly, 52(3), 607-634. Dorfleitner, G., Halbritter, G., & Nguyen, M. (2015). Measuring the level and risk of corporate responsibility. An empirical comparison of different ESG rating approaches. Journal of Asset Management, 16(7), 450- 466. European Commission. (2021). Taxation trends in the European Union. Publications office of the European Union. Retrieved from https://op.europa.eu/en/publication-detail/-/publication/d5b94e4e-d4f1-11eb- 895a-01aa75ed71a1/language-en Fowler, S. J., & Hope, C. (2007). A critical review of sustainable business indices and their impact. Journal of Business Ethics, 76(3), 243-252. FTSE Russell. (2020). ESG Ratings and data model. Integrating ESG into investments. Retrieved from https://research.ftserussell.com/products/downloads/ESG-ratings-overview.pdf Gianfrate, G., & Peri, M. (2019). The green advantage: Exploring the convenience of issuing green bonds. Journal of Cleaner Production, 219, 127-135. Global Reporting Initiative & United Nations Global Compact. (2018). Integrating the SDGs into corporate reporting. A practical guide. Retrieved from https://www.globalreporting.org/media/0sxj0ewa/gri_ungc_reporting-on-sdgs_practical_guide.pdf Green, J. F., & Auld, G. (2017). Unbundling the regime complex: The effects of private authority. Transnational Environmental Law, 6(2), 259-284. Gregory, R. P. (2021). When is greenwashing an easy fix? Journal of Sustainable Finance & Investment, 1-24. Hilbrandt, H., & Grubbauer, M. (2020). Standards and SSOs in the contested widening and deepening of financial markets: The arrival of Green Municipal Bonds in Mexico City. Environment and Planning A: Economy and Space, 52(7), 1415-1433. Sören Hilbrich 18 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) ICMA (International Capital Market Association). (2020a). Social bond principles. Voluntary process guidelines for issuing social bonds. Retrieved from https://www.icmagroup.org/assets/documents/Regulatory/Green-Bonds/June-2020/Social-Bond- PrinciplesJune-2020-090620.pdf ICMA. (2020b). Sustainability-linked bond principles. Voluntary process guidelines. Retrieved from https://www.icmagroup.org/sustainable-finance/the-principles/the-principles-guidelines-and- handbooks/sustainability-linked-bond-principles-slbp IMF (International Monetary Fund). (2021). Fiscal monitor: A fair shot. Retrieved from https://www.imf.org/- /media/Files/Publications/fiscal-monitor/2021/April/English/text.ashx International Platform on Sustainable Finance. (2020). Annual report. Retrieved from https://ec.europa.eu/info/sites/default/files/business_economy_euro/banking_and_finance/documents/in ternational-platform-sustainable-finance-annual-report-2020_en.pdf Jones, R., Baker, T., Huet, K., Murphy, L., & Lewis, N. (2020). Treating ecological deficit with debt: The practical and political concerns with green bonds. Geoforum, 114, 49-58. Kawabata, T. (2020). Private governance schemes for green bond standard: Influence on public authorities’ policy making. Green Finance, 2(1), 35-54. Löffler, K. U., Petreski, A., & Stephan, A. (2021). Drivers of green bond issuance and new evidence on the “greenium”. Eurasian Economic Review, 11, 1-24. Maltais, A., & Nykvist, B. (2020). Understanding the role of green bonds in advancing sustainability. Journal of Sustainable Finance & Investment, 1-20. doi: 10.1080/20430795.2020.1724864 Migliorelli, M. (2021). What do we mean by sustainable finance? Assessing existing frameworks and policy risks. Sustainability, 13(2), 975. Morningstar. (2021). Sustainable funds U.S. landscape report. Retrieved from https://www.morningstar.com/lp/sustainable-funds-landscape-report MSCI. (2020). MSCI ESG rating methodology. Retrieved from https://www.msci.com/documents/1296102/21901542/MSCI+ESG+Ratings+Methodology+- +Exec+Summary+Nov+2020.pdf Nasdaq. (2021). Nasdaq sustainable bond criteria. Retrieved from https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=&ved=2ahUKEwjjyNn12Kbz AhUAhf0HHVBkDWEQFnoECAQQAw&url=https%3A%2F%2Fwww.nasdaq.com%2Fdocs%2F202 1%2F09%2F06%2FNasdaq-Sustainable-Bond-Criteria.pdf&usg=AOvVaw10- OGb2wIYJMvk5mohcL0f Nicholls, A., & Emerson, J. (2015). Social finance. Capitalizing social impact. In A. Nicholls, R. Paton, & J. Emerson (Eds.), Social finance (pp. 1–44). Oxford: Oxford University Press. OECD (Organisation for Economic Co-operation and Development). (2020). Developing sustainable finance definitions and taxonomies. Retrieved from https://doi.org/10.1787/134a2dbe-en OECD & UNDP (United Nations Development Programme). (2020). Framework for SDG Aligned Finance. Retrieved from http://www.oecd.org/development/financing-sustainable-development/Framework-for- SDG-Aligned-Finance-OECD-UNDP.pdf Platform on Sustainable Finance. (2021). Draft report by Subgroup 4. Social taxonomy. Retrieved from https://ec.europa.eu/info/publications/210712-sustainable-finance-platform-draft-reports_en Refinitiv. (2021). ESG data and solutions from Refinitiv. Retrieved from https://www.refinitiv.com/content/dam/marketing/en_us/documents/brochures/esg-research-brochure.pdf Qing, X. & Nedopil Wang, C. (2020). Technical report on SDG finance taxonomy (China). UNDP and CICETE. Retrieved from https://www.cn.undp.org/content/china/en/home/library/poverty/technicalreport-on-sdg-finance-taxonomy.html