Japanese climate experts propose national “transition taxonomy” for finance

The recommendations are another blow to the EU’s plans to drive a global classification system

Japanese researchers have proposed the creation of a “transition taxonomy”, in another swipe by the country at the EU’s flagship classification system of “green” activities.

The “taxonomy” phenomenon, in which countries or institutions attempt to create an official list of climate-aligned business activities or sectors to enable credible sustainable investment, was kick-started by the European Commission back in 2017. The EU has made clear from the start that it believes its framework will be applicable globally, but with Canada and Malaysia working on their own taxonomies, and Australia, Brazil and Saudi Arabia rumoured to be undertaking similar efforts, Japan isn’t alone in wanting a classification system more geared towards the transition of its national economy. 

The country's Transition Finance Study Group, convened by non-profit the Research Institute for Environmental Finance late last year, is asking for feedback on the proposals published in its interim report, Transition Finance Guidance.

The group’s proposed taxonomy, which it said could be called the “brown taxonomy” or “transition taxonomy”, focuses on debt financing and seeks to classify projects, assets and activities that can transition from high to low carbon intensity and environmental impact, rather than ones that are strictly green. 

It says the taxonomy would help determine the eligibility of projects, assets and activities for “transition finance” – additional capital to help them become greener.

“In order to promote and expand the use of this transition finance, it is necessary to assess the appropriateness of the transformation and transition of the targeted projects and to establish common procedures and methods to confirm the results of the transformation and transition,” says the report. 

The proposals include requiring companies to pay additional interest to lenders if they fail to meet their transition targets. It also raises the possibility of setting phase-in transition processes with interim targets, as long as issuers can show how and when they will reach their final targets.

The document lists 18 types of project that could qualify as “transitional” under the taxonomy, including: 

  • Introducing CCS or CCU for coal plants, or converting them to natural gas or biomass; 

  • Restoring natural gas pipelines to reduce methane leakage; 

  • Using recycled materials in clothing production; 

  • Introducing recycled and reusable packaging for consumer goods; 

  • Shifting from oil to gas fuel in shipping.

There are also exclusions, though. The guidance says making coal power generation more efficient by moving from supercritical to ultra-supercritical pressure technology would not be considered transitional, because the final result would not be green enough, and there would be risks around “locking in” future emissions.

The Technical Expert Group on Sustainable Finance (TEG) that is advising the European Commission on the details of its taxonomy recently recommended its expansion to ‘brown’, so that it could identify business activities that undermined the Paris Agreement. Coal is already excluded from the taxonomy. 

The TEG‘s ambition is that the taxonomy would ultimately comprise three performance levels, capturing the whole economy: “substantial contribution” [green], “significant harm” [brown] and a category for activities that do neither. 

“Within this framework, activities can move between categories by improving performance, for example from “brown to “neutral”, or from “neutral” to “green”, but only investments financing the latter – when activities become truly Paris-aligned – would count as green under the taxonomy.”

The Japanese Transition Finance Study Group said that the International Capital Markets Association (ICMA), which oversees the Green Bond Principles and similar initiatives for loans and social instruments, had added the document to its list of items for consideration, as part of its recently-established Climate Transition Finance Working Group. ICMA would not comment on how or whether the paper would be taken forward. 

The final report from the Japanese study group, which will include its “transition taxonomy”, will be published later this year.

Japan is a well-known critic of the EU taxonomy and its associated regulation, which will apply to all financial market participants that sell financial products in the EU, regardless of where the investment itself is located. Earlier this month, RI reported Influence Map findings that the Japanese Business Federation (Keidanren), Japanese Bankers Association, the Japanese Business Council in Europe and five other Japanese trade bodies had sought to water down the current EU taxonomy.

The country’s Ministry of Economy, Trade and Industry (METI) has a Study Group on Environmental Innovation Finance that published a Concept Paper on Climate Transition Finance Principles at the end of March, noting that “in developing the concept of ‘financing for a transition’, international principles should adopt an inclusive and flexible approach that can be applied to various circumstances of countries and regions without excluding specific sectors/industries or technologies from its scope”. The study group is chaired by Kunio Ito, the governance specialist behind the Ito Review, which led to the establishment of the Stewardship Code in 2017. 

Canada’s financial markets are developing a “made-in-Canada” green taxonomy, in a bid to provide definitions that are more sympathetic to resource-heavy economies, while the Malaysian central bank is working on another climate taxonomy, in collaboration with the World Bank, although the latter is currently heavily aligned with the EU.