Taxonomania: What does the trend for creating national and regional taxonomies mean for green finance?

RI takes a look at global developments on taxonomies

This article is part of a series on the creation of sustainable finance taxonomies around the world. You can read more in this series by clicking here.

It’s hard to imagine, but there was a time – not that long ago – when nobody really cared about the EU’s plans to create a green taxonomy. At one somnolent conference full of policy wonks and civil society in early 2018, the head of the European Commission’s Directorate-General for Financial Stability and Capital Markets, Olivier Guersent, tried to inject a bit of excitement into the idea of a lengthy list of certified ‘green’ activities by declaring it “a race” against Asia and the US.

“We need to move fast”, he urged. “The reason we derived a competitive advantage in mobile telephony for 15 years was because we were the standard setters. And we will derive the same advantages if we are the standard setters for sustainability.” 

But then, as people in that somnolent conference room and far beyond woke up to what the taxonomy was – an ‘official’ set of green definitions, created from Europe with a view to being exported around the globe – alarm bells rang and the EU quickly softened its rhetoric. The taxonomy became a ‘shared language’ and ‘a common understanding’, not a commercial competition. It was sold as an apolitical, scientifically-robust market solution, backed by hundreds of experts and aligned with global objectives like the Paris Agreement and the Sustainable Development Goals. European Commission Vice President Valdis Dombrovskis promised that the taxonomy would reduce global confusion by “laying the ground for a single market for sustainable investment”.

That hasn’t quite worked out though: the momentum behind the EU taxonomy has instead triggered the creation of many more taxonomies in many other jurisdictions. And, in 2020, it has begun to feel a bit like the race Guersent described, rather than one, unified push.   

In the coming months, Canada will launch a ‘transition taxonomy’ to define sustainability in the context of a resource-heavy economy, and Russia, Mexico and South Africa will all move forward on their own taxonomies. This RI series will take a closer look at those efforts, but there are many more.

Earlier this summer, the Malaysian central bank, Bank Negara, closed a consultation on its taxonomy after receiving more than 100 responses from financial institutions, asset managers, investors, NGOs and local regulators. The framework will be similar to the EU’s, but ‘principles-based’ (regulatory code for ‘nowhere near as strict’) and the bank is currently revising a draft it published in January. One person closely involved said feedback included calls for more clarity and guidance on the assessment methods for the classification system, and a need for stronger alignment with existing frameworks in Malaysia. The final taxonomy should come out next year.

‘If you’re worried about the proliferation of taxonomies, then knowing China and Europe will have a fairly consistent approach creates a very powerful centre of gravity that others will have to work towards’ – Alyssa Heath

Elsewhere in Asia, Japan is in discussions about creating a ‘transition’ taxonomy, although details are scant. The proposal has been put forward as part of a wider project by the Transition Finance Study Group, convened by non-profit the Research Institute for Environmental Finance. 

At the start of 2019, the Abu Dhabi Global Market said it was working with key regulators and ministries “to develop a UAE-wide harmonised taxonomy for sustainable finance that would enable participants to make an informed judgement on whether particular initiatives would fall under the umbrella of sustainable investment”. It added that the taxonomy would be closely aligned with the Green Bond Principles, Green Loan Principles and the Climate Bonds Initiative Standards. Not much has happened publicly since then, but an update on progress is due later this month.

And the list continues to grow. RI understands that Mongolia and Kazakhstan are among the latest to catch onto the trend. 

The reason for creating all these taxonomies depends on who you ask. One expert said it is the latest attempt to avoid having European standards imposed on economies that aren’t as serious about, or ready for, the climate transition: “Arguing ‘we don’t want one’ hasn’t worked, so now they are all trying to come up with their own as the next best thing”. Business groups in Japan, for example, were shown to be fiercely lobbying against the creation of an ambitious EU taxonomy before there was talk of a national alternative.

But, although strict, Alyssa Heath, Head of EU and UK policy for the Principles for Responsible Investment (PRI), and a contributor to the EU’s taxonomy, says the EU version can be globally applicable.

“The standards around climate mitigation should work for any Net-Zero-by-2050-aligned country,” she tells RI. But, she concedes, while countries may have the same climate targets, the strategy for achieving them could be different, and this could ultimately mean different taxonomies.

“Europe is expecting a 2030 carbon target to be set somewhere in the 50-55% range [the EU’s emissions-reduction target currently stands at 40% by 2030, but is under revision], so the taxonomy has to recognise a very heavily front-loaded transition in Europe,” she explains. “While in a resource-intensive economy like Canada, say, there may be an expectation that the transition will steepen as time goes on, and so they will want to include activities that are likely to have to be exited altogether to achieve the goals.”

But, Heath says, despite the need for local context, having lots of taxonomies is unhelpful.

“Investors really don't want to have to deal with 50 different versions of what a taxonomy should look like,” she says, adding that, while the EU taxonomy is difficult to apply – partly due to lack of data – it is thorough and methodological. “Whereas, if you start getting into these loose, subjective frameworks, it becomes a lot harder to follow. And if you end up with not only lots of different taxonomies, but lots of different ways of designing a taxonomy with fundamentally different methodologies, that's a huge problem.”

The work being done to harmonise definitions between China and the EU could be a game-changer, she thinks. Speaking at an event hosted by RI in July, Ma Jun, one of the leading figures on green finance in China, said the two regions were forming a “taskforce” on the topic. “Six years ago, the problem was a lack of taxonomies, and now we have something like 200,” he noted. “We need to harmonise to really reduce the cost for investors and enhance transparency for the market”.

China itself currently has more than one set of ‘green’ definitions. The earliest were the Green Credit Guidelines launched in 2012 by the China Banking Regulatory Commission, but the most significant is the Green Industries Guidance Catalogue, created by the National Development and Reform Commission, the People’s Bank of China and the Ministry of Ecology and Environment. That guidance is the basis for a number of other green standards including the latest Green Bond Endorsed Project Catalogue – the one infamous around the world for including ‘clean coal’.  

A consultation was launched this year on revising the green bond catalogue, and feedback is currently being assessed; but, as China increasingly looks to attract international investment, it is expected that most of the fossil fuels included in the original framework will be removed.

“We’re seeing more harmonisation from China both among the national ministries and regulators, but also globally,” explains Wenhong Xie, China Programme Manager for the Climate Bonds Initiative, who has been helping to coordinate the efforts. But there is a reason that China has fossil fuels in its catalogue, and it is one that puts its taxonomy ahead of the EU in other ways.

“China has always seen green as supporting the broader transition toward an ‘ecological civilisation’,” says Xie. “In practice, this means it’s been focused on reducing pollution and using natural resources efficiently alongside climate mitigation and adaptation. In fact, there was little mention of climate change as an objective in the earlier version of China’s green definitions.”

It’s primarily for air and water pollution reasons that ‘clean coal’ made the cut. Its removal is not just about China bowing to international expectations, it’s also about climate mitigation moving up the national agenda. And as climate comes into sharper focus in China’s taxonomy, the EU is turning its attention to those other environmental objectives.

“There’s definitely a sense that the EU can learn from China on developing its other environmental goals,” says Xie, referring to the remaining four areas EU experts will now have to conquer: water and marine resources, the circular economy, pollution and biodiversity. “They will be able to look to China to see which areas have already been identified as providing a substantial contribution to those wider objectives.”

And if the two find enough common ground, it will weaken the argument for other countries to each have their own taxonomy, predicts Heath. “If you’re worried about the proliferation of taxonomies, then knowing China and Europe will have a fairly consistent approach creates a very powerful centre of gravity that others will have to work towards,” she says.  

Much of this harmonisation is expected to happen through the International Platform on Sustainable Finance. The intergovernmental body, launched last year, is tracking progress and establishing best practice on taxonomies, disclosure and the labelling of financial products. As well as the EU and China, members comprise Canada, Argentina, Chile, India, Kenya, Indonesia, Morocco, New Zealand, Norway, Senegal, Singapore and Switzerland. Next month, it will publish its first report and announce its next steps, which could include a more official plan for a China-EU ‘taskforce’ on taxonomies.