Regulators in several jurisdictions have developed – or are in the process of formulating – taxonomies aligned with climate or broader sustainability objectives. These are classification systems for economic activities defining the degree of alignment with sustainability criteria. In the EU, the Sustainable Finance Taxonomy Framework was formally adopted in June 2020, setting out six environmental objectives: (i) climate change mitigation, (ii) climate change adaptation, (iii) sustainable use and protection of water resources, (iv) transition to a circular economy, (v) pollution prevention and control, and (vi) protection and restoration of biodiversity and ecosystems.
China’s regulators have developed two sector-based taxonomic frameworks – the Green Industries Guidance Catalogue and the Green Bond Endorsed Project Catalogue. These are intended to guide policy-makers and bond issuers respectively to prioritise the development of projects that tackle climate change, environmental pollution, resource constraints and ecological degradation in China. According to Ma Jun, special adviser to the PBoC Governor and chair of the NGFS first workstream, ‘China is the only large country that has established a green loan statistic system and has been keeping a record of green loan default rates, it has the chance to be the first country to better calibrate the risk weights for green assets.’ This is done through the PBoC’s ‘Plan for Green Finance Performance Evaluation of Banking Depository Financial Institutions’, which is based on a set of quantitative and qualitative indicators such as the proportion, share and growth of green finance business and business risk, as well as external evaluation by regulators on the implementation of green finance policies and strategies.
In December 2019, Bank Negara Malaysia announced plans to develop a principles-based green taxonomy to direct capital towards activities with the potential to mitigate climate change. Under the proposed taxonomy, financial institutions regulated by the central bank would have to classify their economic activities based on six different categories; these include activities with climate-mitigation effects, transition-based benefits, and activities which would be prohibited. The central bank sought feedback for these developments in early 2020, and is engaging with banks and insurers to discuss practical methods of adoption.
While the precise goals and environmental objectives of green taxonomies vary across jurisdictions, their creation can promote more informed decisions and increased financing by identifying specific sustainable investment options for multiple stakeholders in the financial industry. At the same time, the development of major taxonomies can have a wider impact in promoting the adoption of green finance principles among countries and regions that have not yet embraced sustainability on a widespread basis. Policy inspiration and the need for international investors to conform to regulations can potentially drive the spread of taxonomic systems in the USA or developing countries which have yet to develop a comprehensive regulatory regime for green finance. For instance, Rafael del Villar Alrich shared the view that the ‘European Union is at the front line of [harmonising definitions of sustainability]. In my sense the liquidity for green investments is also heavily coming from Europe. Going forward the EU Taxonomy will be a fundamental reference point for emerging markets as well’. Most recently, the World Bank has released a guide distilling the core concepts and procedures needed for regulators to develop a green taxonomy, based on its past experience working with governments in developing similar systems in Colombia, Malaysia, Mongolia, and South Africa.
This is an excerpt from The role of data in sustainable investment, policy and regulation, an OMFIF report in collaboration with Refinitiv.