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Shared Vision, Common Principles

With the benefits of taxonomies increasingly recognised, efforts are under way to create standardisation among disparate initiatives.

In 2025 the EU Taxonomy will reach a milestone, marking the first full year of Taxonomy-alignment reporting for non-financial companies against its environmental objectives, alongside the first reports under the Corporate Sustainability Reporting Directive (CSRD) for the largest EU companies.

Hopes are set for a new era of insight into the sustainability performance of corporates.

“We expect that the reporting requirement – which at present is not yet fully applied for all the environmental objectives of the Taxonomy – will increase transparency of the degree of [companies’] alignment with the EU Taxonomy and will help investors to use the metric as a reference point,” says Pierre Garrault, Senior Policy Advisor at Eurosif, a pan-European sustainable investment organisation.

Taxonomies define economic activities aligned with sustainability goals across multiple sectors and provide guidance to corporates and investors with an aim to mitigate greenwashing. The EU Taxonomy was among the first such tools, with its governing Regulation entering into force on 12 July 2020.

Since that time, the EU Taxonomy has been improved and expanded beyond initial climate-focused criteria, and other jurisdictions around the world have followed suit, developing their own taxonomies. There is growing recognition that some form of standardisation or interoperability between taxonomies would help increase their effectiveness, not least as this would help investors understand which investments are widely regarded by policymakers as sustainable.

The Institute for Energy Economics and Financial Analysis recently said divergence between Asia’s taxonomies had “created confusion”, with criteria differing according to countries’ specific challenges and priorities on the path to a sustainable economy.

The increasing importance of taxonomies was evident during COP29 in Baku. The Central Bank of Azerbaijan (CBA) launched a taxonomy standardisation initiative, and in summarising the outcomes of COP29, the United Nations Environment Programme Finance Initiative (UNEP FI) noted the agreement on an “urgent need” to scale adaptation finance, using concessional finance, metrics and taxonomies in mobilising private investment.

In November, Eurosif published a roadmap on scaling-up investments for sustainable growth. The roadmap recommends using the EU taxonomy “as much as possible”, says Garrault, adding that “there are many instances where the taxonomy is a very helpful tool”.

There are limits, he acknowledges, including the “binary nature” of the taxonomy that means it does not cover activities that are intermediate and may become sustainable and also activities that are harmful to the environment.

Further, the EU Taxonomy’s definition of “environmentally sustainable economic activities” has been conceived to help investors to understand what proportion of their investments can be considered environmentally sustainable, Eurosif observes, meaning its scope remains limited to economic activities with the biggest impact on the environment. As such, it omits social aspects and moreover is not yet complete on the environmental side as the agriculture sector is not included.

These are both significant omissions. Investors’ focus on human and workers’ rights are increasing pressure for a social taxonomy, while agriculture’s contributions to global emissions are substantial.

Room for improvement

Jan Vandermosten, Senior Policy Specialist at the UN-convened Principles for Responsible Investment (PRI), says taxonomies are still in their early stages of development and will take time to achieve optimal effectiveness.

“Taxonomies are by design meant to create more effective capital allocation and stewardship by providing a common, science- and evidence-based language for market participants about what is sustainable,” he says. “In practice, it is difficult to assess taxonomies’ effectiveness given that, like many sustainable finance instruments, many have been only recently adopted.”

There are a variety of factors in taxonomy design that can increase their effectiveness, he adds. “These include their coverage of sustainability objectives (climate, biodiversity, social), their use case (product versus entity-level) and accountability mechanisms (voluntary versus mandatory). The EU, for instance, has connected its taxonomy to entity-level reporting requirements.”

Despite the current drawbacks to the EU model, “significant investments in taxonomy-aligned sustainable investments” have taken place, notes Vandermosten. Data and good practice examples collected by the European Commission’s advisory body, Platform on Sustainable Finance (PSF), show average levels of capital expenditure alignment with the EU Taxonomy at 18%, on a sample of 711 companies.

The PSF noted in its Compendium of Market Practices published in January that “early evidence” suggested corporates were beginning to adopt the EU Taxonomy to support claims of sustainability performance and to improve comparability. The use of taxonomies, over time, is also expected to provide credibility and transparency to debt issuance. PSF’s market practices also highlight some early examples of companies establishing sustainability-linked approaches to financing, with key performance indicators tied to EU Taxonomy criteria.

The EU Taxonomy is one of a number of tools for sustainable investment used by Phoenix Group, a UK-based long-term savings and retirement business with around £290 billion (US$269 billion) of assets under administration. “We make the best efforts to ensure that our sustainable investing approach evolves responsibly with the latest regulatory and taxonomy developments and financial industry as a whole,” says Anand Rajagopal, Private Markets Sustainability Lead at the firm.

“In our view, taxonomies can serve as guiding benchmarks, or core principles, of what is considered to be a sustainable asset, which can help to inform robust decision-making and increase consistency and transparency of reporting across different organisations.”

However, as seen with the UK government’s latest Transition Finance Market Review, there is a “genuine need for balancing contextualisation and interoperability”, adds Rajagopal.

“The focus should be on establishing a set of overarching principles with a requirement for investors and asset owners to closely monitor investment performance – on achieving sustainability/transition outcomes over time/milestones – as opposed to prescribing granular constraints that go against the channelling of financing in the first place.”

Calls for compatibility

Eurosif’s Garrault says other jurisdictions internationally have drawn inspiration from the EU Taxonomy to develop their own versions. “This is a good thing because it creates an appetite for taxonomies internationally. The key to success will be in interoperability between taxonomies. From a sustainable investor’s viewpoint, being able to pinpoint interoperability between different frameworks would be helpful, giving investors a clear idea of what elements in one taxonomy correspond to elements in another.”

Around 50 taxonomies have been published or are in progress globally, says Vandermosten, exhibiting “diverse characteristics, reflecting their unique contexts and purposes”.

It “makes sense”, he says, to leave room for a taxonomy’s objectives and sectoral coverage to be “reflective of a country’s economic structure and the sectors most material to the set objectives. However, the variety of approaches in taxonomy design and application have led to calls for increased compatibility between frameworks.”

In response, the PRI has developed guidance for the implementation of sustainable finance taxonomies, says Vandermosten, providing a baseline from which policymakers in different regional contexts can design interoperable taxonomies that are nonetheless tailored to the context in which they are being developed.

At COP29, the CBA also addressed this harmonisation challenge with its Roadmap for the Development and Relationship of Sustainable Financial Taxonomies, aimed at tackling the “confusion” caused by differing rulebooks. The roadmap has the support of the International Financial Corporation, the Sustainable Banking and Financial Network, the International Platform for Sustainable Finance, the United Nations Development Programme and UNEP FI.

CBA Chairman Taleh Kazemov said: “We have developed new unified taxonomy principles together with 110 countries. These principles will be applied in developing national taxonomies, simplifying the process of issuing green loans.” He added that the bank was committed to overseeing the implementation process and the development of the initiative, throughout Azerbaijan’s COP29 presidency.

There are three main elements in the roadmap for simplifying interaction between taxonomies:

  • Identifying basic taxonomic activities: Identifying key sectors and activities for emerging markets and emerging economies with a common definition system;
  • Technical approaches to consistent adaptation: Establishing standardised adaptation approaches to taxonomic principles, including ecological, social and governance instructions; and
  • Support for transition finance: Identifying instructions for transitional activities that provide decarbonisation and stability in high-emission sectors.

In its November 2024 progress report, the Taskforce on Net Zero Policy also acknowledges the need to strike a balance between reflecting countries’ differing economic and environmental realities with the desirability of compatibility between taxonomies. “This can be achieved though sharing a set of principles, a structure and a baseline, in particular for climate mitigation, given its global nature. Without these common principles and metrics, the market is fragmented and does not enable the optimal flow of capital into green and sustainable projects and activities,” it said.

The taskforce was launched at the UN Secretary-General’s High-level meeting of Non-State Entities at COP28 to further the development of policies and regulations to support the credible net zero commitments by non-state actors.

“Promising momentum”

The development of taxonomies among the Group of 20 (G20) member states has accelerated in the past few years. The taskforce notes that in addition to the EU Taxonomy, China, South Africa, South Korea, Mexico and Indonesia have adopted taxonomies under mandatory regimes. G20 countries developing taxonomies include Australia, Brazil, Canada, India, Türkiye and the UK.

Having established a Green Technical Advisory Group in 2021, the UK finally issued a consultation on a green taxonomy last month. The consultation is seeking views on whether its introduction would be additional and complementary to existing sustainable finance policies, including in supporting market participants to make sustainable investment decisions, and the specific market and regulatory use cases which facilitate this.

PRI’s Vandermosten says there has been “promising momentum” from international bodies and forums to progress standardisation in taxonomies at the highest level of decision making. “The G20 Sustainable Finance Working Group has published high-level principles for taxonomies, signalling willingness for international cooperation to produce interoperable taxonomies,” he observes.

“Other work has happened since, for instance through the Common Ground Taxonomy under the realm of the International Platform on Sustainable Finance or the CBA’s roadmap. But more is needed to create true interoperability, extending from principles to harmonising their development and implementation.”

The PRI has been engaging with investors on the implementation and use of sustainable finance taxonomies since their early inception, most notably for the EU taxonomy, he adds.

It has also entered into a collaboration with the Climate Bonds Initiative and UNEP FI to further build consensus on taxonomy definitions and concepts among standard setters, policymakers, and taxonomy users.

“Enhancing the usability and interoperability of sustainable finance taxonomies is crucial to ensure well-functioning financial markets that collectively contribute to climate and broader environmental goals,” says Vandermosten.

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