Since the EU first established its Technical Expert Group on Sustainable Finance in 2018, the number of taxonomies globally has proliferated. To date 17 new taxonomies in Europe, Asia-Pacific and the Americas were published and another 18 were initiated, including in Africa. From pure green, to sustainable, social and more recently transition focused, taxonomy development is continually expanding. The surge in Taxonomy development may lead to misunderstandings on the definition of sustainable activities and if they are shared across the world. Understanding Taxonomy guiding principles, choice of sectors, definition of technical screening criteria and the overall development stages is fundamental to understand their uses .
We take this opportunity to speak to Leisa Cardoso de Souza, Green & Sustainable Finance Expert with Natixis CIB’s Green & Sustainable Hub, who assessed the underlying principles of taxonomies and how to navigate this dynamic landscape.
What is a taxonomy?
A Taxonomy is a classification tool or system meant to help investors and companies to make informed investment decisions on sustainable economic activities. It aims at establishing market clarity on what is robustly and scientifically “sustainable” when it comes to environmental or social issues.
Ideally, Taxonomies evolve over time as technologies develop and as more and more entities and countries shift their business models. The classifications set out in these frameworks should evolve in hand with scientific, economic and technical knowledge and capabilities. This means they should be continuously reviewed and updated, even to include new sectors and screening criteria, such as done by ASEAN in the second version of its Taxonomy.
Taxonomies are rarely standalone documents, but rather act as the linchpin of entire ecosystems of laws & incentives. With various uses cases such as the labelling of financial instruments, disclosure and financial supervision.
For the time being, Taxonomies primarily underpin voluntary standards for labelled issuances, particularly green and sustainability bonds. Apart from labels on dedicated and specific financial products, disclosure against Taxonomy criteria is the most common use case. Such reporting is mandatory solely in the EU.
What are the main challenges when developing a taxonomy?
Various authorities have taken up the challenge of developing Taxonomies, which are often linked to the issuance of labelled instruments and mobilization of capital to sustainable activities.
A global standard setting-race has begun as more than twenty classifications either announced, under development or adopted worldwide. Taxonomies mostly address climate change (16), but other environmental or even social themes are increasingly addressed, such as gender. So-called transition Taxonomies (3), but also social or SDG-related ones (2) are in the making. Articulating them is not an easy task for either policymakers or Taxonomy recipients and users.
In an ideal world, who should oversee the development of taxonomies?
When we look at taxonomies being developed today, they are led by financial regulators, ministries of finance, ministries of environment. This ownership is fundamental for market participants' legitimacy and acceptance of such frameworks, including incentives for adoption and implementation.
It is important to create a robust governance process to ensure that political changes will not affect the development of taxonomies as the overall process typically takes 1-3 years.
Having a regulator as part of the committee can be a significant advantage as regulators hold a neutral position, and they are also the entity ultimately responsible for implementing the taxonomy in the market. Its important however to take on perspectives from all parties.
How can global corporates & investors navigate the taxonomy landscape?
With a plethora of taxonomies emerging, each with its objectives and different weightings, for the international investor community, the prospect of complying across countries and regions can be quite daunting. That’s why ensuring interoperability to create a common language to avoid confusion on what is sustainable is useful. Taxonomies are aligning objectives and methodologies to select technical screening criteria. For instance, Mexico and South Africa have leveraged the EU Taxonomy, with aligning objectives, use of technical screening criteria, do no significant harm and minimum social safeguards. It is important though to consider the local context to make sure Taxonomies are addressing the most pressing environmental and social needs.
Guidance on taxonomy development is key for countries to develop robust frameworks and for users to understand and navigate the different structural elements. Recently ten multilaterals developed a Common Framework for Taxonomy Development in LAC (Latin America & Caribbean) to guide countries on the guiding principles and elements they should include if planning a Taxonomy.
In our New Geography of Taxonomies report we provide further insights to these elements and to the different taxonomies that are being developed across the world.
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