TaxonomyEconomic policySustainable finance

Next Stop: Common Taxonomy for Sustainable Investment?

Torsten Jäger

“Fostering global ambition” is, rightly, a key element of the EU Sustainable Finance Strategy published by the European Commission in July 2021. It is not surprising that current regulatory discussions often focus on concrete legislative initiatives for the EU area. Implementing European initiatives alone represents an immense challenge since it involves highly complex processes and very sensitive timings. But it is important not to lose sight of the global stage. The European Union, in particular, which sees itself as a pioneer on climate protection, needs to work together with partners in international forums to achieve an even greater impact for more sustainability worldwide.  

Global businesses need global standards 

This must also include setting global standards. The credo of banks especially, as international players and lenders is: global businesses need global standards. A fragmented approach could increase costs and restrict international capital flows – generally speaking, they are likely to be seen as an onerous burden. When it comes to non-financial reporting, the creation of the International Sustainability Standards Board (ISSB) is already a major step towards international cooperation and standards. 

Nevertheless, how far can international cooperation or even developing common standards go in creating a taxonomy for sustainable investment? The Commission’s “Fostering global ambition” approach also touches on this issue. In concrete terms, the EU wants to agree common goals and principles for taxonomies and improve the comparability and coherence of the parameters and thresholds of the different taxonomies. The EU commissioned the International Platform for Sustainable Finance (IPSF) to carry out this task back in 2019. 

EU and China compare their taxonomies

The IPSF has since been working on what it calls a Common Ground Taxonomy (CGT) which identifies the commonalities and differences between the EU and China’s taxonomies. Between 4 November 2021 and 14 January 2022, the IPSF consulted on a detailed table comparing the technical screening criteria for around 80 economic activities.  

The table it published in November is not legally binding and merely represents the current technical state of play. The CGT is also not an overarching taxonomy which will lead to changes in the EU or China’s taxonomies. Rather, the table – and the accompanying report on how it was compiled – provide a method for comparing taxonomies which the IPSF believes can be used as a blueprint for future global harmonisation.

Comparison of 80 activities across six sectors  

The CGT analyses a total of around 80 economic activities across six sectors (agriculture, forestry and fishing; manufacturing; electricity/gas; water supply, sewage, waste management; construction; transportation and storage). The CGT’s sector classification system is based on the International Standard Industrial Classification of All Economic Activities (ISIC) and was used to make an initial comparison of the relevant activities in both taxonomies. Scenarios were then mapped to compare the technical screening criteria, which determine specifically to what extent the screening criteria overlap or not, and which criteria are more stringent/detailed in either the EU’s or China’s taxonomy. Scenario 2 was assigned to the largest number of activities – 30 to be precise. Accordingly, the EU criteria are stricter and/or more detailed. Scenario 4 was assigned to 13 activities in which there was an identifiable overlap of criteria. And scenario 3 came in third place with 10 activities where the China criteria are more stringent and/or detailed than the EU criteria. Scenario 1 was assigned to only two activities with clear overlaps. When the table and the accompanying inception report were being compiled, 24 activities were still under review. 

Taxonomies in other regions still under development

In addition to the EU and China, around 20 countries and regions have developed or started developing green, social and/or transition taxonomies in the past two years. However, most of these have not yet been translated into legislative initiatives. As a publication in autumn of 2021 showed, a comparison of the EU and China’s taxonomy as well as of country-specific taxonomies and the international Climate Bonds Taxonomy is not only relevant for the IPSF and the G20 Working Group on Sustainable Finance, but also for central banks, too.

Outlook for further developments in CGT

Continued cooperation between the EU and China has already been announced. The CGT could be expanded to include other sectors and environmental objectives, the Do No Significant Harm (DNSH) criteria of the EU taxonomy - which describe whether economic activities significantly affect environmental objectives - are not yet covered in the current comparison, other jurisdictions will also be brought in as their taxonomies are finalised. A comparison of the minimum social standards used in both taxonomies will be challenging. So, there is much still to do. 

Taxonomy comparisons are worthwhile 

In summary, there is also international cooperation taking place on sustainable taxonomies and partnerships have been set up with the aim of developing high-level principles. Overall, comparisons of emerging taxonomies are useful for market participants to better understand the different taxonomies, to promote common fundamentals and consistency, to highlight opportunities for interaction between the various taxonomies and thereby reduce transaction costs for market participants. It remains to be seen to what extent these actions will lead to a harmonising of sustainable taxonomies in future.