Over recent years, a consensus has formed between corporates, financial institutions, investors, governments and regulators: environmental disclosure is a market necessity. It has been proved to raise corporate financial performance, boost resilience and — most critically — direct financial flows toward the Paris Agreement goal of limiting temperature rises to 1.5°C.
However, the mainstreaming of environmental, social and governance (ESG) disclosure has gone hand-in-hand with a rise in reported confusion around the growing ecosystem of related ratings, indices and tools, as well as accusations that companies are ‘greenwashing’ by making false claims about their environmental performance. Combined, these phenomena are detracting from the fundamental purpose of disclosure: to allow better capital allocation.
Sustainable finance taxonomies are one of the most important tools developed to tackle these challenges — classification systems that establish a list for investors of environmentally sustainable economic activities. The most widely recognised sustainable finance taxonomy is the EU Taxonomy. Others include China’s National Development and Reform Commission’s Green Industry Guiding Catalogue, and the Singapore Taxonomy (currently under development).
An explosion of taxonomies
At CDP, we strongly believe taxonomies can drive capital allocation towards sustainable activities, reduce greenwashing and enable comparison between investment opportunities. However, with at least 28 initiatives developed globally, the explosion of different taxonomies presents major risks that, over time, could make their use redundant. A wide variety of criteria — often opposing or incompatible — will increase uncertainty, ultimately undermining the core purpose of taxonomies.
Room for regional nuance is important: environments, risks and economies differ, and this should be catered to. Yet a set of common criteria can, and should, be applied to override this risk, and ensure data access, analysis and use by the international investor market. Regulators must work together to identify and adopt a common baseline, together with identifying linkages between existing taxonomies. This will be essential to avoid policy fragmentation and encourage interoperability.
The EU Taxonomy is admittedly high quality and can serve as a blueprint for the development of common criteria. It is based on the foundational principle of ‘do no harm’, which should form the basis of any taxonomy developed.
Climate-related activities are a first stepping-stone for this taxonomy, but it is rightly set to expand to other environmental issues. Taxonomies should be created in digital form, allowing systems to automatically read and work with the information contained, simplifying classification of investments.
However, the EU instrument is not free from sticking points: the inclusion of activities, such as nuclear power generation and natural gas, together with questions about the lack of robustness of certain forestry criteria, have sparked discussions about its ground-breaking credentials.
Common criteria
So, in the absence of one global taxonomy, and as the only global environmental disclosure system, CDP will drive forward the implementation of taxonomies and what we aspire to see reflected in “common criteria”. As outlined in our new policy brief, ‘Seeking clarity amidst fragmentation: The development of sustainable finance taxonomies and the drive towards integration’, from 2023, we will identify the most-high-quality and impactful taxonomy criteria in emerging sustainable finance taxonomies, building on corporate best practice, and leverage those areas by integrating them into the CDP questionnaires and scoring. This was the way taxonomies were intended to be developed and implemented: as a niche of best-practice, data-backed investments.
By collecting data on corporates’ use of sustainable finance taxonomies in one place, CDP aims to provide investors and stakeholders with information that is consistent, comprehensive, and comparable across geographies and regulatory requirements. ‘Comparison’ is another foundational principle of a sustainable finance taxonomy.
It is important to stress that a one-size-fits-all approach will not have the greatest of impacts; a binary approach to taxonomy development may not be most impactful.
The scope of the activities involved should not only consider those that contribute to the environmental objectives set out in the taxonomy. They should also consider those that are necessary for the transition to a more sustainable and resilient financial system: go beyond ‘green’ to identify different ‘shades of brown’.
If developed constructively, as I have outlined, we can build a global green investment rulebook that ensures huge amounts of finance flows towards stemming environmental degradation and stopping climate change. Yet it’s important that we do so in the limited window we have left, if taxonomies are to have the necessary impact.
Pietro Bertazzi is global director for policy at CDP.
This article first appeared in Sustainable Views, the Financial Times Group’s platform on ESG policy and regulation.
