Sherry Madera, Chair of the Future of Sustainable Data Alliance, says there are limits to full taxonomy alignment.
The rise of taxonomies of sustainable activities reflects a recognition from policymakers that global financial markets depend on a shared classification system if they are to identify ‘green’ investment opportunities.
European Commissioner Mairead McGuinness, responsible for financial services, financial stability and Capital Markets Union, told this October’s EU Sustainable Investment Summit taxonomies are critical to “identify environmentally sustainable investments and to increase transparency on sustainability”.
The EU has been a pioneer on sustainable finance taxonomies, establishing a Technical Expert Group in 2008, tasked with determining which economics activities are environmentally sustainable and thus appropriate for inclusion in its taxonomy.
Analysis from The Future of Sustainable Data Alliance (FoSDA) published last month shows that the European Union’s taxonomy has helped to pave the way for more countries to make taxonomy announcements over the past year.
In 2021, only four countries and the EU had regulations or guidance in place. Drafts existed in three jurisdictions and developments were observed in 14 countries and in the Association of Southeast Asian Nations (ASEAN); discussions were under way in two.
In the year to date, the number of jurisdictions with taxonomies has grown to 10 including the EU and the ASEAN. High-level guidance exists in two countries and regulation is being developed in 13.
Taxonomy regulations have been launched in the ASEAN region, Colombia, Indonesia, Russia, South Africa, South Korea, Sri Lanka, and Vietnam. High-level guidance has also been published in Bangladesh.
This October, Australia became the latest country to take positive steps towards establishing a sustainable finance taxonomy, as Australian Sustainable Finance Institute (ASFI) released a report outlining how the country will implement its own classification system.
Sherry Madera, Chair of FoSDA, says that the EU has been a leader in pushing the growth of taxonomies worldwide, but notes its own taxonomy was the preceded by the Chinese Green Bond Endorsed Projects Catalogue, and notes that its efficacy is yet to be tested.
“It would be folly not to acknowledge the EU taxonomy has been the meatiest of all the taxonomies, but we don’t know if is fit for purpose yet.”
Madera says that even though the European Council and Parliament have approved the EU Taxonomy Climate Delegated Act, the taxonomy has not yet been ratified by individual member states.
“If you look at the EU taxonomy journey, we can see how politically challenging it has been. For example, the decision to include nuclear or natural gas [as environmentally sustainable economic activities] was controversial. But even more fundamental is the question of how it is going to be ratified within the 27 member countries.”
She adds: “We have to remind ourselves that the absolutely critical work is not done yet.”
For Madera, making sustainable finance disclosures mandatory is critical in halting the climate change emergency, and points to the importance of the UK, Japan and New Zealand’s introduction of compulsory company reporting under the Task Force on Climate-related Financial Disclosures (TCFD).
“TCFD is a real divining rod for and says ‘here is the source of where we need to go’. But there’s still work that needs to be done on the detail of the data.”
Madera says TCFD-aligned reporting provides helpful building blocks on which taxonomies can be constructed because the disclosures provide much-needed clarity.
“We need to make sure that definitions of are super clear, and the sad fact is that even greenhouse gas emissions are not clearly defined across jurisdictions. It is the lack of clear definitions that is slowing progress [in agreeing taxonomies].”
The limits of harmonisation
The FoSDA taxonomies research says there is widespread debate about the need for “greater alignment and interoperability, as well as comparability and data quality”, but Madera says absolute compatibility between taxonomies should not be the objective.
“I don’t think I’m going to see [harmonised taxonomies] in my lifetime for two reasons. First, the differences between countries mean that one taxonomy cannot be applied universally. Second there is so much complexity in the system that it makes more sense to agree on a set of core datasets that is fundamentally the same in each taxonomy.”
For example, Madera describes the potential for agreement on a “dark green segment” that clearly defines environmentally material activity for all taxonomies.
“This dark green superhighway would run across all taxonomies. Wouldn’t it be amazing if asset managers – whether they are small for large – could use any taxonomy to find rock solid sustainable investment opportunities irrespective of the geography in which they operate?”
Madera says the Alliance is attempting to identify a small number of datasets that will make up this dark green superhighway, and she says progress is being made on understanding and measuring carbon emissions.
Plugging the gaps
Alongside supporting the proliferation of taxonomies, FoSDA also identifies where gaps and holes exist in sustainability-related data.
The Alliance is due to publish a comprehensive report on where data falls short later this month.
Madera says FoSDA has identified where gaps – which they define as poorly populated datasets – are starting to close.
“The data gaps are constantly filling, especially where there is mandatory TCFD reporting. But while that is great for public listed companies, private companies do not have the same sort of regulations. Also, geographically, there are inconsistencies and gaps because getting data from certain countries or regions remains a challenge.”
When it comes to data holes – which Madera says are more significant than gaps and refer to missing datasets such as those measuring supply chain reporting or biodiversity – there are bigger challenges.
“You might think that sovereign debt datasets are going to be robust and that they are well ahead, but they aren’t.”
Madera goes onto argue the lack of transparency in climate risk across sovereign debt creates further complexity given the amount of overseas investment in government debt.
“If you think about the net zero commitments that are happening at the country levels, governments are holding a significant amount of sovereign debt from other parts of the world, and that data isn’t robust or comparable or transparent,” she says.
Madera hopes that COP27, which she is attending, will address some of the outstanding challenges with taxonomies and data gaps alongside other pressing policy decisions.
“It is important that COP27 focuses on the data and gets policymakers closer to understanding the detail of their net zero commitments and making sure they are genuinely achievable.”