As countries move at different speeds towards developing their own standards, is this multiplicity an obstacle to a greener future?
In terms of money flows alone, Asia-Pacific sustainable finance is on an upward trajectory. While lagging their pace-setting peers in Europe, investors in Asia have a robust and growing appetite for ESG-labelled assets. Sustainable bond issuance in Asia ex-Japan rose to a record US$85 billion in 2021, according to Refinitiv data, and the market is expected to almost double in 2022, and quadruple by 2025.
Conditions are also “ripe”, as a Moody’s report asserts, for the increased issuance of sovereign sustainable bonds in the region.
Net inflows into Asia ex-China and Japan sustainable funds, meanwhile, reached US$911 million in the first quarter of 2022. China-based ESG funds alone drew in a net US$11.6 billion in 2021, reaching a record total asset value of US$46.7 billion and overtaking the US as the world’s second-largest climate investment market in the process.
The data clearly show that, in terms of demand, Asia’s ESG finance and investment market is in vibrant health. The question of determining exactly how this flow of money is being invested, however, is another matter.
The task of creating and defining ESG taxonomies in Asia is already well underway. Taxonomies for sustainable finance have been created in mainland China, South Korea, Japan, Mongolia, Indonesia, Malaysia, and the Association of Southeast Asian Nations (ASEAN) region as a whole. Australia, Singapore, Hong Kong, Thailand and New Zealand are in various stages of developing their own.
Singapore’s Green Finance Industry Taskforce, for instance, issued a second consultation in June on its taxonomy, proposing a “traffic-light” system that will classify economic activities as green, amber, or red, as the city-state’s Monetary Authority accelerates its efforts to turn Singapore into a major Asian centre for green finance.
Australia’s newly elected government has set the country’s Sustainable Finance Institute to work on the first phase of its own taxonomy project, after the previous administration left the task to the private sector and declined to get involved.
Laying a foundation
These efforts are an important step in creating the bedrock of a sustainable finance landscape that can then be populated with complementary regulations.
“An ESG taxonomy is essential to allow companies, investors, regulators, and other stakeholders to have a common reference point on what is ESG,” said Jason Norman Lee, Managing Director for Legal & Regulatory at Temasek International in Singapore.
“Across the APAC region, ESG taxonomies are proliferating. These classification systems of economic activities that are under discussion, or in development, include the EU-China Common Ground Taxonomy, the ASEAN Taxonomy, and domestic developments in Singapore, Indonesia, Malaysia, Korea, and Australia. This growth is a recognition of the importance of well-defined parameters that can support transparency and increase reference points for investors.”
“An ESG taxonomy is essential to allow companies, investors, regulators, and other stakeholders to have a common reference point on what is ESG.”
– Jason Norman Lee, Managing Director for Legal & Regulatory at Temasek International
The basis for many of these is the EU taxonomy (and to a lesser extent China’s mandatory taxonomy for use of green-bond proceeds). Aligned with these are new and evolving requirements for asset managers to disclose their ESG integration processes, along with mandatory thresholds for fund investments in sustainable equities – already seen in Singapore, Hong Kong, Malaysia, India, Japan, ASEAN, Thailand, Taiwan, Australia, and New Zealand.
A virtuous cycle
Combined, these trends promise to form what Goldman Sachs described as a “virtuous cycle” that has developed in Europe, in which increased ESG fund labelling requirements trigger greater inflows, which prompts wider taxonomy adoption, which attracts more investment, and so on.
“A taxonomy is the bedrock for sustainable investment and substantial claims over the like, and for this reason forms of alignment with the EU or other taxonomies are beginning to develop a market appeal, not least in Asia-Pacific,” said Prashant Joshi, Director for Global Markets and APAC Regulatory Affairs at BNP Paribas. “Taxonomy alignment, coupled with increasingly robust verifiability mechanisms, make for an appealing combination for qualifying investments.”
The data backs this up. Just as flows into EU Sustainable Finance Disclosure Regulation-aligned (SFDR) Article 8 and 9 funds have outpaced those into Article 6 funds in Europe, a 2022 Goldman Sachs report claims that the market is now paying a “green premium” of about 37% for Asia-Pacific companies that are aligned with the EU taxonomy. This is likely to spur the widening of the regional taxonomy effort and “may expand to more sectors as more APAC taxonomies emerge,” the report said.
“A taxonomy is the bedrock for sustainable investment and substantial claims over the like, and for this reason forms of alignment with the EU or other taxonomies are beginning to develop a market appeal, not least in Asia-Pacific.”
– Prashant Joshi, Director for Global Markets and APAC Regulatory Affairs at BNP Paribas
Still, there are significant challenges, one of which is that, unlike in Europe, taxonomies in most Asia-Pacific countries are currently focused on sustainable financing alone; in other words, the issue of bonds and loans. There are no Asian green taxonomies that impose a standard for corporate and investor reporting of revenue and capital expenditure.
Similarly, the region has no unifying regulatory body that can ensure the alignment of regional taxonomies. Although it must be noted that even within Europe, strong disagreements remain over whether natural gas and nuclear energy should be incorporated into or excluded from the EU taxonomy.
While the EU and China have typically been used as the basis for individual taxonomies, there are wide regional differences. South Korea, for example, has included natural gas in its taxonomy. Singapore has identified eight sectors that account for about 90% of emissions, and classified them as green, amber or red according to whether they are broadly net-zero (or can be so by 2050), transitional or harmful.
The ASEAN taxonomy is built on the EU version but covers all sectors and allows for higher emissions over a limited time “while incentivising progression to lower emissions”. China’s mandatory bond system covers six sectors it classes as green: clean energy, clean transport, climate change adaptation, recycling or resource conservation, anti-pollution, and energy efficiency.
Malaysia and Japan adopted systems based on the Green Bond Principles, while Mongolia is the only Asian country so far to attempt to incorporate a social element into its taxonomy.
As BNP Paribas’ Joshi explains, the variables within Asia-Pacific are considerably wider than in Europe, making a unified set of standards harder to envision.
“There are a number of obstacle factors, ranging from which scenarios the jurisdiction is working with, to nationally determined contributions (NDCs) under the Paris Agreement, to net zero carbon commitments,” he said. “Naturally, these require tools for their achievement, one of which is a taxonomy.”
As high-level goals differ, so may the tools, and in turn taxonomies.
For companies operating across multiple Asian jurisdictions, this multiplicity presents a difficult and expensive compliance and reporting challenge, particularly when businesses are already straining under the weight of increasing anti-financial-crime compliance burdens (as well as a shortage of expertise to manage these burdens).
To an extent, this divergence is inevitable as regional governments in Asia are typically keen to maintain autonomy over their economies, rather than having overseas developed systems parachuted into place.
There are positives to take from this, however.
“We expect there will be greater focus on aligning standards and expanding taxonomy use-cases in the near future,” said Temasek’s Lee.
“While APAC could be perceived as lagging the EU with ESG taxonomies, many regulators have been carefully analysing the pros and cons of global policies like the EU taxonomy and their implementation and impact before adapting them to their domestic markets.
“And while fragmentation may create operational complexity, the converse is that they are thoughtfully adapted to the local operating environment, which means that they are more likely to have local buy-in and succeed in a local market. The taxonomy will feel less like a transplanted alien standard but a base case adapted to local conditions. A variety of supervisory styles allows regulators to test different approaches and learn from each other’s successes and failures.”
“While fragmentation may create operational complexity, the converse is that they are thoughtfully adapted to the local operating environment, which means that they are more likely to have local buy-in and succeed in a local market. “
– Jason Norman Lee, Managing Director for Legal & Regulatory at Temasek International
Cost-cutting imperatives may also help drive greater alignment, as multinational companies push for greater interoperability to streamline their compliance operations. There will also be growing pressure from increasingly informed investors, who may simply avoid assets they believe are inappropriately labelled, or fail to meet their own set of principles.
Help may also come from the Common Ground taxonomy developed by the International Platform on Sustainable Finance (IPSF), which will help countries find the path of least resistance through both the EU and Chinese taxonomies by laying out the commonalities in their respective approaches and outcomes.
On the right track
Temasek’s Lee outlined three areas that could keep Asia-Pacific taxonomies on the “right trajectory”:
- A principles-based approach so that there is some flexibility when tailoring taxonomies in different regions and economies;
- Ensuring taxonomies are aligned with global or international standards that are widely adopted (e.g., CGT, EU taxonomy); and
- Active collaboration amongst regulators, policymakers and stakeholders on developing transparent, relevant, comparable and interoperable standards and guidance.
Meeting this challenge will require a considerable capacity-building effort by regulators, policymakers and adopters (including funds, other businesses, and investors) in the ESG sphere.
It may also require an end to the voluntary nature of many existing Asia-Pacific taxonomies. A mandatory transition would – after a period of testing and trialling of voluntary standards – help to accelerate the pace of adoption.
“At an application level, the interoperability of APAC taxonomies with other regulatory regimes and taxonomies needs to be appropriately positioned and worked out, as far as working with the pertinent considerations for progressive local and global investment flows and transactions,” BNP Paribas’ Joshi said.