Is a Global Taxonomy the ‘Investment Highway’ to a Net-Zero Transition?

IPSF’s Common Ground Taxonomy could take a principles-based or prescriptive form.

If current plans to set up a global taxonomy on sustainable finance are well executed, it could supercharge responsible investment flows globally.

The International Platform on Sustainable Finance (IPSF), consisting of 17 member jurisdictions, is currently developing a common ground taxonomy to this end.

The body serves as an international forum of dialogue between policymakers developing sustainable finance policy and seeks to scale private capital towards environmentally sustainable investments.

While not itself a standard setting body, the work of the IPSF will prepare the ground for international standard setters to develop global standards, a 2020 annual IPSF report explains.

A spokesperson at the European Commission told ESG Investor the common classification system, which is being developed in a working group co-chaired by the EU and China, is planning to deliver “its work on taxonomy by autumn 2021, along with a report on sustainability-related disclosure”.

“The comparison exercise will focus on existing (regulatory) taxonomies which, as of now, can be found in the EU and China,” while also considering taxonomies developed by other IPSF members.

Meanwhile any talk of alignment of taxonomies “would seem to be premature”, the spokesperson added, given the different targets and transition pathways of nations.

One taxonomy, two goals

Among the central questions surrounding such a taxonomy is to which degree it will be able to achieve the 1.5 degree target of the Paris Agreement while also enabling high carbon-emitting industries to transition.

From an EU perspective, the global taxonomy would function as a key tool to internationalise its Green Deal, which aims at climate neutrality by 2050.

A recently published report by European think tank Bruegel highlights: “A transition away from carbon that would only focus on Europe would not do much to mitigate global warming, as Europe represents less than 10% of global greenhouse-gas emissions.

“Worse, if the Green Deal simply displaces Europe’s greenhouse gas emissions to its trading partners, it will have no impact at all on climate change.”

The Bruegel report also warns that the Green Deal will have geopolitical repercussions, including for oil and gas-producing countries and for global trade, notably via carbon border adjustment measures.

“Responses will range from cooperation in implementing complementary climate policies, to competitive efforts to redirect trade and investment flows, to downright hostile efforts to counter the effects of the Green Deal,” the report writes.

ESG Investor talked to sustainable finance experts and stakeholders on the forms a global taxonomy should take to scale climate finance internationally.

The EU has defined its taxonomy as a list of environmentally sustainable economic activities and relevant criteria, which are flexible to different investment styles and will be developed dynamically responding to changes in technology and science.

Its thresholds are based on a limited range of activities. These support the transition, as they allow high-carbon emitting companies investing in green activities to benefit from green finance. The taxonomy also includes thresholds for transitioning and enabling activities. While fossil fuels have not been defined as sustainable, the status of gas and nuclear as transition activities is currently under discussion.

The expert opinions gathered can be broadly summarised into three different strains; ranging from the most flexible form of a more principle-based structure, to one that mixes a globally aligned taxonomy with transition finance, to a robust global taxonomy which excludes fossil fuels.

Principles-based frameworks

Advocates of a global principles-based framework argue that a rigid taxonomy could curb the growth of innovative and diverse green technologies.

Amane Yamazaki, Head of Sustainable Business Office at Mitsubishi UFJ Financial Group, believes taxonomies with too stringent definitions limit access to financing and slow down the low-carbon transition.

Because a taxonomy defines sustainable activities by scrutinising every single technology in different industries, it can struggle to capture the diversity of economic activities, Yamazaki explains.

Accordingly, he favours principles, which he says can “define what is green, rather than defining green by technologies”.

He argues that loosely defined taxonomies based on principles and with certain flexibilities (by region or country) may be best suited to generate innovation, expand the market and deliver the targets in a profitable and sustainable way in the long term.

Pablo Berrutti, Senior Investment Specialist at Stewart Investors and Founder of sustainable finance resource centre Altiorem, also supports a principles-based approach.

“Global alignment in terms of having one taxonomy to rule them all is not the right objective,” he says, given the different forms of natural capital stewarded by different nations, such as water scarcity.

“There is the risk of seriously perverse outcomes if the industry tries to assess these complex issues through a single lens,” he notes.

Berrutti suggests that, instead of relying on a single taxonomy, the onus should be on the investor to demonstrate the sustainability of each investment.

He also warns that “the ability and willingness of companies to change needs to be a question in every investor’s deliberations”.

While fossil fuel energy needs to exit the system as soon as possible and shouldn’t be seen as sustainable, Berrutti says “a just transition for workers and communities should be key concern for policymakers, investors and society at large”.

Global taxonomy allowing regional variations

Other experts believe a global taxonomy is needed, but that it should be flexible enough to allow adaptation to regional differences and transition finance.

Mervyn Tang, Global Head of ESG Research at Fitch Ratings, believes “the benefit of global taxonomies and principles is to foster a common understanding rather than necessarily common rules”.

“The development of the ‘Common Ground Taxonomy’ through the IPSF helps to provide a reference point for regional and national taxonomies to follow.

In Asia, natural gas could play a longer-term role as a ‘bridge fuel’ in the transition than in Europe, Tang notes.

“The key is to be able to identify and articulate why national taxonomies might be different in a consistent way, allowing investors and other users to take a view on whether the differences are consistent with their views on sustainability,” he adds.

Tang sees the need to set boundaries for regional differences by finding common ground on central issues like gas and nuclear, for example through a global set of principles.

He explicitly calls for a brown taxonomy to allow capital to be channelled away from fossil fuels.

Matthew Chan, Head of Policy and Regulatory Affairs at Asian finance sector trade organisation ASIFMA, argues for a global but not binary taxonomy to increase the financing of transitionary economic activities and enable more systemic change.

“Ideally a single taxonomy would support a global market for climate-aligned finance, which is so vital to meeting the US$100-$150 trillion in investment needed to transition the globe to a low carbon economy [over the next three decades],” says Chan, recently appointed Sherpa for the Asia Pacific Financial Forum’s Sustainable Finance Development Network, with responsibility for taxonomy issues and recommendations for APEC finance ministers.

Only a few economic activities operate at or near zero emissions today, he asserts, and a binary approach would hinder certain industries from decarbonising.

Chan also warns that, without a global taxonomy, markets will become fragmented and block the scaling of climate finance.

As an example, he says green bond certification costs of between US$10,000 to US$100,000 may occur in recognition of different international standards. This creates “a massive inefficiency in the market, making the cost of green investment higher on this count than traditional investments”, he continues.

Rory Sullivan, Co-Founder and CEO of consultancy Chronos Sustainability, believes a globally aligned taxonomy is ideal but unlikely, and suggests regional taxonomies which reflect national conditions but are broadly equivalent.
Sullivan emphasises that a differential treatment of nuclear and gas in taxonomies would be problematic.

“Is it prohibited because it is a fossil fuel or is it allowed because it is a transition fuel? These are not theoretical arguments but are real fault lines in the taxonomies that are being developed,” he argues.

Meanwhile, considering projections by the intergovernmental organisation International Energy Agency (IEA), Sullivan believes that sufficient time will allow companies to adapt their business models.

The question is “what do we replace [fossil fuel] with, and when do we make that change,” he notes.

Globally aligned taxonomy

Ralph Thurm, Managing Director of Redesign, Resilience and Regeneration platform r3.0 and Founder at management advisory A|HEAD|ahead, is the strongest proponent of a global taxonomy.

Thurm’s view differs from the others because he sees a paramount urgency to act on the climate emergency; and because he envisions that a global taxonomy must function based on a future economic vision of sustainability which respects planetary boundaries.

As such, he believes that the immense consequences from not transitioning by far outweigh any concern about stranded fossil fuel assets or related geographical conflicts.

“The question is what is more important: an economy that thrives for another couple of years or humanity that accepts the [sustainability] challenge?” he asks.

Thurm also fears that lobbying efforts by industries will continue to delay political action and could gamble away the remaining years left to transition.

“We have created a regime where we are sub-optimising in an existing economic, unsustainable system,” he explains, instead of taking actual steps towards sustainability.

Since 2013, r3.0 has examined how to create a regenerative and inclusive global economy and avoid ecological and social collapses.

Based on this research, Thurm envisions a global taxonomy which applies scientific thresholds – in line with the Global Reporting Initiative’s sustainability context principle – and reflects remaining ecological budgets backcasted from planetary boundaries and broken down to regions.

“[An EU threshold] does not answer who should receive what part of the carbon budget as a fair share allocation,” he says, criticising the methodology of the taxonomy regulation.

Thurm also claims that the EU thresholds have been adapted according to political motives.

Originally, the Technical Expert Group (TEG) on Sustainable Finance recommended its threshold methodology to the Commission in a report, which identified the critical sectors that need to be decarbonised to achieve the EU’s climate goals.

However, last December, 123 scientists from 27 countries claimed that the draft delegated act on the Taxonomy Regulation has made a “critical oversight” by omitting any reference to tightening the criteria over time as the TEG had recommended.

Opinions on fossil fuels in the transition largely differ depending on how urgent experts believe that action is needed.

While all see it vital to set global standards and scale climate finance, views differ on the effects a taxonomy can have on economies, including in regard to preventing greenwashing.

The type and form of taxonomy that will be set up globally will be key to achieving sustainability in the long term.


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