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Taxonomies are not Instruments of Industrial Policy

Christina Ng, Managing Director of the Energy Shift Institute, says Asia’s transition finance complications could harm its climate goals.

Is transition finance an attempt to extend the spectrum of green finance? Or is it a covert means of financing non-green activities, which have had limited opportunity in gaining access to sustainability-conscious investors?

This phenomenon appears to be occurring in Asian markets.

And nowhere is this more apparent than in the realm of national financing frameworks, where the drive to foster economic growth is so strong that it can be pursued at the expense of transitioning to a genuinely green and sustainable energy future.

Recent developments underscore this troubling trend.

For example, Indonesia’s revamped Sustainable Finance Taxonomy incorporates certain new and existing coal-fired power plants as transition activities and therefore qualifies them for transition finance. The Indonesian government justifies this classification due to the role of coal power generation in processing critical minerals for electric vehicles and clean energy technologies – which aim to contribute to economic growth.

Flawed reasoning

This flawed reasoning not only perpetuates the reliance on fossil fuels but also risks alienating climate-minded foreign investors. Indonesia’s logic, if applied universally, would imply that any power plant, including fossil-fired ones, could be labelled transitional, simply because it powers the manufacturing of clean energy technologies.

Up in the northeast of the region, the government of Japan launched a Green Transformation (GX) policy. It aims to switch Japan’s fossil fuel-oriented industries to clean energy focused ones and issue sovereign transition bonds, among other instruments, to finance the GX plan. But a deeper dive reveals that the centrepiece of the government’s GX strategy is about ensuring economic growth.

This observation is also shared in a Sustainable Fitch note which found an emphasis on the term ‘competitiveness’. Specifically, the term was mentioned 15 times in the GX framework as compared to just once in Singapore’s green financing plan and not at all in India’s framework. The note goes on to say “this may explain why some of the eligible transition activities under Japan’s strategy are supportive of industry, but do not meet international green standards”. The questionable activities referred in Japan’s strategy include hydrogen, gas infrastructure, and ammonia co-firing in coal and gas power plants.

The approaches in Indonesia and Japan overlook the fundamental goal of sustainable finance – chiefly, to channel capital to activities that mitigate greenhouse gas emissions that would, in turn, facilitate the structural transformation of economies centred on clean energy. Sustainable finance taxonomies are not instruments of industrial policy.

Resistance or misunderstanding?

Could the common issue in Indonesia and Japan be the deep-rooted on-the-ground resistance to transitioning away from fossil fuels? Or is there a misunderstanding of the shared goal of sustainable finance?

To be clear, some activities can be transitional and work towards being green. A reasonable example is repurposing a coal-fired power plant into a low-emission facility. If the activity is a genuine transition, funding from green-labelled capital is likely available, rendering transition-labelled capital redundant.

There are also economically important activities that are not green and will never be green. These should not be entitled to a special financing label that could grant them cheaper borrowing costs. Multilateral development banks are there to provide concessional financing for activities that are needed but not necessarily green. And the conventional financing market can be tapped, of course.

A misdirection of green, sustainable or transition capital to activities that are not climate-aligned but fuel economic growth drains capital resources available to clean energy technologies, undermines genuine efforts to tackle climate change and erodes trust in sustainable finance initiatives.

A call for clarity

The intersection of economic growth and economic transformation by investing in a future that contributes positively to climate has become a focal point of debate. The confusion in policymaking underscores the fragility of the transition finance concept.

Should we not tighten the criteria for what qualifies as ‘transition’ within global sustainable finance rules? Or is the ambiguity intentional?

Perhaps the transition label has been thrown in as a way to pull the wool over the eyes of investors and the public.

Transition activities can and should rely on conventional capital when not objectively green. And the conventional markets will then decide through price signals on when these ‘transition’ activities no longer make sense.

The conversation to date indicates that the ‘transition’ label has yet to convince sustainable investors, not to diminish the numerous efforts aimed at offering guidance on transition finance.

However, if this is the best we can achieve, we must seriously question whether promoting transition finance truly serves our climate goals.

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