What is green taxonomy?
A green taxonomy is a framework for defining what can be called environmentally sustainable investments. In addition to tackling “greenwashing”, such a taxonomy will help companies and investors make more informed green choices.
Sustainability is a key feature of today’s global corporate culture. But the term is often too broad for companies to process. Governments have trouble setting universal standards, while businesses struggle to measure progress against each other’s records and, at times, their own.
One of the ways to address this issue for investors is a green taxonomy – designed to give the necessary insight needed to make crucial decisions.
What is green taxonomy?
A green taxonomy is a classification system that highlights which investment options are sustainable and, by extension, those that aren’t.
Think of the taxonomy as a guest list. An investment must meet specific criteria for sustainability to appear on it.
Taxonomies closely connect to environmental, social and corporate governance (ESG) efforts. They can relate to any of those three components – not just the “environmental” part, although “environmental” is arguably the most discussed component.
Green taxonomies are relatively new, but they are rapidly gaining a reputation as a must-have guidebook for anyone involved in investing because it answers two of their most important questions:
- What is the ESG landscape of the jurisdiction I want to invest in?
- Will my money go towards genuinely sustainable efforts, or will it simply contribute to greenwashing?
Who decides what investments meet taxonomy criteria?
Lawmakers and governments.
They are the people who will weigh the pros and cons of every investment and decide what makes the list and what doesn’t.
Mostly, they do this by measuring the investment’s promise of sustainability against the jurisdiction’s green goals.
Now that several important jurisdictions worldwide have committed to some variant of having “net-zero carbon emissions by 2050”, investments will likely be measured against that benchmark. I.e. “will this help us reach that endpoint or not?”
What investments qualify under green taxonomy?
It depends because different jurisdictions will approach the decision in different ways. We can, however, pinpoint globally prevailing trends.
In general, taxonomies address an investment on both its merits and demerits. The good or service must positively contribute to one or more sustainability-related goals and, at the same time, not cause harm to one or more of the same goals.
Positive contributions usually cannot be minuscule or negligible, so the word “substantial” or some variant will usually be applied to this criteria. Similarly, taxonomies will usually insist that negative impacts must be “significant” or some variant for it to count against an investment’s green taxonomy criteria.
Examples of goals used to measure an investment include:
- Its contribution to climate change mitigation (i.e. stopping climate change)
- Its contribution to climate change adaption (i.e. helping prepare for specific impacts of climate change that are considered unavoidable at this stage).
- Its contribution to sustainability
Why should boards and management pay attention to green taxonomy?
The simple answer is investors and ESG.
Investor enthusiasm for ESG values – particularly the “environmental” component – is growing. They know that investing in ESG now will mean greater returns in the long term. Markets will reward them, governments will favour them, and employees will be more productive for them.
Investors conscious of ESG know they will depend on green taxonomy to ensure they make the right business decisions.
Because of this, managers and directors need to know the ins and outs of green taxonomies. How do they work? Is the business part of an industry that qualifies? If so, can this be maintained? If not, will it be in the future?
Knowing these things ahead of time is crucial for businesses – especially now, as a recession looms and investors are more conscious of the money they spend. Companies should target investors with the most significant promise of success. Green taxonomy is part of that.
Where are green taxonomies active?
The topic is still in its infancy, so several countries remain in the planning phases of rolling out a green taxonomy. Some, however, are already active.
- The European Union’s “Taxonomy for Sustainable Activities” was launched in July 2020. It’s primarily aimed at supporting the bloc’s ambitious target of being a “net-zero” economy by the year 2050. While the taxonomy has been met with broad approval across the Union, it has attracted criticism for including nuclear energy and natural gas as “sustainable” investments.
- The UK is working on its green taxonomy, independent of the EU. However, it has repeatedly indicated that it will base its work on the EU’s model, making changes where appropriate.
- China focuses its efforts on its Green Bond Endorsed Project Catalogues, issued yearly since the mid-2010s. These essentially list criteria for what projects can be attached to green bonds and have much the same result as the EU’s green taxonomy.
- Russia’s State Development Bank published the country’s green taxonomy in November 2021, covering the same investment opportunities as the EU.
- Canada intends to publish its taxonomy in the coming years, although it is unlikely to have the “green” label as it is more tailored to Canada’s resource-driven economy. In the meantime, however, it has been delayed by internal disagreements as of April this year.
- The United States does not have a green taxonomy and would likely endure much more political pushback from conservatives if efforts to launch one advanced. The country’s market watchdog, the Securities and Exchange Commission (SEC), has disclosure and ESG regulations. It has been suggested that this could stand in for taxonomy in the short term. Nevertheless, many of the biggest brands in America also have a foothold in the EU. A green taxonomy is already functioning there, meaning some of its impacts will likely filter across the Atlantic in the meantime.
Green taxonomy classifies investments according to how sustainable they are and how much they align with a jurisdiction’s sustainability goals.
They will rapidly become the go-to knowledge bank for investors who seek to ensure their money is causing positive change. Managers and directors must be aware of this and shape their search for investment.