They’re essentially systems for organizing information, and form the basis of codes for sustainable corporate conduct and investing. Those that already exist focus mostly on environmental risks, and are based on research by scientists backed by the United Nations. When the 2015 Paris climate accord was struck, its roughly 200 signatories acknowledged that action must be taken. The average global temperature is already 1.1 degree Celsius (2 degrees Fahrenheit) higher than it was before the industrial revolution. Scientists say the limit is 1.5 degrees Celsius, beyond which lies climate catastrophe. Taxonomies provide a detailed guide for which activities jeopardize climate goals and which support them.
2. Which jurisdictions have taxonomies?
The European Union has set a global benchmark with its taxonomy, on which a technical group began work back in 2018. The EU has since been followed by Colombia, China, Japan and members of the Association of Southeast Asian Nations. The UK is also working on its own version of one. Based on work by the EU and China, the International Platform on Sustainable Finance is focusing on establishing some uniformity through a “Common Ground Taxonomy,” which covers areas such as agriculture and manufacturing. If definitions diverge too much, that could hamper efforts to channel funding to sustainable businesses and meet climate goals.
3. What does the EU’s taxonomy cover?
Right now, it addresses climate change mitigation and adaptation. It covers 170 different economic activities that combined represent around 40% of the EU’s listed companies operating in industries responsible for almost 80% of direct greenhouse gas emissions. There are four more environmental objectives to go, including biodiversity, and also a social taxonomy in the works. Companies are being required to report on how well they aligned.
4. How do they work elsewhere?
There are more than 20 are under development around the world, according to the IPSF, and they’re starting to diverge. The EU for example has established minimum social safeguards and criteria reflecting the principle of ‘do no significant harm,’ but these aren’t universally used.
5. Will all businesses have to comply?
Which companies or business activities will be included and by what deadline is currently under review. Larger listed corporates are first in line in the EU, where companies including those in the financial industry will be required to identify how much of their business corresponds to the lists, so investors can direct their money to those with the highest degree of alignment. But requiring disclosure from all companies irrespective of size is at present unrealistic; it’s too complex and costly, with lack of data a constant obstacle.
6. How do you know which companies are aligned?
Calculating how much of sales, operating profit and capital expenditures are eligible to be aligned with the EU’s taxonomy is difficult. Data is tough to obtain and financial institutions, for example, can’t use estimates. To help both investors and companies, the EU is developing a central database of information, and the IPSF has created a tool to map sales that are eligible, though it warns this isn’t an indicator of environmental performance.
A recent survey by the Network of Central Banks and Supervisors for Greening the Financial System found that, of two dozen financial regulators, 20% are using taxonomies and another 60% plan to use, or are considering using, one. But in a sign of what may come, the EU’s taxonomy became mired in controversy over the inclusion of some gas and nuclear plants to temporarily meet demand for energy, a situation worsened by the war in Ukraine. Some trade organizations have warned regulations are so complex that there’s a risk investors will steer clear of companies, even low emitters, depriving them of financing to clean up. But organizations like the UN’s Intergovernmental Panel on Climate Change warn failure isn’t an option.
More stories like this are available on bloomberg.com