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Taxonomies

What are Taxonomies?

The dictionary defines taxonomies as “the science of classification; laws and principles covering the classifying of objects". For our purposes, a sustainable taxonomy provides a classification system for identifying activities or assets that deliver on sustainability objectives consistent with sustainable activities, including climate change mitigation and adaptation.

A field of solar panels

What Role Do Taxonomies Play in Sustainable Finance?

Taxonomies can play an important role in advancing sustainable finance objectives by identifying, defining, and classifying activities that can be considered sustainable. For example, the January 2018 EU Expert Panel report states: “If Europe is to mobilise capital at scale for sustainable development, it needs a technically robust classification system to establish clarity on what is ‘green’ or ‘sustainable.’”1 The Canadian Expert Panel on Sustainable Finance similarly noted on page 33 of its October 2018 interim report that “accurate labeling enables the financial sector to more strategically identify and address sustainable growth prospects with a reasonable view of relative risk and opportunity.”2 In essence, taxonomies are tools that promote the allocation of capital toward or away from certain activities. They are necessary to prevent “greenwashing” behaviour and are central to the proper functioning of markets for green bonds, transition financing, and other sustainable investments.

Are There Universally Accepted Taxonomies?

While there is widespread adoption of standards for Green Bonds (i.e., the Green Bond Principles), there are presently no broader-coverage, universally accepted, sustainable finance taxonomies. Recognizing the importance of setting such global standards, the International Organization for Standardization (ISO) established a task force to develop such a taxonomy. According to the Chair of this committee, Peter J. Young, the desired outcomes from doing so include:3

  • Helping to reduce market confusion and lowering transaction, verification and communication costs for players engaged in the sustainable finance market;
  • Preventing “sustainability washing,” which will underpin the credibility, integrity and scalability of sustainable finance activities, and guide financial institutions (including banks, investors and insurers) to better integrate environment, social and governance (ESG) considerations into investment and finance practices;
  • Improving understanding of sustainable finance activities to facilitate the innovation and development of sustainable financial products, as well as related services such as third-party verifications and ESG data provision;
  • Standardizing metrics to allow the measurement and improved transparency of sustainable finance flows and the ESG performance of sustainable finance activities, financial institutions and markets.

In October 2019, authorities from seven countries, including Canada’s Department of Finance, launched the International Platform on Sustainable Finance (IPSF). The group, which has since grown to 18 members, focused on two areas during 2021: (a) comparing taxonomies and (b) sustainability-related disclosures. So far, the taxonomy workstream has produced the Common Ground Taxonomy, which represents a potentially important step forward in fostering increased comparability and interoperability of existing and emerging approaches.

Global Actions

In recent years, regulatory efforts to develop taxonomies that guide what constitutes green or sustainable investments have rapidly proliferated. Jurisdictions such as the European Union (EU), China, and Mongolia already have taxonomies in place, while others, including South Africa, Russia, and South Korea, have published drafts. Many additional efforts are currently in development. The Future of Sustainable Data Alliance (FoSDA) has initiated a workstream to track taxonomic development globally.

The EU Taxonomy Regulation (TR), which is one of the more ambitious efforts to date, identifies the following basic principles.4 For an action to meet the definition of an “environmentally sustainable economic activity” (TR Article 3) and thus be considered Taxonomy-eligible, it must:5

For an action to meet the definition of an ‘environmentally sustainable economic activity’ (Article 2) and thus be considered Taxonomy-eligible, it must:

  1. Contribute substantially to one or more of the environmental objectives.
  2. Do no significant harm to any other environmental objective.
  3. Comply with minimum social safeguards (TR Article 18: OECD Guidelines for Multinational Enterprises; UN Guiding Principles on Basic Human Rights).
  4. Comply with the technical screening criteria.

The implication is that economic activities, even when making a substantial contribution to climate change mitigation and/or adaptation, will not be eligible for the Taxonomy if they cannot be performed in a way that avoids significant harm to other environmental objectives.

What's Happening in Canada?

In the Final Report of the Expert Panel on Sustainable Finance, the Panel, on page 28, called for convening “key stakeholders to develop Canadian green and transition-oriented fixed income taxonomies.”5 This recommendation (9.1) reflects the Panel’s view that Canada, as a resource-rich economy with a strong financial sector, has an opportunity to develop a standard for fixed-income instruments tailored to transition activities, which are often outside the scope of and not compatible with, emerging green finance standards.

The importance of developing more encompassing taxonomies that incorporate transition opportunities is evident in the recent comments provided by Mark Carney, the UN Special Envoy on Climate Action and Finance, and former Governor of the Bank of England, where he underscored that if we are concerned about the whole economy transition and mainstreaming sustainable finance, then we need a transition bucket in the middle, rather than just a binary of ‘green’ and ‘not-green’ finance. This is consistent with survey results included in ISF’s September 2021 Changing Gears: Sustainable Finance Progress in Canada report, which indicated that the development of a transition taxonomy for Canada was the 6th most commonly cited “potential need for action in the short-term” among experts surveyed for the report.6

Given the current lack of one globally accepted taxonomy, despite multiple efforts towards that end, there is a great deal of urgency to develop our own taxonomy, as well as to provide a unified Canadian perspective on taxonomy issues at the global level. In other words, it is important for us to be at the table and to make meaningful contributions to ongoing conversations; otherwise, we run the risk of letting others establish rules that may penalize our economy. Canada’s involvement in a multilateral dialogue on important sustainable finance topics, including taxonomies, through the IPSF forum, represents an important avenue for Canada to provide its perspective internationally.

Domestically, signs of progress include the Government’s launch in May 2021 of the Sustainable Finance Action Council (SFAC). The Council is tasked with helping guide the integration of sustainable finance into standard industry practice within the Canadian financial sector. SFAC’s Terms of Reference are indicative of the increasing prioritization of developing a made-in-Canada taxonomy, stating that “the Council’s principal mandate is to make recommendations on the critical market infrastructure needed to attract and scale sustainable finance in Canada, including enhanced assessment and disclosure of climate risks and opportunities; better access to climate data and analytics; and common standards for sustainable and low-carbon investments.”

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