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, including climate change mitigation and adaptation.

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 a universal, globally agreed taxonomy for sustainable finance does not exist at present, establishing one would have certain advantages. The International Network of Financial Centres for Sustainability (FC4S) argued that an internationally compatible taxonomy would:

• Reduce transaction costs,
• Provide a common, foundational starting point for standards, products, and asset classes,
• Enhance market trust and liquidity, and facilitate cross-border financial flows,
• Improve the ability of market participants to express their sustainability preferences,
• Inform additional policy measures for incentivizing sustainable finance,
• And ultimately accelerate transitions towards a sustainable economy.³

Despite the benefits, the agreeance of a global taxonomy is unlikely given the heterogeneity of countries and markets. A taxonomy is more likely to be effective if it is designed with a jurisdiction’s sustainable development priorities and socio-economic realities in mind.⁴ At the same time, a balance must be achieved between the need for (a) approaches tailored to domestic context, and (b) ensuring that cross-border financial flows are not hindered by a lack of comparability between taxonomies.

In October 2019, authorities from seven countries, including Canada’s Department of Finance, established the International Platform on Sustainable Finance (IPSF). The IPSF, which has since grown to 18 members, aims to facilitate knowledge exchange and promote best practices in sustainable finance. The group has focused on two initial priority areas: (a) comparing taxonomies and (b) sustainability-related disclosure. The taxonomy workstream has published the Common Ground Taxonomy, the result of an effort to compare China’s Green Bond Endorsed Project Catalogue and the European Union Taxonomy. The IPSF may be an important venue for further cooperation to improve the comparability (i.e., interoperability) of taxonomies going forward.

Global Actions

In recent years, taxonomy development has rapidly accelerated, with efforts at the national, regional, and multilateral levels. This momentum has, in large part, been driven by rising interest from policy makers and financial regulators in taxonomies and the role they can play within policy frameworks for sustainable finance. By mid-2022, upwards of 30 country- and regional-level taxonomies in varying stages of development are underway globally. This includes comparatively early efforts in China and the EU, and more recent initiatives in Colombia, Singapore, South Africa, and the United Kingdom, among others.

What's Happening in Canada?

In their 2019 Final Report, the Expert Panel on Sustainable Finance called for convening “key stakeholders to develop Canadian green and transition-oriented fixed income taxonomies.”⁵ This recommendation reflects the Panel’s view that Canada’s economic context and strong financial sector is well-suited for the development of a transition-oriented approach.

In fact, the development of a ‘transition’ taxonomy is a significant opportunity for Canada to advance existing global approaches in taxonomy design, which have primarily focused on identifying activities that are already ‘green’ or ‘environmentally sustainable.’ This opportunity is underscored by Mark Carney, the UN Special Envoy on Climate Action and Finance, who stated in 2020 that a whole economy transition and the mainstreaming of sustainable finance requires moving beyond a rigid dichotomy of green and not-green in favour of an approach that includes a ‘transition’ bucket in the middle. This is also consistent with findings included in ISF’s September 2021 Changing Gears: Sustainable Finance Progress in Canada report, which indicated that a Canadian transition taxonomy remains a commonly cited short-term action item among surveyed experts.⁶

Developing a Canadian Taxonomy would also ensure that Canada has a seat at the table, where the country would be positioned to contribute to the ongoing taxonomy-related dialogue at the global level. If Canada is absent, we run the risk of letting others establish rules that may penalize our economy.

That being said, important progress to establish a Canadian-oriented approach has been made over the past year through the Federal Government-established Sustainable Finance Action Council (SFAC). SFAC has acted on the above Expert Panel recommendation by convening the Taxonomy Technical Expert Group (TTEG). The TTEG has recently published the Taxonomy Roadmap Report, outlining ten recommendations to the Government for establishing a Canadian-oriented green and transition taxonomy. The recommendations reflect the TTEG’s view that a taxonomy would mobilize green and transition finance aligned with Canada’s transition pathways, support the growth of a Canadian transition finance market, and serve as a foundational tool across a variety of use cases, including as a key input for formulating credible climate transition plans.

• ¹Source: Financing a Stable European Economy, 2018.
• ²Source: Interim Report of the Expert Panel on Sustainable Finance, 2018.
• ³Source: Building Shared Language for Green and Sustainable Finance – Expert Briefing on the Development of Taxonomies, the International Network of Financial Centres for Sustainability, 2018.
• ⁴Source: Developing a National Green Taxonomy: A World Bank Guide, the World Bank, 2020.
• ⁵Source: Final Report - Mobilizing Finance for Sustainable Growth, Expert Panel on Sustainable Finance, 2019
• ⁶Source: Changing Gears: Sustainable Finance Progress in Canada, 2021.