Climate Finance Taxonomy: 5 Principles to Steer TransitionBy Dave Sivaprasad and Tushar Agarwal
The accelerating impact of climate change is growing more evident by the day, necessitating substantial shifts in financial market structures and taxonomies in order to rapidly scale climate investments and achieve low-carbon targets.
The Global Guiding Principles for Developing Climate Finance Taxonomies is the latest report from Boston Consulting Group (BCG) in partnership with the Global Financial Markets Association (GFMA) aimed at presenting actionable principles to unlock green investment pathways.
There needs to be a substantial shift in market structures for climate finance if we are to mitigate the worst impacts of climate change, and meet the required USD$3 to 5 trillion total annual investment required to de-carbonise the global economy.
Accelerating shifts in financial systems
There is a need to refocus our efforts to expand transition finance, including ‘green’ equity targeted at supporting low-emissions projects. The financial markets will play a fundamental role in driving this transition, with equity contributing 35% of the funding needed to meet the Paris Agreement’s stated 2°C maximum, alongside 44% from loans and 21% from bonds.
Our shared climate crisis has been a growing focal point of major geopolitical events such as the G20 and G7 in recent years and will take centre stage at the UN Climate Change Conference of the Parties (COP26) in October.
The BCG-GFMA report highlights the need to encourage a fundamental transformation in finance markets, with growth required at an unprecedented scale, speed, and geographic scope to meet the investment needs of our transition to a low-carbon economy. This is essential if we are to mitigate the worst impacts of climate change while unlocking benefits to economic growth and ensuring the viability of communities around the world.
Meeting these goals will require commitment by all market participants, and necessitate the development of consistent, comparable, and reliable taxonomies that encourage positive climate investment and enable rapid mobilisation of climate finance.
This shared consensus will be critical if we are to prevent cases of so-called ‘green washing’, with equity finance growing to play an increasingly important role in nurturing businesses along a green transition pathway.
In order to address the critical need for effective global climate finance taxonomies, the report defines five crucial global principles to steer the transition:
- Climate Finance taxonomies should be broadened beyond use of proceeds structures (e.g. green bonds) to capture entity-level activities and all eligible sources of capital.
- Climate Finance taxonomies should be objective in nature, supported by clearly defined metrics and thresholds aligned to the Paris Agreement, and science-based targets.
- Climate Finance taxonomies should have a consistent set of principles and definitions, but provide flexibility for regional and temporal variation to align with differences in transition pathways.
- Climate Finance metrics should be defined and applied to sectors using science-based targets, balancing ease of use with transparency and robustness to both assess climate impact and support third-party verification.
- Climate Finance taxonomies should be based on a governance process that is robust, inclusive, and transparent, and has the flexibility for continued evolution.
Defining the right strategies for Asia and ASEAN
Developing effective climate finance taxonomies will require regional and sector-specific science-based transition (SBT) strategies that clearly outline the expected pathway, interim targets, and ultimate destination.
Asia will be a pivotal region in ensuring an effective transition, accounting for around half of the world’s current annual carbon emissions. Of the USD$100 to 150 trillion climate-aligned finance required, USD$66 trillion needs to be invested in Asia alone. Defining the right taxonomy within this economically diverse region will require a nuanced, localised approach.
Developing the right taxonomy to nurture an effective transition in Indonesia will be far removed from one which works in Singapore. Nevertheless, a global consensus on these five key imperatives, alongside an SBT approach to define local thresholds and inform transition efforts with evidence will be a unifying feature underpinning efforts.
Collaboration, coordination, consistency, and interoperability will be vital in Asia. Collaboration and coordination efforts within the region will require the development of taxonomies that account for both internationally agreed upon climate goals as well as a diverse range of ASEAN’s climate targets.
Bank-intermediated lending is expected to play an outsized role in ASEAN and across Asia, reflecting the limited maturity of capital markets across the region. Singapore is an outlier in this regard, potentially placing it as an important nexus in steering climate financing transitions in other countries across the region. The market capitalisation of Singapore’s stock market for example was around ~USD$700 billion in 2020, almost USD$200 billion more than that of significantly larger neighbour Indonesia.
Recognising the varied threshold targets as well as pathways tailored for emerging economies will also be important in Asia. Governments must balance improvements in environmental standards with economic growth to support industrialisation and urbanisation. Singapore for example relies on natural gas for much of its energy needs today and is investing in a green energy transition with innovations such as floating solar, as well as developing regional energy grid ambitions. Nations such as Vietnam and Indonesia on the other hand could abate emissions by shifting from more polluting coal towards natural gas as an interim replacement.
Development banks will also play a major role in many Asian and ASEAN nations, motivating the mobilisation of private sector capital through blended public and private solutions. These institutions will also play an important role in coordinating and developing effective sector- and region-specific taxonomies.
There is no single silver bullet to deliver a unified and uniform global taxonomy that drives positive climate financing transitions. What we should recognise however are the common features and evidence-based measures which can be leveraged to drive this transformation.
Boston Consulting Group is the Consultancy Partner for the 2021 UN Climate Conference
Dave Sivaprasad, Managing Director & Partner, SEA Leader for Climate & Sustainability, Boston Consulting Group
Tushar Agarwal, Managing Director & Partner, Boston Consulting Group