Blog | Should a Sustainable Finance Nomenclature be Enforced?

The mandatory disclosure of information under sustainable finance taxonomies is becoming more relevant to measure taxonomy alignment Related:

• Blog 1: Sustainable Finance Taxonomy

• Policy Brief: “Towards a Common Pathway Across Sustainable Finance Taxonomies"

• Blog 2: Sustainable Finance Taxonomy: A Key Financial Regulatory Tool in the Reform of the Financial System

Key Takeaways:

1. Disclosure of information and verification is necessary for the compliance and provision of data to financial regulators to assess the level of alignment with the taxonomy and prevent greenwashing practices.

2. The EU is the only jurisdiction with in-place governance for mandatory disclosure of information; however, there are signs that a new wave of jurisdictions will likely move from voluntary to mandatory disclosure.

3. A series of conditions are needed for developing countries to enforce a sustainable finance nomenclature, such as internal capacities at the political and technical levels, same as raising awareness and accompanying entities subject to disclosure.

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The momentum towards taxonomy development continues in 2023 as the latest implementation trends among countries have started to show signs of lessons learned and best practices with the recent publications of taxonomies in the first quarter of this year (Thailand, Mexico, and ASEAN 2.0), as well as Canada’s Taxonomy Roadmap Report and Australia’s Taxonomy Recommendations Report.

As such, some jurisdictions are following best practices in governance and compliance with the European Union (EU) taxonomy. It currently stands as the most sophisticated taxonomy in terms of reporting, verification, and disclosure of information by financial and non-financial entities concerning the proportion of environmentally-sustainable economic activities in their business, investments or lending activities. The disclosure of taxonomies In our recent Policy Brief, Towards a Common Pathway Across Sustainable Finance Taxonomies (co-authored with GIZ), we emphasize the importance of assessing and tracking compliance of taxonomies with clear sustainable goals and objectives. As a result, disclosure of information and verification is necessary for compliance and provision of data to financial regulators for assessing the level of alignment with the taxonomy and preventing greenwashing practices.

Disclosing information on sustainable businesses, investments, financial products or activities by market participants is paramount to understanding the level of taxonomy eligibility and alignment. This practice is essential for providing transparency to investors, investees, financial regulators and policymakers on the degree of capital, expenditure and revenues on sustainable national and international goals. Who is requesting the disclosure of information? For most jurisdictions evaluated in the Policy Brief, CCAP and GIZ found that taxonomies are not legally binding. However, it is mandatory to report on taxonomy alignment when obtaining certifications for financial instruments such as loans or bonds. Taxonomies in Bangladesh, China, Japan, Malaysia, Mongolia, Russia, and South Africa encourage verification by an independent third-party certifier. Colombia is advancing towards linking its national measurement, reporting and verification (MRV) system for climate finance with its taxonomy to assist in MRV. Nonetheless, the EU is the only jurisdiction with an in-place governance scheme for mandatory disclosure. Despite this, there are signs that a new wave of jurisdictions will likely request mandatory disclosure of information, like Mexico’s sustainable finance taxonomy or Australia's forthcoming taxonomy. During a stakeholder consultation in Australia, participants suggested having a government-led mandatory taxonomy informed by an industry-led technical working group, subject to be phased in over time to address existing data challenges and capacity-building gaps from entities and financial regulators. Therefore, the reporting on taxonomy alignment has high potential to be mandatory in Australia where users are seeking to label sustainable activities in their activities, financial instruments, or products. What are the challenges of disclosing information? More information is required to determine the challenges and best practices for verifying measures or disclosing taxonomy data. However, as jurisdictions increasingly enter the implementation phase and fourth movers develop taxonomies, more technical capacity for verification and disclosure of information will be needed, especially for entities mandated to report results and evaluate impacts aligned with taxonomies. Increasing standardization of reporting will give way to new stakeholders, such as third-party certifiers and verifiers. Examples of this phenomenon exist in the “ISO 14030-3:2022 Green debt instruments Part 3: Taxonomy,” the International Financial Reporting Standard (IFRS) Sustainability Disclosure Taxonomy, and the integration of the Carbon Disclosure Project’s (CDP) four key questions related to the EU Taxonomy from the climate change questionnaire. Is it viable to enforce a sustainable finance nomenclature in developing countries? It is too early to state that entities and financial regulators in developing countries are ready for mandatory disclosures of information. However, emerging markets and developing economies (EMDEs) would likely shift from voluntary to mandatory, contingent upon moving into the bigger picture of strengthening the climate information architecture and then understanding the extent of taxonomies as a financial regulatory tool to align financial flows with the goals of the Paris Agreement, which can accelerate private sector investments. There is a series of conditions needed in place for developing countries to enforce sustainable finance nomenclatures that will enhance interoperability among regional and international markets:

• Create internal capacities at the political and technical levels

• Receive technical assistance to bridge capacity-building gaps

• Involve local sectoral experts to understand taxonomy development and implementation processes better

• Harmonize overarching methodologies for fast-track adoption

• Localize (or adapt) technical aspects to a national context

• Promote an open consultation

• Raise awareness and accompany entities subject to disclosure

• Conduct pilot tests for the disclosure of information for entities and financial regulators

• Enact legislations or regulations for a step-by-step mandatory rollout of disclosure of information.

However, it is relevant to stress that developing a taxonomy is not the final milestone but rather the beginning of a complex testing and implementation process. Implementation will reveal challenges at each step in the taxonomy development. It will provide an opportunity to refine verification and disclosure steps. Implementation will also reveal political and technical difficulties that can be overcome by constant collaboration between relevant stakeholders to achieve a pertinent taxonomy for all users.