IEMS - Thought Leadership Brief #75

3 SUMMER 2023 NO.75 / THOUGHT LEADERSHIP BRIEF Central banks and financial regulators are actively working to provide more clarity around the definitions of sustainable finance within their markets. China, the EU and approximately 30 other countries are at different stages of adopting classification systems for defining what can be considered as a ‘sustainable investment’. Such systems are commonly referred to as ‘climate finance taxonomies’, or if their scope allows, ‘sustainable finance taxonomies’.1 1 In these instances, the taxonomy provides criteria to clarify whether an investment contributes (or at the very least, does not cause significant harm) to multiple sustainable development objectives including but not limited to biodiversity, circular economy, water and climate adaptation, in addition to climate change mitigation. Nevertheless, due to the common but differentiated responsibilities and respective capabilities of developed and developing countries alike, it is conceivable that the global market may witness the rise of various, distinct taxonomies that are tailored to the unique policies, preferences and circumstances of individual jurisdictions. For instance, while the EU Taxonomy uses technical screening criteria to establish clear requirements for what constitutes a 'green' economic activity, the China Taxonomy provides a prescriptive 'white-list' of technologies and activities that are considered green. On the other hand, the ASEAN Taxonomy also includes transitionary criteria that can be used to label a financial product as sustainable, provided that the entity as a whole is making plans to transition towards net-zero – a feature that has not yet been incorporated into the taxonomies of either China or the EU. Thus, a project or corresponding financial product that is labelled as sustainable in one jurisdiction might not be considered sustainable in another. Figure 1. Below Illustrates the State of Climate Finance Taxonomy Developments in Different Markets Globally Source: This situation could pose a challenge for international institutional investors seeking to report their investment impact to their regulatory headquarters. As financial markets play a critical role in addressing climate change, it is essential to consider how to transfer immense capital from developed to developing countries while respecting regulatory frameworks. Hong Kong’s Role in Sustainable Finance and Taxonomies Hong Kong can play a unique role in bridging global investors with local projects, particularly in China, one of the world's largest emitters. A handful of financial institutions have issued green bonds which reference the International Platform for Sustainable Finance (IPSF) Common Ground Taxonomy – a comparison exercise which clarifies, line-by-line, the relationship between the EU and China’s taxonomies. It appears that these issuers have indeed, enjoyed lower borrowing costs. By using a sustainability standard that can be understood by both European and Chinese investors, issuers could potentially benefit from a more diverse investor base. The Hong Kong Monetary Authority (HKMA) recently released its own prototype of a Green Classification Framework for public consultation, with the aim of being compatible with the sustainable finance taxonomies developed globally, thus bridging the gap between different markets and helping to position Hong Kong as a hub for channeling international green capital into China and across Asia. Recommendation: Taxonomies and the Broader Climate Finance Framework As the HKMA considers its next steps on the development of a local classification system, there are some elements that may be worth considering. Firstly, the HK Taxonomy criteria should continue to prioritize development of climate change mitigation criteria, using an emissions-intensity based approach to measure decarbonization, striving to keep carbon intensity as the main metric for criteria development. Doing so will be fundamental to ensuring that a taxonomy provides clear trajectories and thresholds that explain how an activity can be performed to meet the Paris Agreement objectives. In place Under development In discussion High level guidance available