What Is Finance Taxonomy?


Author: Albert
Published: 8 Feb 2022

Green Finance: A Standardization Approach

An economic taxonomy is a system of classification of economic activity. The study of economic policy requires a different approach than most economists think. The London Stock Exchange conference said that green finance becomes permanent in global capital markets if data and taxonomy are standardized. Green finance can be defined as financial investments flowing into sustainable development projects and initiatives, environmental products, and policies that encourage the development of a more sustainable economy.

The Four Short and Medium Term Sustainable Business Activities of the Industrial Economy

Carbon dioxide emissions have increased over the past century. The Paris Agreement requires countries to cut their greenhouse gas emissions. Every industry has a part to play in the transition towards decarbonization.

The financial sector is well positioned to demonstrate its commitment to green finance. The final report on the EU Taxonomy for sustainable finance has been released. The economic activities that contribute the most to the first two goals of climate change are defined in the report.

It will be implemented by the end of the year. The activities that contribute to the fulfillment of the other four environmental goals will be covered by a supplementary taxonomy at the end of 2022. The four short and medium term milestones are related to regulation and financial supervision.

Expanding the taxonomy beyond its initial environmental scope will encourage economic activities that are socially sustainable. The development of a classification system that identifies economic activities that harm the environment is second. The non-financial information directive will be updated in 2020 to make it easier to compare apples-to-apples.

Stress tests are used to weigh the risks of climate change. The document addresses the need to prevent businesses from pretending to be sustainable when they are not, so that financial players can fall prey to them. The European Commission will require companies to use a common standard of language to clarify their investment strategies.

Towards Sustainable Development in the EU

. To enable this, companies will need to assess and disclose what extent their activities are in line with the environmental criteria set out. Businesses will be more likely to get financing if they are aligned with the Taxonomy.

The EU needs to implement the European Green Deal and become climate neutral by the year 2050, and the EU taxonomy will help to orient investments towards sustainable projects. The EU Climate Delegated Acts set out the criteria for screening and which activities will be considered sustainable. The first act for the EU Taxonomy will come into force on January 1, 2022.

NACE Classification of Economic Activities

The NACE Classification system of economic activities is used by EU institutions such as Eurostat and has already been implemented by some financial institutions.

Climate Change and Sustainability: A Key Issue for Investors

Climate change and broader sustainable issues have become more important for investors to consider in their investment decisions. Diverse financial market actors have engaged in a wide range of initiatives with different objectives. There are many different understandings of which investments are sustainable.

The Data Taxonomy Chart

The data taxonomy chart is unique in that it only shows the hierarchy of the entities. Expansion of observations and attributes within the model is always possible, but the core is ranking.

Climate Bonds Taxonomy

The Climate Bonds Initiative is developing a Climate Bonds Taxonomy that will identify assets and projects that are consistent with the goals of the Paris Agreement.

The EU Taxonomy: A tool to help investors understand the transition towards a low-carbon economy

The EU Taxonomy is a tool to help investors understand the transition to a low-carbon economy. Setting a common language between investors, issuers, project promoter and policy makers helps investors assess whether investments are meeting robust environmental standards and are consistent with high-level policy commitments.

Environmentally Responsible Investments

That shows that corporations can be recognized for creating investments that are friendly to the environment. If an oil company invested in a wind farm, it could be labeled as being "environmentally friendly". Third, transitional actions that can not be created thoroughly sustainable, but which have emissions underneath the marketplace typical and do not lock in pollution or crowd out green options. An example of that would be a cement plant with emissions under.72 tonnes of CO2 equal for every ton of gray clinker generated.

The Taxonomy Report

The Taxonomy was developed by a technical expert group. It was developed after consultations with over 200 industry specialists and scientists. The aim is to provide clarity to both corporates and investment firms on how to fund green economic activities.

The Taxonomy report in March 2020 details the assessments that are required to demonstrate substantial contribution to either a mitigation or adaptation criteria. The next version is expected to cover the criteria for the remaining environmental objectives. Those selling products into the EU will fall in scope due to the nature of global capital markets.

Regulating Multiple Agencies

The patchwork of responsibilities and rules of multiple agencies has long made speaking with one voice a challenge for U.S. regulators. With climate risk regulation still in the development phase, coordination among banking, securities and derivatives regulators is seen as an essential step towards providing firms with a clear understanding of what is expected from them. Without coordination and collaboration among regulators, financial firms will be faced with conflicting guidance. Compliance with future rules would be more difficult.

The need for action in practice

Applying the Taxonomy in practice can lead to some challenges for banks. There are gaps between the requirements given through the taxonomy and the internal requirements that are already in place. Taxonomy thresholds are a key requirement for a global understanding of sustainable products and practices.

The current practices require less reporting of carbon emissions and this causes difficulties in the assessment of technical screening criteria. There are differences in the current stage of investments in renewable energy sources, lack of incentives to information reporting or lack of pollution thresholds set by government agencies. Taxonomy use requires the education of employees on sustainable business practices and requirements.

There is a practical understanding of the basics of its applicability through expert seminars and online training. Banks should get a better idea of their clients processes through an understanding of their entire value chain. The client should comply with relevant legislation during the transition period.

Reliance on certification schemes, third party assurance and labels, and ensuring potential gaps are filled through bank or portfolio manager research, or in case of immaterial issues at stake, closing the transaction while the assessment is still ongoing. The need for action is imminent because the amended obligations are not foreseen to be applicable before Q3 2022, Updating the client questionnaire, planning and arranging a client outreach, updating service models and control frameworks, and aligning interpretations between manufacturer and distributor are all time consuming activities.

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