European Climate Foundation explains the bewildering different approaches to taxonomies

ECF Strategic Communications Manager/Sustainable Finance, Alba Málaga Homs, provides a helpful communication to sort through national approaches to what counts as green finance.

 

While the European Union considers adopting a sustainable finance taxonomy that classifies fossil gas as a green investment, Russia and China have stepped forward and recently adopted more ambitious initiatives that exclude all fossil fuels. In view of the debate in the EU, South Korea has included gas in its draft taxonomy expected to be finalised in the next weeks. These are just a few of the taxonomy projects being developed around the world, in which the EU classification will have a major influence (see “Taxomania” infographic).

• Russia 

The Russian Green Taxonomy, officially announced by the Russian state development bank VEB.RF on 9 November, has aligned with the original scientific recommendations of the European Commission’s Technical Expert Group (TEG) on gas: the limit of emissions for energy production has been set at 100 grams of CO2 per kilowatt-hour, which de facto excludes gas power plants. The adoption of this threshold by the Russian Federation means that gas power projects will not be considered green investments in its jurisdiction.

• China

The equivalent initiative to the EU Taxonomy in China is the Green Bond Endorsed Project Catalogue 2021 Edition (English link), jointly developed by the People’s Bank of China (PBoC), the National Development and Reform Commission (NDRC) and the China Securities and Regulatory Commission (CSRC). The updated version was officially effective on 1 July and excluded most forms of natural gas production and gas-fired electricity generation, except for construction and operation of natural gas transmission, storage, and peak load regulation facilities.

After including “clean coal” in its first green taxonomy in 2015 and receiving criticism especially from foreign investors, China decided to remove coal-fired power activities from the Catalogue in 2021. This clears a major technical hurdle that has long been in the way of improving the compatibility of green bond standards at home and abroad, and can help China attract more private capitals to fill the funding gap to achieve carbon neutrality by 2060.

China’s latest effort to make its taxonomy more internationally recognized is the release of the Common Ground Taxonomy (CGT) with the European Commission at COP26. The CGT is based on the comparison of the EU and Chinese respective classification systems and covers the initial phase of work which will be expanded over time. Due to its central bank and financial supervisor’s active role in steering the financial market in green direction, China ranks first among G20 countries on Positive Money’s Green Central Banking Scorecard. Furthermore, China has not shielded away from leading the charge in taxonomy globally, and has sought to support countries along the Belt and Road Initiative in establishing or improving their green finance standards.

• South Korea

Despite having resisted industry pressure for months, the latest draft of the South Korean taxonomy circulated on 20 October (not yet available online) finally classified unabated gas-fired generation with newer technology or co-generation as “green” economic activities. If, as expected, the K-Taxonomy moves forward as it is by the end of the year, new unabated gas power projects would qualify for green bond and loan financing in the Asian country.

According to Youn Sejong, Director at Solution for Our Climate, a South Korean non-profit organisation, the debate around gas and nuclear in the EU taxonomy could be one of the reasons why South Korea has introduced gas at the last minute (See quote below).

In view of this, the Institute for Energy Economics and Financial Analysis (IEEFA) has reminded that investors trust science-based taxonomies able to prove green credentials, and has warned that South Korea “risks missing out on new pools of global capital”.

What are the scientific recommendations of the European Commission on gas?

In November 2020, the EU published a first draft list of economic activities to be labelled as sustainable in the EU Taxonomy. The draft, based on science and the recommendations of an expert group, set the limit for greenhouse gas emissions from electricity production at 100g of CO2 equivalent per kilowatt hour (100g CO2e/kWh) in order to be labeled sustainable under the EU Taxonomy. Unabated natural gas-fired power generation – even today’s best-in-class gas plants – exceeds that limit, excluding the possibility of labelling gas as green.

Despite these scientific recommendations, EU governments and industry have pressured the EC to include gas in the EU Taxonomy, a decision that has been postponed for months but that is expected to see the light in the next few days (1 December).

The French government has been one of the biggest advocates of gas in the EU taxonomy. Although it has not yet taken an official position, its ambassador in the Czech Republic announced that Macron’s plans were to be aligned with the Eastern European block. Having led a group of ten countries in lobbying to ensure that nuclear energy is labelled green, Macron’s government seems to be willing to let fossil gas be included in the Taxonomy if it can secure a green stamp for nuclear energy, according to a recent leaked paper that unveiled what France’s position could look like.

Investors to reject EU Taxonomy with fossil fuels

The debate around the possible green labelling of gas has raised the alarm not only among the climate community, but also among financial institutions. The UN-convened Net-Zero Asset Owner Alliance, an international group of 60 institutional investors representing more than 10trn USD in assets under management, has warned that it will oppose classifying gas and nuclear as green assets. In a document seen by Bloomberg, the Alliance says the inclusion of gas “would be inconsistent with the high ambition level of the EU taxonomy framework overall”. The investors’ group, whose worldwide members include Allianz SE, AXA Group, BNP Paribas, Banco Santander, Barclays or the California Public Employees’ Retirement System, has urged the European Commission to deliver “a taxonomy that is credible, usable, as well as science and evidence-based”.

Likewise, The Net Zero Banking Alliance Germany, formed by eight German banks (Deutsche Bank, Commerzbank, ING Germany, BNP Paribas Germany, LBBW, DKB, DZ Bank, Umweltbank) has opposed the inclusion of gas and nuclear energy in the EU Taxonomy in a statement published on 18 November. The banking group states that “the EU taxonomy follows the principles of technology neutrality and of scientific rigour, so there is little room for these technologies [fossil gas and nuclear power for electricity generation]”.

The UN Principles for Responsible Investment (PRI)’s initiative also reminds that the EU Taxonomy’s goal is defining “which economic activities are green – not which economic sectors are needed for the transition to a net-zero by 2050 economy”, stressing that including gas and nuclear energy would “fundamentally undermine the scientific integrity of the EU Sustainable Taxonomy – the bedrock on which the entire credibility of the EU sustainable finance framework relies”. In a position paper recently published, UN PRI states: “The inclusion of gas-fired power would seriously compromise the EU Sustainable Taxonomy’s ability to act as an independently and scientifically designed tool for guiding investment into environmentally sustainable activities in line with the EU’s goal of reducing emissions by at least 55% by 2030.  The IEA net zero by 2050 pathway stresses that there is no remaining carbon budget for new gas investments at all and that existing gas-fired power plants will have to be phased out by 2035 in the OECD and 2040 globally”. PRI has now over 4,300 signatories (pension funds, insurers, investment managers and service providers) to the PRI’s six principles, representing US $121 trillion in assets under management.

 

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Voices:

Sean Kidney, CEO of Climate Bonds Initiative:

“Institutional investors have proven their appetite for green bonds, but they seek confidence and guidance to commit the trillions required for rapid decarbonisation to Net Zero. The Russian Taxonomy adds to the wave of regulators that are adopting international best practice and providing credible green definitions.”

“Taxonomies adopting common science-based, dynamic, and conscious principles are key to harmonisation that facilitates cross-border flows of green capital. If it is green, they will invest. The taxonomy is designed to let investors know what investments are Paris Agreement-consistent. It’s a ‘shopping list’  for the future.”

Wenhong Xie, Head of China, Climate Bonds Initiative:

“China, like elsewhere, is keeping its taxonomy dynamic and has been keeping a close watch on how the gas and nuclear debate will play out within the EU. The potential inclusion of unabated gas into the EU definition will have a significant implication for China’s proposed taxonomy for transition activities and the EU-China Common Ground Taxonomy, both under development, and will be detrimental to the global effort in creating a concerted action to combat climate change.”

​​Peiyuan Guo, Chairman of SynTao Green Finance:

“China’s exclusion of clean coal from the 2021 version of the Green Bond Endorsed Project Catalogue is an important sign of the convergence of standards, indicating that Chinese policymakers want to further align with international standards. However, a few natural gas-related projects are still retained, mainly construction and operation of natural gas transmission, storage, and peak load regulation facilities, which I think is still in line with China’s national conditions.

It is normal for China and Europe to have differences in taxonomy, but it is also vital to gradually converge or further enhance the comparability, compatibility, and consistency between standards, which can effectively reduce market transition costs. The recent publication of the EU-China Common Ground Taxonomy is an innovative attempt to improve the convergence.

China started its green finance in the field of green credit and has accumulated more technical experience than Europe. China can count the non-performing rate of green loans. This is related to the structure of the Chinese market, where the indirect financing(credit) market is much larger than the direct financing market.”

Youn Sejong, Director at Solution for Our Climate (South Korean non-profit organization):

“The recent draft for the K-Taxonomy has set a very low threshold for fossil gas power generation, allowing unabated gas power projects to be financed with green bonds. This will lock the country’s energy system further into fossil fuel and cause massive stranded asset risk. Placing fossil fuel projects in the “green” category defies the purpose of establishing a green taxonomy. It will fundamentally compromise the credibility and useability of this important element of the green finance regime.”

“The Korean government is aware of the discussions around gas and nuclear in EU Taxonomy, and I understand this was one of the reasons why they introduced gas power to the green taxonomy at the last minute. If the EU fails to properly set the bar on sustainability of its taxonomy, it could compromise the integrity of the taxonomy around the world. This is particularly important because the taxonomy is the first piece of a green finance regime for many countries, and is likely to play a critical role as the foundation of climate finance programs going forward.”

 

Materials:

• Unbranded factsheet: “EU Taxonomy: the risk of classifying gas as a green investment”
• Infographic by Future of Sustainable Data Alliance: Taxomania: an international overview
• Report by the Institute for Energy Economics and Financial Analysis (IEEFA) : Asian Hopes for Sustainable Finance Will Rest on More Credible Taxonomies
• UN Principles for Responsible Investment position paper: ALTERNATIVE SOLUTIONS TO INCLUDING GAS-FIRED POWER AND NUCLEAR ENERGY IN THE EU SUSTAINABLE TAXONOMY
• Briefing paper by E3G: “SAFEGUARDING EUROPEAN LEADERSHIP ON ‘DEFINING GREEN’. Why a strong outcome on the sustainable finance taxonomy is important for the EU’s domestic and international policy goals”.
• Factsheet by the European Consumer Organisation (BEUC): How green is green finance? Can consumers trust the Taxonomy? 
• Factsheet by Climate Bonds Initiative: “The Hidden Emissions from Gas-Fired Power”