Common Ground Taxonomy: Consolidation of China and EU Green Definitions

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  • Common Ground Taxonomy: Consolidation of China and EU Green Definitions

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    The Common Ground Taxonomy (CGT), a comparative study of the green taxonomies of China and the EU, was published by the International Platform on Sustainable Finance (IPSF) on November 4 at the COP26. The CGT’s mission was to comprehensively assess existing taxonomies and identify commonalities and differences in their methodologies and outcomes. To undertake this project, the IPSF established the Working Group on Taxonomies in July 2020, co-chaired by China’s central bank PBoC and the EU Commission. The working group analyzed China’s Green Bond Endorsed Project Catalogue and the EU Taxonomy Climate Delegated Act for the first edition of the CGT.

    In this article, the term “EU Taxonomy” refers to the EU Taxonomy Climate Delegated Act, and the term “China Taxonomy” refers to the Green Bond Endorsed Projects Catalogue (2021 Edition), as consistent with the official CGT. For more background on China’s and EU’s green taxonomies, refer to Seneca ESG’s previous article.

    What is a Green Taxonomy?

    A green taxonomy informs entities whether their activities align with environmental objectives as determined by their jurisdictions and help mobilize financial resources to projects with verified green contributions. By clearly defining what projects are eligible, a green taxonomy can lower the likelihood of greenwashing and improve the credibility of green financial products, hence direct funds to support green businesses, assets, and projects.

    With a growing need to regulate sustainable financial markets, a growing number of authorities are developing and issuing taxonomies to dictate what investment falls in line with green objectives. In addition to China and the EU, Japan, Malaysia, and Mongolia have also adopted their respective green taxonomies. Other authorities such as ASEAN, Canada, Colombia, India, Indonesia, Singapore, and the UK are also developing their regional taxonomies. Aside from governments, non-governmental bodies also issued green taxonomies, such as the Climate Bonds Taxonomy developed by Climate Bonds Initiative, and the Common Principles developed by multilateral development banks (MDBs) and International Development Finance Club (IDFC).

    The map below shows an overview of green taxonomy development and adoption status around the world. (Update: as of November 10, 2021, the Russian Federation announced its official adoption of the Russian Green Taxonomy.)

    Source: Future of Sustainable Data Alliance

    The Need for a Common Taxonomy

    Since taxonomies differ across jurisdictions, market players conducting cross-border economic activities may be confused by the asymmetry of green classifications. A comprehensive study of commonalities and distinctions between existing taxonomies will bring more clarity and transparency on their approaches, hence help other developing standards align their language and scope with existing ones. This harmonization across taxonomies can enable greater coherence and interoperability for cross-border sustainable financial activities.

    As the EU and China are both pioneers of green taxonomy development, a comparative study on their taxonomies will provide crucial insights and clarity to the rapidly growing green finance market. While the CGT is not a legal document that mandates either China or the EU to change their taxonomies in accordance with the other, it serves as an important reference for both economies as they further develop their taxonomies. It also provides an analytical tool for other jurisdictions as they consider the development of their local green taxonomies.

    Comparison between China and EU Taxonomies

    The EU Taxonomy and China Taxonomy have largely aligned high-level objectives. Within their jurisdictions, the EU Taxonomy can be broadly applied to various financial and non-financial activities by companies and financial product issuers, while the current China Taxonomy applies only to domestic green bond issuers. In terms of eligibility, the EU Taxonomy provides technical conditions an activity must disclose to meet the taxonomy, while the China Taxonomy provides a definitive list of activities that meet the green definitions.

    Environmental Objectives

    The EU Taxonomy has six environmental objectives, for which the first two, climate change mitigation and climate change adaptation, have adopted technical screening criteria.

    1. Climate change mitigation (with technical screening criteria)
    2. Climate change adaptation (with technical screening criteria)
    3. Sustainable use and protection of water and marine resources
    4. Transition to a circular economy
    5. Pollution prevention and control
    6. Protection and restoration of biodiversity and ecosystems

    China’s green taxonomy refers to financial services provided for economic activities that support environmentally sustainable objectives under these three themes:

    1. Climate change response
    2. Environmental improvement
    3. More efficient resource utilization

    Overall, objectives in the EU Taxonomy and China Taxonomy can be mapped together at a high level, while there may be differences at a more granular level.

    Source: Common Ground Taxonomy Instruction Report

    Users and Mandatory Disclosure

    The EU Taxonomy can be applied to any type of entities, whether they are issuers of bonds, private investors, or businesses. For example, EU Member States and the EU are legally required to apply the Taxonomy when they set out any public measures, standards, and labels, as well as financial market participants that create available sustainable financial products. Large companies with over 500 employees under the Non-financial Reporting Directive (NFRD) are also required to adopt the Taxonomy.

    On the other hand, the China Taxonomy is mainly an instrument to regulate the green bond market and ensure the environmental benefits of financed projects. The China Taxonomy is mandatory for all green bond issuers in the Chinese onshore markets, including all financial institutions, corporations, and state-owned enterprises (SOEs).

    Determination of Eligibility

    Under the EU Taxonomy, an activity is in scope of the Taxonomy if it meets three requirements:

    1. The activity makes a substantial contribution to at least one of the six environmental objectives outlined in the EU Taxonomy.
    2. The activity causes no significant harm to any of the other five environmental objectives.
    3. The activity meets minimum safeguards that ensure its alignment with the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights.

    Details on what constitutes “substantial contribution”, “no significant harm”, and “minimum safeguards” are documented in the Technical Screening Criteria, which has only been developed for the first two environmental objectives as of the time of this article.

    Source: Common Ground Taxonomy Instruction Report

    Meanwhile, the China Taxonomy provides a detailed white list of eligible economic activities and projects. Activities are eligible only if it is included in the list. There are 204 activities in total from the following six categories:

    1. Energy-saving and Environmental Protection Industry
    2. Clean Production Industry
    3. Clean Energy Industry
    4. Ecology and Environment-related sector
    5. Sustainable Upgrade of Infrastructure
    6. Green Services

    Activities in the white list target all three objectives under the China Taxonomy, hence are not mapped to corresponding objectives like in the EU Taxonomy.

    CGT and Future Development

    At this stage, the CGT covers the first environmental objective of the EU Taxonomy (climate change mitigation) and its corresponding technical screening criteria. The Working Group plans to broaden the scope of the CGT to include other activities. For example, the current CGT analyzed 80 economic activities across six different sectors under the International Standard Industrial Classification of All Economic Activities (ISIC), which include:

    • Agriculture, forestry, and fishing
    • Manufacturing
    • Electricity, gas, steam, and air conditioning supply
    • Water supply; sewage, waste management, and remediation activities
    • Construction
    • Transportation and Storage

    These sectors were prioritized for analysis due to their significant impact on GHG emissions for both China and the EU. In future iterations, the Working Group considers bringing in additional sectors such as services and information and communication technology (ICT) into its scope to provide greater coverage.

    Another future focus of the CGT is the inclusion of other environmental objectives and transition considerations, as the EU and China taxonomies evolve to expand in scope and provide more technical guidance. The CGT also requires further analysis to assess the myriad of local codes, standards and regulations on climate change adaptation in China, as there are currently no criteria specified as adaptation under the China Taxonomy. In addition, the CGT intends to incorporate other finalized taxonomies beyond China and the EU for future analysis as well.

    Sources:

    https://ec.europa.eu/info/sites/default/files/business_economy_euro/banking_and_finance/documents/211104-ipsf-common-ground-taxonomy-instruction-report_en.pdf

    https://ec.europa.eu/info/sites/default/files/business_economy_euro/banking_and_finance/documents/211104-ipsf-common-ground-taxonomy_table_en.pdf

    http://www.pbc.gov.cn/en/3688110/3688172/4157443/4382112/index.html

    https://futureofsustainabledata.com/taxomania-an-international-overview/

    https://www.eib.org/attachments/documents/mdb_idfc_mitigation_common_principles_en.pdf

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