With global policy tailwinds backing key sustainability themes, the need to mobilise capital into ESG-aligned activities unlocks a pipeline of investing opportunities. As ESG assets worldwide are on track to exceed US$50 trillion by 2025, capital providers have expressed a primary concern over “greenwashing” – misleading claims made by companies regarding the sustainability credentials of their products.
To provide assurance on the integrity of sustainable investments and transparency in how funding proceeds are utilized, a taxonomy for sustainable finance was introduced to set clear definitions for what can be labelled as “green” or “socially responsible”. This is a big milestone for the ESG ecosystem. By developing a universal language among investors, issuers, and regulators, market participants can better understand what is expected from business activities and financial products.
As a result, the past decade has witnessed a proliferation of ESG taxonomies. What are the underlying implications and what should Asian financial market participants (FMPs) expect for the future of ESG taxonomies?
- EU Taxonomy Regulation. Although taxonomies are not yet legislative in Asia, FMPs offering financial products abroad now must comply with rules in their target countries. A prime example is the recently passed legislative amendment that interlinked the existing EU Taxonomy to sustainable finance disclosure obligations. Under this new act, financial institutions must disclose how their ESG-themed funds align with the EU Taxonomy in order to market financial products in the EU. More economies are expected to follow suit.
- Common Ground Taxonomy (CGT). Within Asia, ESG disclosure has been at the top of the regulatory agenda. China is co-leading with the EU to develop a global ESG taxonomy standard- the CGT- which is expected to be released by late 2021. Asian regulatory authorities have already displayed deep interest in this framework, with Japan, Singapore, Hong Kong, and others co-participating in the CGT development. Regulatory authorities such as the Hong Kong Monetary Authority (HKMA) and Securities and Futures Commission (SFC) already stated their intent on adopting the CGT upon release. Asian institutional investors should be prepared to align their ESG initiatives to the CGT as this new taxonomy can be the precursor for future policy interventions, and early adoption can help facilitate cross-border green transactions.
- Double materiality. Financial institutions are increasingly asked by stakeholders to assess not only their financial exposure to sustainability risks (financial materiality), but also the negative impact of their investment on environmental and social factors (outward materiality). This concept is now widely recognized as “double materiality”. To this end, an ESG taxonomy helps bring clarity to what extent business activities negatively impact sustainability, strengthen comparability among firm disclosures, and will only accelerate the integration of double materiality into policy expectations.
- Transition Finance. Once the market established a mutual understanding of what constitutes “green”, the next step would be to address the “shades of green” – transition activities that do not yet qualify as “environmentally sustainable” but actively contribute to decarbonization. This is of particular interest to investors holding assets in high-emitting industries as it may be unrealistic to fully divest from carbon intensive industries as a whole. In that event, a transition taxonomy can help investors distinguish leaders and laggards in carbon intensive industries to invest, exclude, or engage.
In early 2021, Bank of China Hong Kong became the first financial institution in the world to issue a transition bond (US$780 million) by public offering. This is also the first transition bond from Asia that references the EU Taxonomy. Being backed by a well-recognized taxonomy elevated investors’ confidence in the credit strength, with the bond oversubscribed by 5.5x. Looking ahead, we expect market appetite for taxonomy-aligned transition products to continue to rise.
While it remains to be seen how the regulatory roadmap for a sustainable finance taxonomy will evolve in Asia, market forces are progressively reshaping investors’ ESG mindset and investment considerations. The numerous efforts made globally to contribute to ESG taxonomies is an encouraging sign for the future of sustainable investing.