EU-China Common Ground Taxonomy, a painkiller to taxonomy headaches?

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10-minute read

 

On November 4, 2021, the International Platform on Sustainable Finance (IPSF)[1] taxonomy working group unveiled the “EU-China Common Ground Taxonomy - Climate Change Mitigation (CGT)”. This in-depth comparison identifies commonalities and differences between the EU and China’s taxonomies[2] and is expected to improve the comparability and interoperability of global sustainable finance standards.

The first phase publication includes three deliverables: (i) an instruction report explaining the contexts and methodologies, (ii) an activities’ table with descriptions and criteria, and (iii) a document calling for feedback. The release of the Common Ground Taxonomy marks a milestone of international cooperation on sustainable finance and will be instrumental in worldwide taxonomies harmonization and standardization.

 

Common Ground Taxonomy in response to complexity mitigation

There is a growing number of sustainable finance taxonomies across jurisdictions and their discrepancies in use-cases, sectoral coverage and eligible criteria have brought confusion and fragmentation in the market (please read our flagship report on New Geography of Taxonomies; the report has been updated on November 15th  to incorporate elements on CGT and the replay of our Nov 18th dedicated Webinar is available here). To cope with this risk of fragmentation, two of the most active players in sustainable finance, namely EU and China, initiated a dedicated taxonomy working group within the IPSF in July 2020. The working group undertook a technical comparison of the taxonomies from the two jurisdictions, the research output forming the EU-China Common Ground Taxonomy. This joint international effort to improve taxonomy’s comparability and interoperability are much needed in a jumble of classification systems. It has fueled up expectations from various actors on more harmonized taxonomies and mobilization of greater cross-border sustainable capital flows. To this end, special stated objectives are shaped for this Common Ground Taxonomy.

Instead of proposing a ‘single’ or ‘common’ taxonomy, the primary purposes of the CGT are to put forward commonalities from the EU and China’s taxonomies and provide generic methodologies for benchmarking taxonomies. As emphasized by the working group, the CGT has no legal implications and does not intend to be formally or legally endorsed by any jurisdictions. It is rather a source of inspirations and provides analytical toolkits for other jurisdictions when developing their own taxonomies. On top of these objectives, the potential users will be more extensive compared to other taxonomies.

In addition to providing tools for national governments or regional bodies to develop their own taxonomy, the primary users of CGT will mostly be market participants, such as Chinese and European Green bond issuers and verifiers:

  • Chinese companies can voluntarily reference to CGT in their offshore green bond issuances, while western companies can do the same when issuing green panda bonds in mainland China.
  • Besides, various entities, including financial institutions and corporates can take it to assess their business alignment with low carbon economy objectives and underpin business model transition.

 

Methodologies to benchmark the EU and China’s taxonomies

Environmental Objectives

The EU taxonomy establishes six environmental objectives[3] , whereas China taxonomy reflects three objectives[4]. Although the environmental objectives of EU and China taxonomies are not substantially different and can be broadly matched, it varies at more granular level. Economic activities covered in China taxonomy echo its three environmental goals but are not mapped in the same manner with EU taxonomy to corresponding objectives. Thus, the working group limits the initial scope of analysis to climate change mitigation, where the 2 taxonomies share more similar features. 

 

Chart 1 Scope of comparison

Source: IPSF, Instruction Report on Common Ground Taxonomy – Climate Change Mitigation, November 2021

 

Within the defined scope, the working group has developed methodologies for macro-sector classification and scenario analysis approach to ascribe technical screening criteria.

Categories of economic activity

The CGT’s sector classification system is based on the International Standard Industrial Classification of All Economic Activities (ISIC)[5] as for the EU and China taxonomies. With priority sectors selected based on GHG emission levels and mitigation potentials, the CGT Activities’ Table eventually comprises 7 macro-sectors and 55 economic activities[6].  Only the sectors included in both the EU and China taxonomies are covered by the CGT, i.e. ICT from EU taxonomy and green services from China’s taxonomy are not included at this stage.

The seven macro-sectors covered in the CGT are:

  • Agriculture, forestry and fishing
  • Manufacturing
  • Electricity, gas, steam and air conditioning supply
  • Water supply; sewage, waste management and remediation activities
  • Construction
  • Transportation and storage
  • Others (underground permanent geological storage of CO2 and hydrogen storage)

Scenario analysis approach

The working group does not propose to develop the same descriptions and criteria. Hence, the below illustrated (table 1) scenario analysis was designed to conclude the detailed descriptions and technical screening criteria of each activity. The six scenario’s designations present the results of the comparison on which area of activities and criteria are overlapped, more stringent, or of obvious divergence. To note, scenario five and six are excluded from the study for now. This methodology developed in the CGT is the core underpinning and is consistent with the stated goals of CGT.

 Table 1 Scenario analysis

Source: IPSF, Instruction Report on Common Ground Taxonomy – Climate Change Mitigation, November 2021

[1] IPSF is a multilateral forum that aims to enable exchange of practices and increase international cooperation on sustainable finance related matters. Members of the IPSF represents 55% of global GHG emissions and 55% of global GDP.

[2] To avoid confusion, China’s taxonomy here refers to China Green Bond Endorsed Projects Catalogue (2021 Edition), released in April 2021. English version available here.

[3] Six environmental objectives of EU taxonomy include: climate change mitigation, climate change adaptation, the sustainable use and protection of water and marine resources, the transition to a circular economy, pollution prevention and control, and the protection and restoration of biodiversity and ecosystems.

[4] Three environmental objectives of China taxonomy include: climate change response, environmental improvement (pollution control and ecological conservation), and more efficient resource utilization (circular economy, waste recycling and pollution prevention)

[5] The regional taxonomy in ASEAN applies the same sectors mapping methodology. ABT, ASEAN Taxonomy for Sustainable Finance Version 1, November 2021. Available here.

[6] Although the instruction report states that 61 economic activities are included, only 55 activities are actually in the CGT Activities’ Table.

Outstand shortcomings in usability

The methodology developed in this comparison study is very valuable. However, we find the Common Ground Taxonomy Table (the activities’ table) is not user-friendly enough for the moment.

  • The CGT does not provide explanations and rationale behind each scenario chosen. Readers must “blindly trust” the text which does not disclosure any underlying information and specific criteria leading to pick a scenario rather than another. The absence of justifications undermines the interoperability.
  • Apart from this, when in a so-called identifiable overlap situation (scenario #4), such overlap in terms of activity perimeter and overlap regarding criteria are not distinguished; in the cases of scenarios two and three, stringency and granularity are often mixed up.

Thereby, we propose several suggestions to improve the usability and avoid new “taxonomy headaches”:

  • Adjust the layout of the table
  • State the sources of description and substantial contribution criteria
  • Provide scenario selection reasoning
  • Distinguish whether stringency/overlap is in terms of the scope/granularity of activities or regarding the technical screening criteria

As an illustration, we provide two examples with our comments and mark-ups to exhibit our expectations on the display of CGT activities’ table.

Suggested layout

Example I: Scenario 2 (EU criteria are more stringent and/or detailed)

Example II: Scenario 3 (China criteria are more stringent and/or detailed)

Future steps and implication

Despite limited usability, this first international attempt to mitigate the fragmentation of taxonomies is quite welcome. The substance and methodology presented in the CGT provide valuable tools to facilitate the future comparability and interoperability of taxonomies worldwide.

For example, the Hong Kong Monetary Authority (HKMA)[7] intends to take the CGT as reference to design its tailored sustainable finance taxonomy according to its own economic structure. By referring to the Common Ground Taxonomy, HKMA is expecting to participate more actively in the international green financial flows and become a regional green finance center. Besides, as stated in the press release from China’s central bank[8], the CGT is expected to mobilize cross-border climate financing by reducing the green certification costs. However, we believe the pre-issuance green certifications such as Second-Party Opinion (SPO) provided by independent third parties will still be vital in short-term and a must required by the investors. The CGT may bring the anticipated influence in long term after becoming more credible, usable and widely recognized by investors.

Regarding the next steps, the working group has already created a to-do list:

  • Additional sectors: The current CGT only covers the sectors that significantly contribute to the GHG emissions to both jurisdictions. Other enabling sectors such as ICT and services will be considered for future iteration of work.
  • Additional environmental objectives: The working group will put forward additional environmental objectives, map and assess corresponding criteria in the two taxonomies.
  • Transition considerations: The working group will work to evolve more transition considerations and activities, to enable the transition of high emissions activities.
  • New areas of alignment in existing activities where mapping alignment was challenging, and more research work needed to understand possible commonalities. The working group assessed 80 activities in total. 19 of them are still pending for further analysis.
  • Other eligible features: features such as DNSH and minimum safeguards would be considered in the future stage to strengthen the comparability and interoperability.
  • Other jurisdictions: Other finalized taxonomies could be added to the breadth of the comparison.

The CGT taxonomy is currently in public consultation until 4 January 2022. We anticipate the working group to enhance the comparability and interoperability of sustainable finance taxonomies globally through the improvements of clarity and usability. Natixis Green & Sustainable Hub will soon organize a dedicated webinar on this EU-China Common Ground Taxonomy. Stay tuned on our website and subscribe to our newsletter.

 


[7] China Green Finance Committee, Press release, November 2021. Available here.

[8] PBoC, Press release, November 2021. Available here.


To Go Further

  • Our Flagship report: EU Taxonomy for Sustainable Activities – Skydiving kit – Available here
  • Our past newsletter article: A Greener Green Bond Catalogue: The incoming China’s unified Taxonomy notches new win – Available here