This consideration of green taxonomies draws on a roundtable held by the Centre for Climate Engagement in partnership with Clyde & Co, the first in a series of three discussions on legal aspects of sustainable finance. The event brought together academics and legal practitioners to discuss challenges and opportunities presented by green taxonomies, the direction of travel for these mechanisms, and how they might impact the way that businesses and investors operate.
Taxonomy – the science of classification – has become an important part of efforts to drive sustainable business and investment. Identified as a key framework item in the G20 Sustainable Finance Roadmap[1] and most prominently implemented as part of the European Green Deal, a green taxonomy is a classification system that defines which economic activities and assets are ‘green’ or sustainable. By creating clarity around these terms, green taxonomies aim to channel investment into activities which meet their criteria and set clear standards for environmental labelling in financial products. However, achieving these aims is not so simple. External factors such as technological development and litigation can create uncertainty within taxonomies, potentially impeding the clarity they aim to provide to investors. The global proliferation of green taxonomies has created separate challenges – significant divergence between different taxonomies may lead to further uncertainty. Mitigating these risks through careful policy design will be a priority for regulators, including those developing the UK’s green taxonomy.
Green Taxonomies: A global overview
The EU’s Taxonomy for Sustainable Activities is perhaps the best known, but in recent years the number of green taxonomies around the world has multiplied. Research by Natixis identified seventeen existing green taxonomies as of July 2023,[2] which grew to nineteen with the launch of taxonomies in Singapore and Rwanda at COP28. In total, taxonomies are either under development or operational in over thirty jurisdictions, covering every continent and economies of all sizes. While these taxonomies broadly share the same underlying goal, they differ in certain ways including:
- Different taxonomies use different methods to classify activities, including taking a white-list based approach where specific eligible activities are identified, relying on technical screening, or using guiding qualitative principles.
- Some taxonomies use a binary classification system (simply separating ‘green’ from ‘non-green’ activities), whereas others have additional categories (e.g. a ‘traffic light’ system).
- Some taxonomies require compliance and create binding legal rules, but voluntary taxonomies remain more common.
- Taxonomies have different sectoral scopes – for example, taxonomies will almost invariably make determinations regarding different types of energy generation, but some are silent about sectors such as aviation and shipping.
These differences between taxonomies can lead to activities being classified as green in one jurisdiction, but not in another. Even in taxonomies which are structurally similar, there may be differences between specific determinations about whether an activity should be considered green. The key cause for concern is whether this variation will make it difficult for global companies and investors to align their business with clearly defined social and environmental goals. These divergences may also increase compliance costs for businesses, adding to some businesses’ existing concerns about regulatory burdens. Opinions about the scale of this problem differ – some believe that focussing on convergence and interoperability between international taxonomies is critical to preventing market fragmentation and preserving cross-border flows of green capital,[3] while others argue that emphasis on global harmonisation and consistency gives more advanced economies justification to drive down standards and key performance indicators in order ‘to accommodate everyone’.[4] In some cases, the best step to avoid uncertainty and reduce compliance burdens may be to align with the most stringent taxonomy wherever possible.
There have been efforts to harmonise approaches to green taxonomies. The IPSF has developed a Common Ground Taxonomy (CGT) initiative, which looks to foster international comparability and interoperability of taxonomies.[5] The CGT is a co-development effort between Chinese and European taxonomy experts which analyses 80 economic activities across six sectors. While reflective of industry and regulatory interest in interoperability, the future outcomes of this initiative are unclear, and it is yet to move beyond the Chinese and the European contexts. As such, there remains ‘no universally accepted principles-based framework in place that would automatically grant equivalence’[6] for companies reporting under multiple taxonomies and a corresponding framework. Of course, regulators are now conscious of the potential drawbacks related to divergence, and may aim to create some level of alignment. This is clear from the Green Technical Advisory Group’s (GTAG) guidance to the UK government, which is discussed later in this briefing. However, it is important that policymakers designing taxonomies also have the chance to learn from issues with existing green taxonomies and tailor their mechanisms to national contexts – both of which may lead to some level of divergence.
Defining ‘green’
Given that the feasibility and impacts of emerging sustainable technologies may be difficult to predict, there is inherent uncertainty surrounding many activities that may be classified under green taxonomies. For example, hydrogen may play a significant role in the green transition if industry can shift to lower-carbon methods of production, but there is disagreement about the feasibility and scalability of different solutions. Whether certain incumbent technologies such as nuclear energy should be classed as green is also subject to debate. Conceptions of these terms (in particular with regards to ‘transition’ activities such as using energy from natural gas) are also dependent on the context of the given country or jurisdiction, including factors such as economic development, political leadership, and the prevalence of hard-to-abate industries.
Recognising these nuances and debates in a taxonomy can be difficult. Beyond measures such as the EU’s classification of ‘transition’ or ‘enabling’ activities,[7] the majority of existing green taxonomies do not explore classification outside of the binary ‘green’ or ‘non-green’. Having a small number of simple categories may be important to ensuring taxonomies fulfil their key goal of providing clarity but also means that certain determinations may face opposition. These complexities may also create investment uncertainty – a ‘green’ technology of today may turn out to be ‘non-green’ a year, five years, or a decade from now. Binary thinking is not necessarily well-suited to largescale, long-term investment decisions. Backlash against certain inclusions, alongside increasing awareness and scrutiny of ‘greenwashing’, could also go as far as deterring firms from developing products aligned with a voluntary green taxonomy, which could impact negatively on investor perception of the efficacy of these instruments.[8]
A small number of taxonomies utilise a traffic light system, which typically categorises sustainability activities as follows: green for those that offer a substantial contribution to environmental objectives, amber for those that can assist in transitioning to more clearly sustainable activities, and red for those that are unsustainable and present significant harm to environmental objectives. The Singapore-Asia Taxonomy for Sustainable Finance includes a traffic light system, in which activities are scaled according to their level of contribution to climate change mitigation. Launched by the Monetary Authority of Singapore (MAS), it claims to be the ‘first taxonomy globally that sets out credible definitions for transition activities’.[9] MAS also states that the Singapore-Asia Taxonomy will be reviewed ‘periodically to keep pace with emerging science and technology improvements’, which may help address the risks associated with adhering to taxonomy rules within time-sensitive investment windows. Considering that ‘few Taxonomies include continuous review and development models’,[10] there is opportunity to explore how flexibility can be better integrated in the taxonomy development and implementation process, which may help maintain investment in taxonomy-aligned activities over time.
It is important to note that green taxonomies may have limitations even if they avoid these potential implementation issues. At this early stage in the development of taxonomies, their impact on the behaviour of firms and investors is still relatively unclear. Legislators and regulators should therefore continue to implement rules that can more directly influence investor and firm behaviour, found in various types of legislation including reporting rules, due diligence requirements, and carbon pricing mechanisms. There are diverse views about the extent to which information-based regulation can or should govern the transition to net zero, but it is likely that green taxonomies will have limited impact if not aligned with other pieces of climate regulation. Well-designed taxonomies may provide clarity and consistency to other pieces of legislation, whereas inconsistencies in the legislative landscape could further add to the uncertainty explored above.
Litigation risks
Climate litigation is increasingly common globally, and taxonomies themselves have been subject to legal challenges, primarily in the EU. As mentioned above, perceptions of the term ‘green’ can vary which has led to litigation related to the classification of certain activities. In 2023, ClientEarth and three other environmental organisations filed a claim in the Court of Justice of the European Union targeting the EU Commission’s inclusion of natural gas in the EU’s Taxonomy for Sustainable Activities.[11] The organisations argue that the inclusion of natural gas is unlawful under the EU Taxonomy Regulation, which requires technology classifications to be science-based, given the EU’s scientific advisors recommended against this inclusion.[12] This aligns with a lawsuit filed by eight European Greenpeace organisations over the European Commission’s inclusion of both natural gas and nuclear energy.[13] Additionally, five NGOs have launched a legal challenge against the European Commission’s changes to its taxonomy criteria for aviation and shipping. The NGOs are concerned that incorporating fossil fuel-based activities as ‘transition activities’ jeopardises the urgent action needed to decarbonise these emissions-heavy sectors and argue that current determinations lack clear scientific backing.[14]
Regardless of the outcome of these cases, they indicate the challenge with green taxonomies’ classification of complex and controversial activities. As more jurisdictions implement green taxonomies, litigation on similar grounds may become widespread. This not only presents a challenge to regulators implementing green taxonomies, but also to businesses and investors. Successful litigation could mean that certain ‘green’ activities would lose their status, making it harder for investors to ensure long-term taxonomy-aligned investment. Even when remote, these litigation risks add to the uncertainty surrounding green taxonomies.
Considerations for the UK’s Green Taxonomy
As explored above, green taxonomies can bring clarity to sustainable investment but there are risks and uncertainties with their implementation. Regulators are of course aware of these issues, evidenced by international collaborations that aim to harmonise taxonomy requirements. If the ‘Brussels Effect’[15] manifests in this area, the EU’s Taxonomy for Sustainable Activities may become the de facto model for taxonomies globally. This phenomenon has occurred to some extent in other areas of climate policy, as EU climate reporting requirements and ETS design have been influential in the development of similar mechanisms elsewhere. However, different national contexts make it likely that there will be some level of divergence as taxonomies continue to emerge worldwide. These considerations have become evident in the UK’s development of its own green taxonomy.
The GTAG, established by the Green Finance Institute, has provided non-binding advice to HM Treasury on the development and implementation of a green taxonomy, including on issues related to interoperability and alignment.[16] Since introducing the idea, the UK government has suggested that its version will be largely based on the EU Taxonomy,[17] with a clear imperative for alignment given the strong trade links between the two jurisdictions, and broad similarities in climate policies and ambitions. GTAG has suggested that the UK largely adopt the EU’s technical screening criteria, but also identified areas for revision.[18] These include criteria which would need to be revised to align with the UK’s Net Zero Strategy, and those which cover sectors that lack a similar legislative framework in the UK. For example, GTAG argues that EU taxonomy rules on renovating existing buildings should be revised to suit the UK’s EPC rating system and chemicals regulations. GTAG has also recommended that the UK’s taxonomy addresses activities not currently covered by the EU’s taxonomy, highlighting agriculture and fisheries as key sectors. Divergence may therefore also be an opportunity for the UK to showcase its green ambition and drive the market forward via stricter green definitions and investment criteria. As the UK has been able to observe the ‘teething problems that have been experienced in the EU’,[19] the government may also take heed of taxonomy-related challenges in the EU to potentially engineer a more seamless introduction of the green taxonomy.
While GTAG has suggested a principled and evidence-based approach to taxonomy alignment and potential revisions, it remains to be seen how HM Treasury will implement these recommendations in practice. It is important to note that the UK is approaching a general election, and the potential change in government may impact the development and substance of the green taxonomy. As part of its current technical advice, GTAG proposes a grandfathering clause to maintain a level of market certainty in how emerging technologies and practices can remain taxonomy-aligned over time,[20] which may be particularly beneficial to ensuring both political and market buy-in to taxonomy delivery as the UK’s circumstances continue to change.
Conclusion
The risks outlined above do not suggest abandoning the theory of change behind green taxonomies, which have the potential to bring much-needed clarity to green investment decisions. However, policymakers must avoid numerous pitfalls when developing taxonomies and cannot create such instruments in a vacuum given the rapidly developing global landscape. Flexible science-based taxonomies which take account of other international standards are likely to avoid some of these challenges, but it may be difficult to fully eliminate uncertainty in this area. Investors and businesses must therefore remain vigilant to potential risks arising from changes within taxonomies or divergences between taxonomies. Green taxonomies alone are unlikely to create the large-scale change required to create a sustainable financial system, so governments must also continue to implement additional climate policies to shift the market towards sustainable practices.
Green taxonomies combat greenwashing by setting clear criteria for sustainable terminology, but other mechanisms can address misleading environmental claims in lieu of, or in addition to, taxonomies. In continuation of this series with Clyde & Co, the Centre for Climate Engagement will next explore the legal implications of greenwashing in the financial sector.
With thanks to our roundtable attendees for their valuable contributions: Nigel Brook, Jasmin Fraser, Catherine Higham, Sarah Hill-Smith, Richard Power, Nick Scott, Thomas So, Sofie Surraco and Harro van Asselt.
[1] ‘G20 Sustainable Finance Roadmap’, G20 Italian Presidency (2022). Link.
[2] ‘The New Geography of Taxonomies’, Natixis (2023). Link.
[3] ‘Taxonomies – why the world needs harmonisation but not uniformity’, Jochem Spaans and Danae Wheeler, Allen and Overy (2024). Link.
[4] ‘Who cares if the UK and EU’s green taxonomies diverge?’ in Capital Monitor, Elizabeth Meager (2021). Link.
[5] ‘Common Ground Taxonomy – Climate Change Mitigation’, IPSF Taxonomy Working Group (2021). Link.
[6] ‘The importance of global cooperation on green taxonomies’ in Bloomberg Professional Services, Nadia Humphreys (2023). Link.
[7] ‘EU strives to clarify ‘transition activities’ on path to zero-carbon goal’ in Euractiv, Frédéric Simon (2019). Link.
[8] ‘UK Green Taxonomy – GTAG provides further technical advice to the UK government’, Freshfields Bruckhaus Deringer (2023). Link.
[9] ‘MAS Launches World’s First Multi-Sector Transition Taxonomy’, Monetary Authority of Singapore (2023). Link.
[10] ‘The New Geography of Taxonomies’, Natixis (2023). Link.
[11] ClientEarth v Commission T-579/22 (2022). Link to summary.
[12] ‘Environmental groups take EU to court over ‘green’ gas label (2022). Link.
[13] Greenpeace and Others v Commission T-214/23 (2023). Link to summary.
[14] ‘Legal challenge to review EU Commission’s green investment rules on aviation and shipping’, Opportunity Green (2024). Link.
[15] The Brussels Effect: How the European Union Rules the World, Anu Bradford (2020).
[16] ‘UK Green Taxonomy – GTAG’, Green Finance Institute. Link.
[17] ‘ESG – UK sets out its roadmap on sustainable finance’, Simmons and Simmons (2021). Link.
[18] ‘GTAG: Advice on the development of a UK green taxonomy’, Green Technical Advisory Group, Green Finance Institute (2022). Link.
[19] ‘Taxonomy delay has enabled UK to understand ‘teething problems’’ in FT Advisor, Chloe Cheung (2023). Link.
[20] ‘Treatment of green financial products under an evolving UK Green Taxonomy’, Green Technical Advisory Group, Green Finance Institute (2023). Link.
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