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PRIMER: ASEAN Taxonomy for Sustainable Finance – Version 1

IFLR’s latest explainer looks at how the framework compares with other taxonomies and what implementation challenges it will present

With a goal to provide a framework for the public and private sectors to work together on the development of an ASEAN taxonomy, the ASEAN Taxonomy for Sustainable Finance – Version 1 is a collaborative initiative of the sectoral bodies that make up the ASEAN Taxonomy Board.

What is the taxonomy about?

Taking into account the diversity of ASEAN countries, the taxonomy has a principles-based Foundation Framework that provides a qualitative assessment activities and a Plus Standard with metrics and thresholds to further qualify and benchmark eligible green activities and investments.

Key components include four environmental objectives and two essential criteria for the assessment of economic activities that promote transition to low carbon practices, such as climate change mitigation and adaptation; a list of focus sectors that the Plus Standard will cover, such as agriculture, electricity and manufacturing; a sector-agnostic decision tree in classifying economic activities under the Foundation Framework; and the stacked approach that will be used to determine thresholds and technical screening criteria under the Plus Standard.

“The ASEAN taxonomy is key to establishing a common language for sustainable finance among the ASEAN member states, as a strategic policy focus of the ASEAN finance ministers and central banks,” said Vivien Teu, partner and head of ESG at Dentons Hong Kong. “It reflects the capacity and will for a regional coordinated effort towards sustainability among the 10 members states, although the stages of development, cultural fabric and economic structure can be quite different from one country to another.”

What does the ASEAN taxonomy aim to achieve?

The ASEAN taxonomy seeks to create an umbrella framework which will harmonise other frameworks within scope in the region.

“Ultimately, taxonomies are designed to aid the flow of capital towards sustainable investment opportunities and in particular, to scale climate finance, providing a level of confidence for investors that they are funding activities that will be significant in the transition to a low carbon economy,” said Helena Fung, head of sustainable investment, APAC at the London Stock Exchange. “Given the amount of private capital required to transition economies in Asia towards alignment with the objectives of the Paris Agreement, ensuring that private capital is mobilised towards meeting these goals in ASEAN will be critical.”

The ASEAN taxonomy is intended to assist in that process.

“Investors welcome taxonomies as they can avoid greenwashing and help fund managers refine and benchmark sustainability at a more granular level,” said Rebecca Mikula-Wright, CEO at Asia Investor Group on Climate Change. “But they have to be credible to be effective in building trust and confidence.”

“The ASEAN taxonomy is significant for the region and it has moved quickly in parallel with other market-based taxonomies,” she continued. “Investors need clear and consistent standards and the ASEAN taxonomy can boost confidence in financial products in ASEAN and enhance transparency through a common framework.”

Mandatory climate risk disclosure requirements have come through quickly across Asia so there is strong likelihood that the ASEAN taxonomy would become mandatory as well, added Mikula-Wright.

See also: EU, China produce first Common Ground Taxonomy  

How does the ASEAN taxonomy compare with other taxonomies?

Compared with the EU taxonomy, the ASEAN taxonomy has a number of differences and the biggest one is that it takes a multi-tiered approach in classifying activities whereas the EU taxonomy uses a binary approach.

“The definition of whether an activity is sustainable is singular as the EU taxonomy has defined one threshold per activity that is applicable across all EU member states,” said Kelvin Tan, head of sustainable finance and investments, ASEAN at HSBC.

In contrast, the ASEAN taxonomy has a Foundation Framework that classifies activities into green, amber and red depending on whether an activity contributes to climate change mitigation. It also includes a Plus Standard that uses a stacked approach to determine thresholds and technical screening criteria.

“This means that for each activity, there are multiple decarbonisation pathways and, therefore, there could be more than one threshold that can be referenced at a single point in time,” said Tan. “The main motivation for multiple thresholds is to cater to the different starting points of entities across ASEAN undertaking a particular activity.”

However, the EU has realised the limitations to its binary approach and has published a draft report on an extended taxonomy to support transition activities.

One issue is the potential inclusion of gas-fired power into the ASEAN taxonomy. “This has been a concern for Europe and Korea’s taxonomies and might be asked of ASEAN,” said Mikula-Wright. “There is a need to avoid confusion around energy as too much inclusion could hurt the taxonomy.”

The ASEAN Taxonomy working group has been clear in setting out that the ASEAN Taxonomy has been developed and catered for ASEAN at a localised and regional level. “This is to cater for real and practical differences between ASEAN member across multiple facets: national and institutional differences, differences across stages of development, and sophistication and make-up of markets,” said Jeremy Saw, director and general counsel at InfraCo Asia, a company of the Private Infrastructure Development Group (PIDG).

For example, Singapore is a heavily services dependent economy, whereas agriculture, manufacturing, heavy industry may be significantly relevant to Indonesia, Vietnam or Cambodia, for example. These differences affect the thinking behind sustainability pathways and outcomes across ASEAN.

The ASEAN taxonomy seeks to provide an overarching framework for existing regional approaches, including the Bank Negara principles-based taxonomy and the work being undertaken by the Green Finance Industry Taskforce (GFIT) coordinated by the Monetary Authority of Singapore. “Of these, the Singaporean taxonomy is most similar to the EU taxonomy in that it contains a level of granularity in technical specifications for eligible activities and references the UN sustainable development goals,” said Fung.

Tan added: “The Singapore taxonomy will possibly dovetail with the Plus Standard in the ASEAN taxonomy and use a science-based glide path approach, compatible to international standards, and address some of the challenges highlighted on the ASEAN taxonomy.”

What will be the biggest implementation challenges?

The ASEAN taxonomy is not legally binding and is intended to provide a framework for interoperability across markets which may already have their own approach or be developing one. “Both Singapore and Malaysia have been involved with the International Platform for Sustainable Finance which released the Common Ground Taxonomy,” said Fung. “As many of the users of the taxonomies will be international financial organisations, there still needs to be some consideration given as to how these documents will fit together.” 

In addition, while the sector agnostic decision tree in the ASEAN taxonomy provides a clear guideline for categorisation of use of proceeds and project finance, it needs to do more. “One of the biggest challenges for taxonomies generally will be applying definitions towards assessing what companies are doing on the ground and how existing reporting enables classifications to be mapped against revenue streams as well as capital expenditures and operating expenses,” said Fung. 

Compared to the current need to disclose only entity-level data, the ASEAN taxonomy will require companies to disclose activity-level data to assess and classify activities under the taxonomy.

“Efforts will be required from companies to understand and determine what data they need to disclose as well as put in place processes to collect and report on such data,” said Tan. “Data reported by the companies may not be verified by a third party, which could also pose questions around the data’s quality and reliability.”

While the multi-tiered approach of the ASEAN taxonomy provides flexibility, its structure is complex. “It may be difficult for users to track how a given activity is being assessed in different countries across ASEAN, as the same activity could be qualified under one threshold in one member state and a different one in another,” said Tan.

Investors need to keep up with the changes to the taxonomy, such as new sectors that may be added and thresholds for activities may be included or excluded or change over time. “For fund managers, meeting disclosure requirements and engaging with portfolio companies is complex so harmonisation is critical,” said Mikula-Wright.

As not all activities under the taxonomy would be aligned with a ‘net zero by 2050’ goal and pathway, this introduces uncertainties around its interoperability with other taxonomies. “Investors outside of ASEAN, in particular those in jurisdictions with more stringent taxonomies, such as the EU, would have to navigate and decide whether they could leverage the ASEAN taxonomy while considering local requirements they may have to meet,” said Tan.

See also: DEAL: Bank of China’s world first sustainability re-linked bond

What aspects could be improved?

There are a few key areas that subsequent versions of the taxonomy will need to address, according to sources. “Firstly, determining a list of activities which could potentially be classified automatically as green or red activities,” said Tan. “Secondly, as the current draft of the taxonomy only addresses one environmental objective (climate change mitigation), there is a need to integrate the remaining three environmental objectives.”

These are climate change adaptation, protection of healthy ecosystems and biodiversity, and promotion of resource resilience and transition to circular economy, into the overall classification framework.

“Thirdly, more work can be undertaken to elaborate on the sector-agnostic decision tree template under the Foundation Framework,” said Tan. “More targeted questions can be designed to cater to ‘buckets’ of sectors with similar attributes and allow for a more targeted assessment of activity classification. Finally, thresholds can be developed for the focus sections under the Plus Standard.”

According to Saw, adoption, acceptance and broad-based market participation is where implementation in the near term will be focused. “In the end, wider adoption will likely be driven by the engagement, prerogatives and expectations of likely capital providers, stewards of capital, investment research houses and shareholder or stakeholder activists,” he said. “This will drive demand and green capital flows to relevant markets, corporates and financial products, which is then expected to drive disclosure and standard-setting demand.”

“As expectations adjust and markets adapt, we may in future see developments in reporting and disclosure requirements similar to EU markets,” he continued. “And perhaps a ratcheting up of minimum expectations and standards.”

“What would be interesting at that stage is to observe whether individual ASEAN markets start introducing individual rules such as stock exchange disclosure requirements, or whether an ASEAN consensus is sought first,” he concluded. “Another thing to watch out for is how different taxonomies start to interplay and align with the adopted IFRS standards and future audit outcomes around ESG pathways, taxonomies and financial reporting.”

See also: Green Islamic finance faces critical challenges

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