Norway’s sustainable taxonomy: the tool investors have been missing?
The country’s policy reform is a reminder of why definitions matter in sustainable finance and why it is crucial to know what constitutes ‘green’ capital.
To welcome the year ahead, Norway’s cabinet signed into force its Sustainable Finance Act. At the heart of the regulation is an attempt to define the term “sustainable economic activity”, a taxonomy as it is formally known. According to Norwegian authorities, the taxonomy serves two goals: it helps “channel capital to sustainable projects and solutions”; and, arguably, it constrains the possibility of greenwashing. Both goals involve and affect players in the financial markets.
Norway’s Ministry of Finance says the taxonomy is “the tool investors and companies have been missing until now”. It gives investors a way to assess whether a “green” financial product, a green bond for instance, is aligned with Europe’s long-term emissions-reduction plans.
It does so by outlining six goals: emissions reduction; adaptation; marine resource preservation; circular economy transition; pollution control; and biodiversity protection. For an activity to be classified as sustainable, the act dictates, “it must contribute significantly to the achievement of at least one of the goals, and not have a significant negative impact on the other goals”.
Apart from the significance of a country that historically made fortunes in the petroleum industry putting effort into a green taxonomy, the Norwegian policy reform is a reminder of why definitions matter in sustainable finance. When it comes to green capital, it is important to know what it is and, more importantly, what it is not.
For all the work that has already gone into taxonomies, a lot remains to be done. Two challenges in particular stand out:
When it comes to green capital, it is important to know what it is and, more importantly, what it is not.
1. Insulated Design
By its very nature, a taxonomy has distributive consequences in that it produces winners and losers. This makes constructing a taxonomy divisive and difficult to insulate from interest groups. The EU’s taxonomy is a prime example of this reality.
In February 2022, the European Commission approved the inclusion of gas and nuclear projects in the EU taxonomy – a move that received criticism from investors and activists alike. The Institutional Investors Group on Climate Change (IIGCC) wrote a letter to the Commission warning against the inclusion of gas. Stephanie Pfeifer, CEO of IIGCC, pointed out: “While there is a place for gas as a short-term bridge as part of a period of transition, it cannot honestly be classified as green. For institutional investors, the inclusion of gas will limit their ability to align their portfolios and investment with net zero”.
Reclaim Finance, a French think-tank, blamed interest group lobbying for the final design. Their research found that between January 2020 and May 2021, gas industry lobbyists scheduled one meeting every two days with EU officials and spent over €78m to drive their point across. Over the same period, nuclear industry lobbyists scheduled 27 meetings with a similar agenda. It seems therefore that the EU taxonomy was not wholly an outcome of independent scientific analysis.
Definitions have been subject to heated debates and divisive politics the world over. At one point, the Chinese taxonomy allowed green bonds to fund “clean coal”, a decision that the regulators were pushed into reconsidering.
2. Common Language
In addition, given the “tragedy of the commons” nature of climate change, coordinating the global rules of the game is a key challenge. When it comes to taxonomies, one concern is that everyone could end up with their own.
The rapidly expanding global green bond market knows this to be true. Research by the Climate Bonds Initiative found that “separate taxonomies can lead to market fragmentation. Thus, harmonising eligible assets and metrics across jurisdictions is an essential step in taxonomy development and will help to facilitate international green capital at scale”.
The value of finding common ground was the driving force behind the “Common Ground Taxonomy” (CGT). The CGT, a multi-jurisdiction taxonomy experiment, was co-designed by the EU and China and presented at COP26 in 2021. The CGT has two methods of finding common ground: first, criteria present in both jurisdictions is adopted; second, if there is variation in criteria, the CGT adopts the more stringent version.
According to Institutional Shareholder Services, a proxy voting advisor, the CGT is hugely beneficial to the global green bond market. “Without the CGT, investors from both Europe and China would be wary of investing in green finance products from the other jurisdiction. CGT therefore reduces segregation between the markets and brings investors and issuers closer together. As such, it is expected to be popular with issuers in both jurisdictions that hope to attract investors from the other jurisdiction.”
Will the spotlight refocus?
As Norway’s taxonomy enters the country’s financial veins, it is an opportune moment to recall the value of definitions. In 2022, greenwashing concerns took centre stage. It would be logical to expect taxonomies to recapture the spotlight in 2023. Defining the term “green” could emerge as the most critical raison d'etre of sustainable finance regulation.
Atharva Deshmukh is Net Zero Investor’s head of research.
