An overview of green taxonomies and their role in shaping financial flows
“The adoption of common green taxonomies is vital for banks, financial institutions and corporates as they enhance transparency, facilitate investments in sustainable activities, mitigate environmental risks, foster innovation, and empower stakeholders in their technical financial decisions. Incorporating these frameworks aligns with global sustainability goals and positions institutions competitively within the evolving landscape of responsible finance.”
Globalfields has undertaken substantial work on green taxonomies in several countries, including Iraq, Mongolia and Rwanda. The insight below is based on our work.
Green taxonomies serve as a framework that categorises and defines economic activities based on their environmental sustainability and climate impacts, providing guidance for financial institutions in their investment and lending decisions. To deliver impact, taxonomies must be clear, transparent, based on common frameworks, simple in application, and relevant to the operations of the organisation.Where they comply with these requirements, they can deliver substantial and lasting changes, as set out below.
Stimulating capital flows
Green taxonomies stimulate the flow of capital toward sustainable projects by providing a definition of what constitutes "green" through adopted corporate strategies. While broad definitions can be provided, such as defining "green investment" as an investment that supports environmentally sustainable practices and projects in clean energy, sustainable agriculture, or waste management, aiming to generate both financial returns and environmental benefits, the specific ‘green determination’ should be integrated into a corporate strategy that addresses climate and sustainability.
These strategies determinations can be based on the EU taxonomy or other relevant regional taxonomies that outline both principles of interventions as well as the typology of sectors and activities. This clarity not only encourages investment in sustainable development but also enhances the credibility of the efforts among investors and stakeholders. For example, adherence to green banking principles can improve banks' financial performance by enhancing their credibility and reputation (Hossain & Karim, 2020).
Figure 1 below shows an example of this clarity from the MDB Climate Finance Tracking methodology, which has operated for 15 years.
Beyond tracking, green taxonomies can drive new, sustainable business development by aligning financial products with green taxonomies, and/or developing new green products.This enables institutions to innovate and issue new financial instruments, such as green and blue bonds, or use targeted blended finance to support investment vehicles for sustainable and green projects, which would otherwise be too expensive or risky to cover with own resources. Research indicates that the development of green financing strategies facilitates corporate green innovation, by compelling banks to adopt comprehensive measures supporting sustainable development, thus accelerating the transition towards green economies (Mehmood et al., 2023; Tanet al., 2024) as well strengthening the alignment with ESG reporting.
Managing Climate Risk
Financial institutions integrating environmental considerations into their operations are better positioned to evaluate the long-term viability of their investments against climate risks. The intersection of green finance and corporate governance leads to improved sustainability outcomes for firms, underscoring the need for clear guidelines in identifying and supporting sustainable business activities (Tolossa & Gota, 2023). On the transition side, implementing green taxonomies and investments helps mitigate the risk of losses from investments that may become stranded or face regulatory penalties in an increasingly sustainability-focused regulatory landscape. Regarding physical risks, these measures can enhance understanding of the exposure of assets and operations financed to climate change risks such as extreme weather events, drought, or flooding.
Enhanced reporting and choice
Green taxonomies also impact the internal reporting by the financial institutions that apply them. For example, green taxonomies enhance the consistency and comparability of financial disclosures related to sustainability, as well as impact-related disclosures. Without a standardised and easily applied taxonomy, financial institutions are likely to have difficulties assessing the environmental impact of their portfolios, leading to potential misalignments in risk management strategies. For instance, a green taxonomy helps financial service providers classify green activities, thus supporting efforts in environmental protection and climate change mitigation (Dariah et al., 2023). Clear guidelines enable practitioners to navigate the complex landscape of sustainable finance, ensuring that investment decisions are informed by reliable environmental criteria (Krastev & Krasteva-Hristova, 2024).
Figure 2 below provides the example of Georgia, where the central bank reports annually on the lending performance of Georgian banks against the green taxonomy criteria, and compares bank portfolios. This type of reporting is enabled by a transpaprent and consistent green taxonomy framework and related methodology, applied across all banks.
Figure 2: Total (Taxonomy-aligned and other green loans) Green Loans Outstanding by Georgian Banks (excluding exchange rate effect) 2024
Customer choice and public trust
This level of transparency can also be utilised by consumers interested in investing with banks that are performing better environmentally. Green taxonomies, therefore, can significantly impact the demand side, as they empower consumers and investors to make informed decisions by providing transparent frameworks to evaluate the environmental impacts of their financial choices. A well-defined taxonomy can enhance public trust and increase willingness to engage with green products, reinforcing the strategic role of banks in promoting sustainable practices. Transparency stemming from green banking disclosures can drive positive changes in consumer behaviour towards more sustainable choices (Ahmar et al., 2024; Stojanović, 2020).
Globalfields' work in developing green taxonomies and sustainability reporting
At Globalfields, we have led several assignments on the determination of green projects. These included:
- The development of the Paris Alignment assessment systems for two Multilateral Development Banks (MDBs), followed by
- Assessments to screen MDB projects’ Paris alignment
- The development of green taxonomies, applied in a variety of contexts, including in:
o The public sector (to facilitate the uptake of green principles and criteria for tracking at the ministerial level and through national banks), and
o The private sector (enabling financial institutions and their clients in the real economy to understand what is green).
- Work on aligning projects to green taxonomies applied by development partners, to ensure that the use of proceeds by the recipient is compliant with the requirement of the project financiers.
Recent assignments include:
- Team-leading the climate change work under the Iraq TechnicalAssistance Facility to support policy dialogue with the Iraqi government, commissioned by the European Union Delegation in Baghdad. This has included 3 green project proposals:
o Green budgeting and green revenue raising
o Green taxonomy support
o Monitoring and reporting.
- Green finance specialist support for the Rwandan DevelopmentBank, commissioned by Agence Française de Développement, to boost the bank’s capacity to build a green pipeline and support the green determination of projects, including the building of a system of monitoring and evaluation for their work, training events and material.
- Green finance specialist support to the development of IREME Invest (Rwanda), commissioned by FCDO. This assignment resulted in the development and then adoption of a system of green taxonomy at the corporate level for the Green Fund (FONERWA) and the Rwandan Development Bank, including methodologies and operations manual for their implementation.
- Supporting the work of the ADB in Mongolia to design and implement a system for Climate Finance Tracking and Monitoring, based (but going further than) the existing Mongolian green taxonomy.
For more information, contact Marta Simonetti
Further reading
Ahmar, N., Rahmah, L., & Darminto, D. (2024).Green banking disclosure from the perspective of corporate governance, financial slack and human resource slack in Indonesia. Banks and Bank Systems,19(2), 101-114. https://doi.org/10.21511/bbs.19(2).2024.08
Dariah, A., Rani, A., & Srisusilawati, P.(2023). Green taxonomy for sustainable production across countries. Kne SocialSciences. https://doi.org/10.18502/kss.v8i18.14257
Hossain, M. and Karim, M. (2020). The effects of green banking practices on financial performance of listed banking companies in Bangladesh. Canadian Journal of Business and Information Studies, 120-128. https://doi.org/10.34104/cjbis.020.01200128
Kirby, D., MacMahon, C., & Thompson, S. (2024).The co-evolution of sustainable finance stakeholders under the eu taxonomy for sustainable activities: an exploratory study of irish disclosure experiences.Sustainability Accounting Management and Policy Journal, 15(6), 1257-1285. https://doi.org/10.1108/sampj-11-2023-0842
Krastev, B. and Krasteva-Hristova, R. (2024).Challenges and trends in green finance in the context of sustainable development—a bibliometric analysis. Journal of Risk and Financial Management,17(7), 301. https://doi.org/10.3390/jrfm17070301
Mehmood, S., Abdi, F., & Raza, A. (2023). Green finance green technology innovation and financial development and their role insdg. Journal of Accounting and Finance in Emerging Economies, 9(3), 421-436. https://doi.org/10.26710/jafee.v9i3.2799
Stojanović, D. (2020). Sustainable economic development through green innovative banking and financing. Economics ofSustainable Development, 4(2), 35-44. https://doi.org/10.5937/esd2001035s
Tan, W., Yan, E., & Yip, W. (2024). Go green:how does green credit policy promote corporate green transformation in china.Journal of International Financial Management and Accounting, 36(1), 38-67. https://doi.org/10.1111/jifm.12218
Tolossa, D. and Gota, G. (2023). Green finance impact on sustainable development: insights from diverse perspectives a systematic literature review. Epra International Journal of Economics Business and Management Studies, 78-84. https://doi.org/10.36713/epra14458
Main cover picture credits: Levi Meir Clancy, unsplash.com
