Why businesses need a UK green taxonomy

The EU has a green taxonomy. So does Japan, Canada, China, and Singapore. In fact, it is estimated that there are over 30 taxonomies – common frameworks for classifying which economic activities can be defined as environmentally sustainable – in development or implementation across the globe. As other jurisdictions press ahead, it is important that the UK isn’t left behind.

The good news is that the UK Government has committed to delivering a green taxonomy, first in 2020 and again in the 2023 Green Finance Strategy. Thanks to the work of the Green Technical Advisory Group (GTAG), an independent group set up by the Treasury in 2021, the groundwork has already been laid with robust advice on the effective design and implementation of a UK Green Taxonomy. Over two years, GTAG produced a suite of nine published papers exploring various design and implementation issues including managing data gaps, implementing an effective reporting regime, and creating an institutional home.

Businesses are clear, the UK must now press ahead with implementing its own taxonomy. Since first announcing its intentions to introduce one, the UK Government has favoured a ‘wait and see approach’ to observe what has worked well and what has not worked well elsewhere – missing a legal deadline to put the climate element of the taxonomy into law by the 1 January 2023. Whilst this approach will help the UK to sidestep the pitfalls that other jurisdictions have fallen into, a growing sense of uncertainty around timelines risks undermining the confidence of companies and investors.

There is strong private sector demand for taxonomies

The concept of green taxonomies is not novel. As far back as 2008, FTSE launched the Environmental Markets Classification Systems to help investors identify companies with products and services that deliver solutions to environmental challenges and track their performance through the FTSE Environmental Markets Index Series.

At their core, green taxonomies exist to solve a transparency problem: the extent to which a business or investor is or isn’t investing in assets or solutions that will genuinely help deliver climate targets over time.

Green taxonomies, therefore, serve two primary purposes. First, they promote market integrity, consumer protection, and avoid greenwashing. This is key, as a 2023 poll found that the fear of greenwashing is the most significant barrier preventing investment firms from integrating sustainability into their investing strategy. Second, taxonomies can help mobilise capital towards the green economy by supporting investors to identify and value green assets. By reporting alignment of capital expenditure, operational expenditure, and revenues, companies can provide investors with decision-useful, consistent, and comparable information in the market – helping investors to integrate climate and nature into their capital allocation decisions.

Since the UK first announced plans to introduce a green taxonomy, an additional 21 taxonomies have been announced or come into force globally. With scores  now in development or implementation, including the world’s biggest single market, lack of progress on the UK green taxonomy leaves a gap which could impact the UK’s competitiveness and ability to attract investment. UK companies with sustainability-linked financing facilities, for example, may struggle to draw on them without a taxonomy.

A UK green taxonomy must be internationally operable, practical, and science-based

To ensure that the UK Green Taxonomy is as effective as possible, and minimises regulatory burdens on companies, it must be internationally operable, practical, and science-based.

Interoperability is essential for the UK’s global competitiveness. Financial markets are global in nature and businesses operate across borders. Ensuring a degree of harmonisation between taxonomies will avoid creating confusion for investors and will help manage compliance costs for companies with multiple reporting requirements. Aligning closely with the EU’s green taxonomy is key, given that two-thirds of country-led taxonomies in place or under development use the EU as a benchmark. The EU is also the largest investor into the UK and the largest market for UK investors.

The UK is well-placed to leverage its ‘second-mover advantage’ by observing the teething problems in other jurisdictions and balancing trade-offs. For example, the EU’s do no significant harm (DNSH) criteria has raised usability concerns due to its ambiguity. The UK could improve the usability of DNSH reporting in the UK by streamlining and revising the EU DNSH criteria for the UK context. Similarly, the UK could also improve on the EU’s implementation approach by rolling out taxonomy-related reporting with corporates first, rather than financial institutions who would have to rely on proxy data and voluntary reporting.

Finally, the UK green taxonomy must be scientifically based and aligned with a 1.5C pathway. This is integral to ensure that the taxonomy holds value as a trusted definition of which economic activities can be considered as environmentally sustainable. Where possible, the UK should strive to be more ambitious than the EU, such as by not classifying natural gas and particular intensive agricultural practices as green.

Businesses need clarity on the UK green taxonomy

With significant market appetite for a UK green taxonomy, delay is creating a growing sense of confusion amongst investors and corporates.

To restore confidence amongst businesses, the Government must set out a clear timeline to implementing the UK Green Taxonomy, starting with the publication of the long-awaited consultation. As a leading green financial centre in a highly competitive market, the UK cannot afford to waste the second mover advantage it has gained.

James Fotherby is Senior Policy Officer and Green Finance Lead at the Aldersgate Group.