Deciphering the Australian sustainable finance taxonomy

By providing a framework, the Taxonomy aims to help distinguish sustainable economic activities from those that are not, guiding investment decisions towards greener options and reducing greenwashing risks (which has been a significant complication in delivering on sustainability goals).

Although the adoption and use of the Taxonomy will not be compulsory, we expect it will be used by a wide range of stakeholders in the financial sector, including:

• lenders and investors looking to allocate capital towards sustainable projects and assets;
• companies seeking to classify their activities as environmentally sustainable and attract funding on this basis; and
• regulators and policymakers in developing and enforcing sustainability standards.

We expect there is a future role for the Taxonomy to be integrated into financial regulatory policies, and for its scope in defining 'green' and 'transition' activities to expand, helping to ensure that private and institutional investors follow international best practices that are tailored to the Australian economy.

By adopting the Taxonomy, stakeholders may benefit from, among other things:

• a simplification of the process for identifying potential sustainable investment opportunities, including comparability between products and portfolios, as well as reduced due diligence costs due to better market clarity; and
• increased transparency and confidence in sustainability claims and verification of those claims, including more uniform and comparable data to allow regulatory agencies to examine sustainability assertions.

The Taxonomy will initially establish criteria for economic activities undertaken within the six priority sectors set out below. Within each of those sectors, the Taxonomy will establish technical screening criteria to determine which activities will constitute either 'green' or 'transition' activities within the definition of the Taxonomy. The technical screening criteria will differ between sectors to reflect the nature of the activities undertaken in each sector.

In addition to meeting the relevant technical screening criteria within a certain sector, an activity will also need to satisfy the do no significant harm (DNSH) criteria, and the 'minimum social safeguards' (MSS) criteria. DNSH criteria can be both generic (applying to all activities) and specific (applying to certain activities), whereas MSS criteria are generic only.

In order for an activity to be classified as a 'green' activity or a 'transition' activity within a sector, it will need to meet the relevant technical criteria applicable to that activity, the relevant DNSH criteria and the MMS criteria. 

The diagram below provides a useful representation of how each element of the Taxonomy fits together.

Transition activities are defined as those that, based on current technology readiness, continue to play a role in a net-zero greenhouse gas emissions economy. These activities as defined do not have low-carbon alternatives, can be decarbonised across Scope 1, 2, and 3 emissions without phase-down or phase-out, and can mitigate the risk of locking in future high-carbon assets.

Under the Taxonomy, transition activities must show substantial progress towards sustainability within a defined timeframe and cannot remain in transition indefinitely. They should facilitate significant reductions in emissions rather than marginal improvements.

The TTEG acknowledges that some activities will remain economically necessary while the economy transitions, but are ultimately not compatible with a net-zero emissions economy. While these activities are economically important to Australia, the Taxonomy is looking towards the future and how to mobilise capital to support Australia’s transition to renewable energy.

The TTEG recommends the following purpose for the transition category:

• recognise activities capable of significant progress towards a 1.5°C trajectory within a defined timeframe;
• facilitate the decoupling of emissions growth from production growth;
• encourage the deployment of technologies that create emissions reductions and decoupling; and
• identify timeframes by which activities must be 1.5°C aligned.

Under the proposal, activities would not be eligible for inclusion in the transition category where they have low-carbon emissions substitutes and emissions cannot be substantially reduced or decoupled from the activities (and, therefore, will decline and ultimately be phased out).

The methodology suggests there are three broad levers that can be used for decarbonising an economy consistent with a net-zero emissions future. The use of each of these levers depends on the nature of the activity and applies to activities that are not currently consistent with the Paris Agreement:

• Phase down: activities with low-emission substitutes where emissions cannot be reduced or decoupled from the activity. The only feasible pathway for these activities is to reduce or phase down/out the activity.
• Decarbonise: activities with no low-carbon substitute but that are still needed in a decarbonised world, such as steel production. These activities must transform internally to decouple emissions growth from activity growth.
• Substitute: high-emission activities replaced with low-emission substitutes.

The Taxonomy aims to exclude activities that are not aligned with a 1.5°C pathway, including: (i) those without decarbonisation pathways for Scope 1, 2, and 3 emissions without phase down/out, (ii) carbon-intensive activities with low-carbon alternatives, (iii) technologies locking in carbon intensity, and (iv) activities with potential short-term emissions reductions but that are inconsistent with a 1.5°C pathway.

By including transition activities, the Taxonomy permits the eligibility of activities that may not appear to be consistent with a sustainable future, so long as they can be decarbonised or decoupled from growing emissions.

The DNSH principle aims to ensure that defined sustainable finance activities, while substantially contributing to one Taxonomy objective, do not significantly harm any of the other objectives.

For example, a renewable energy project must not significantly harm biodiversity or water resources.

DNSH criteria look to consider impacts throughout the lifecycle of an asset, activity or project, as well as any associated impacts across supply chains. Globally, DNSH implementation and verification has been challenging, largely due to the lack of data and capacity to verify DNSH requirements. Another key issue is the lack of specificity and objectivity in the language used to define the criteria, especially when linked to national regulations and standards.

Other sustainable finance taxonomies have determined certain environmental objectives that will be given priority, and that are to be addressed through DNSH criteria.

Following assessment, the TTEG has recommended the inclusion of the following environmental objectives in the Australian taxonomy:

• climate change mitigation
• climate change adaptation
• pollution prevention and control
• biodiversity and ecosystems protection
• sustainable use and protection of water resources
• circular economy.

Sustainable finance taxonomies worldwide have primarily addressed social objectives through MSS. These safeguards ensure that activities classified under a taxonomy do not result in adverse social outcomes, by requiring stakeholders to comply with specific social standards.

The TTEG has specified a process it will undertake to define the core social pillars for Australia's taxonomy. Given the significant challenges associated with activity-level disclosures, it is proposed that MSS shall be applied across entities or assets, rather than at an individual activity level.

Once the environmental objectives and core social pillars are defined, draft DNSH, MSS and technical criteria will be developed. ASFI is currently seeking feedback on the DNSH and MSS criteria (as well as all six sectors) in the second round of public consultation.