INSIGHT

Deciphering the Australian sustainable finance taxonomy

By Renee Boundy, Jacinta Dyer, Sally Page, Flynn O'Byrne-Inglis
Banking & Finance Climate Change & Sustainability Environmental, Social & Governance Mining

A framework for 'green' and 'transition' for the informed investor 14 min read

Australia's first sustainable finance taxonomy (the Taxonomy) will be a critical tool in the global push towards sustainable development.

Released by the Australian Sustainable Finance Institute (ASFI), the Taxonomy has the potential to play a critical role as a framework to efficiently and credibly evaluate green and transition activities, and facilitate investment and financing in them.

With more than 40 sustainable finance taxonomies either in place or under development across the world, there's much the Australian market can learn from in developing and applying its own Taxonomy.

In this Insight, we set out a high-level guide on what the Taxonomy is trying to achieve, how it is being developed and how it may impact businesses in the future. We also outline some of the key themes stakeholders want addressed in the Taxonomy's development and implementation.

About the sustainable finance taxonomy 

The primary aim of the Taxonomy is to mobilise private capital towards activities in Australia that can significantly decarbonise the economy and support the transition to net zero emissions by 2050. It is expected that other sustainability goals will be integrated into the Taxonomy in the future.

What is the sustainable finance taxonomy and why is it important?

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.
How does it work?

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 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.

 

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What is being addressed in the first round of public consultation?

The Taxonomy will be implemented in phases, with various rounds of public consultation undertaken as part of each phase.

In this first round of consultation, ASFI is seeking feedback on the draft climate change mitigation criteria that have been developed for the first three priority sectors:

  • electricity generation and supply (energy)
  • minerals, mining and metals
  • construction and the built environment.

Of particular interest is the minerals, mining and metals sector, which has only been addressed in taxonomies elsewhere in the world to a very limited extent. Australia's Taxonomy will be one of the first to specifically develop green and transition criteria for the mining sector.

Which sectors are being prioritised by the Taxonomy?

The Taxonomy will focus on developing technical screening criteria for the following priority sectors:

  • Electricity generation and supply: activities related to renewable energy generation, energy storage and grid infrastructure improvements.
  • Minerals, mining and metals: processes involving the extraction and processing of critical raw materials, with an emphasis on reducing emissions and environmental impact.
  • Construction and the built environment: projects promoting energy-efficient buildings, sustainable materials and green construction practices.
  • Manufacturing/Industry: activities aimed at decarbonising industrial processes and improving resource efficiency.
  • Transport: initiatives that support the transition to low-emission transportation modes, including electric and hydrogen-powered vehicles.
  • Agriculture: practices that enhance sustainable farming, reduce greenhouse gas emissions and promote biodiversity.

Minerals, mining and metals: Australia leading the way?

As mentioned above, mining activities have been addressed in existing taxonomies in other countries in a relatively limited manner, particularly in terms of clarifying what alignment with 1.5°C climate goals means for the sector. Technical discussions are ongoing in the EU and key mining economies (such as Canada, Indonesia and Chile) around the potential inclusion and integration of these elements.

Given the significance of the mining sector to Australia's economy and energy transition, the Taxonomy proposes criteria for both green initiatives and transition activities directed solely toward climate mitigation, focussing initially on four key minerals: lithium, nickel, copper and iron ore. This aligns with the Climate Bonds Initiative's current development of sustainable finance criteria for copper, nickel and lithium mining.

The table below sets out the rationale for inclusion of those minerals.

Minerals in scope for initial development phase Status in Australia Rationale for inclusion
Lithium Critical mineral Australia a key global producer. Demand set to grow significantly. Important battery metal.
Nickel Critical mineral Demand set to grow significantly. Important metal for batteries and other clean energy technologies.
Copper Strategic mineral Demand set to grow significantly. Important metal for a wide range of clean energy technologies. Important for the Australian economy.
Iron ore Neither strategic nor critical Vital mineral for the Australian economy as world's largest producer of iron ore. Essential component in modern technologies and infrastructure, including those needed for the clean energy transition (eg wind turbines, green buildings etc).

Original source: Australian Sustainable Finance Institute, 2024.

ASFI has indicated that, in future, further minerals will be introduced as a matter of priority, such as bauxite, cobalt and certain rare earths.

What types of activities will be eligible activities under the taxonomy?

Within the above outlined priority areas, specific types of activities will then be eligible for classification under a green or transition category. The definitions of each of these categories has been developed by the Taxonomy Technical Expert Group (TTEG) and are subject to public consultation.

What is a 'green' activity?

Green activities are defined as those economic activities and assets aligned with achieving net-zero greenhouse gas emissions in accordance with the temperature goals of the Paris Agreement. Performance thresholds for these activities are to be determined using internationally recognised, science-based scenarios consistent with limiting global warming to 1.5°C.

Green activities include those already meeting these targets, typically involving low-emission technologies such as renewable energy projects, energy-efficient buildings and electric vehicles.

What is a 'transition' activity?

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).

How will transition activities be categorised?

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.

What thresholds must activities meet to be eligible under the Taxonomy?

Technical criteria

In a future round of public consultation, ASFI will seek feedback on the technical screening criteria to be included in the Taxonomy. These will consist of science-based thresholds that determine whether an activity is eligible for classification under the Taxonomy. The criteria are expected to be sector-specific and include performance benchmarks such as emissions-intensity levels in industrial processes and the proportion of recycled materials in manufacturing. The thresholds will be derived from scientific sources and frameworks, such as those provided by the CSIRO, the International Energy Agency and the Climate Bonds Initiative.

Do no significant harm (DNSH)

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.
Minimum Social Safeguards (MSS)

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 has indicated that feedback on the DNSH and MSS criteria (as well as the three remaining sectors) will be sought in the second round of public consultation scheduled for Q4 2024.

What are the key themes and concerns we've heard so far?

While the Taxonomy has general support, we're hearing a few key themes from various clients and industry groups in connection with their submissions. So far, these include:

Key theme Concern
The 1.5°C pathway Whether the 1.5°C pathway as the basis for eligibility is appropriate and feasible.
Usability The usability of the Taxonomy across a range of jurisdictions, segments, entities, assets and projects at different stages of transition.
Compatibility with other regimes Inconsistencies between:

the Taxonomy and other disclosure regimes, including Australia's mandatory climate-related financial disclosures and the Taskforce on Nature-related Financial Disclosures; and

international reporting and financial standards which may apply to foreign investors.
Implementation guides The role of relevant Australian guidance to support the implementation of the Taxonomy.
Ensuring ongoing review The importance of a built-in review process to ensure the Taxonomy is updated to reflect the changing Australian landscape.
The critical role of technology Technological assumptions made in the Taxonomy to achieve the 1.5°C pathway.

What happens next?

The development of the Taxonomy will involve extensive public consultation. Stakeholders, including lenders, investors, companies and policymakers, are being encouraged to participate to provide feedback and insights. For more information on the public consultation process, or how the Taxonomy may impact your business specifically, please contact our sustainable finance experts.