SBFN Toolkit As a Development of Sustainable Financial Taxonomy

The SBFN Toolkit on Sustainable Finance Taxonomies is part of a series of guidelines developed by the Sustainable Banking and Finance Network (SBFN) together with the International Finance Corporation (IFC) to support member countries in developing a national support framework for sustainable finance. This toolkit is designed for financial sector regulators and banking associations in emerging markets that are in the process of developing regional or national taxonomies or have done so and want to update their taxonomies by utilizing good international practices and lessons learned from other jurisdictions.

The International Capital Market Association (ICMA) defines sustainable finance taxonomy as a classification system that identifies activities, assets, and/or project categories that have a climate, green (environmental), social, or sustainable impact, with reference to identified thresholds and/or targets. The main objective of the sustainable finance taxonomy is to provide a uniform language regarding what is considered “green”, “social”, and “sustainable”. With clear and standardized language, the taxonomy can help identify sectors, activities, and entities that meet agreed criteria, which in turn provides more precise direction for investors and related parties. This taxonomy also serves to reduce greenwashing practices, which often lead to unfounded sustainability claims. By reducing greenwashing, taxonomy can help create a more transparent and accountable investment environment.

In addition, the taxonomy also supports the achievement of more ambitious Sustainable Development Goals, by ensuring that funded activities actually contribute to the achievement of these goals. The taxonomy enables countries and financial entities to focus funds on projects that support long-term sustainability, such as climate change mitigation, nature conservation, and inclusive social development. This taxonomy can also include criteria for managing social and environmental risks and impacts that may arise from an activity, ensuring that funded projects do not cause damage to the community or the surrounding environment.

With a structured and clear approach, taxonomy can also strengthen investor confidence, giving them assurance that the funds they invest will truly support sustainability and not just be used for detrimental purposes. This trust is important for a sustainable financial market to grow and develop more healthily. In addition, taxonomy helps drive innovation in the financial sector by opening up opportunities for more entities to participate in a green and sustainable economy.

Realizing International Goals and National Priorities

Taxonomy offers a way for a country to ensure that local assets, activities, projects, and entities labeled as environmentally friendly, social, and sustainable can make a substantial contribution to achieving international goals and national development strategies and priorities. In order to achieve these international goals, the taxonomy can be structured based on four interconnected levels. Each level reflects the efforts and regulations implemented to support sustainability in the financial and investment sectors.

At the global level, sustainability goals are set to be applied widely throughout the world. At this level, there is a commitment to address the problems of climate change, protect biodiversity, and achieve the sustainable development goals set by the international community. Countries around the world have agreed to act on these pressing global challenges, with the shared goal of creating a positive impact around the world.

At the regional level, policies and frameworks are developed to support countries in encouraging sustainable investment flows towards greater goals and to support collaboration between countries. At this level, countries work together to ensure that their investments and policies are aligned with common goals, and to facilitate cross-border investments that can strengthen collective efforts to achieve sustainability. This framework helps countries integrate sustainability into the financial sector, encouraging the flow of funds that support positive change.

At the national level, each country tailors their sustainability policies to their respective local conditions and priorities, while remaining committed to global goals. Countries set specific sustainability goals, whether related to climate change mitigation, natural resource management, or inclusive social development. With clear and focused policies, countries can direct investment to sectors that support their sustainability goals, and ensure that economic growth occurs without compromising the environmental or social future.

At the industry level, the private sector plays an important role in implementing the taxonomy of sustainability in their operational activities. Companies and industries must adjust their strategies to align with sustainability goals set at the global and national levels. This includes changes in more environmentally and socially responsible ways of doing business, including adopting environmentally friendly practices, funding green projects, and creating products and services that support sustainability. The industrial sector plays a role in driving the transition to a green economy through innovations that support common sustainability goals.

Various Types of Taxonomy

Countries are now continuing to expand the scope of their taxonomies. This is done not only by creating taxonomies that focus on climate mitigation, but also by including social themes (such as financial inclusion, gender, health, and education) as well as other environmental themes (such as biodiversity, land use, and blue finance).

Pendekatan Umum dalam Pengembangan dan Implementasi Taksonomi

With more and more countries publishing their taxonomies, there should be a need for ongoing governance and maintenance of these taxonomies. This is to ensure that the taxonomies can function effectively, and also that existing taxonomies can be continuously updated and developed. The taxonomy needs to be embedded in a strong national framework for sustainable finance involving regulators and industry representatives from all parts of the financial sector. The taxonomy also needs to be linked to regulations, directives, and disclosure requirements. The general approach to taxonomy development and implementation consists of three dimensions, which include: Governance of Taxonomies, Design of Taxonomies, and Implementation of Taxonomies.

Governance of Taxonomies

Clear and structured governance of taxonomies is a crucial element in ensuring effective implementation in the taxonomy of sustainable financial ecosystems. One of the main steps is to confirm the key institutions that will be responsible for its management. The decision as to whether the taxonomy will be managed by regulators or industry must be made with its effectiveness and sustainability in mind. In addition, relevant stakeholder groups, including financial regulators, supervisory authorities, and the financial services industry, need to be actively involved for the taxonomy to be properly implemented.

In addition to establishing an initial structure, plans need to be made for the ongoing expansion and review of the taxonomy to remain relevant to developments in the financial sector. In various jurisdictions, the taxonomy continues to evolve by adjusting the categories and activities covered, as well as updating the alignment criteria. This process requires a well-planned strategy so that expansion can be carried out systematically. To support sustainability, the roles and responsibilities of each party in the review process must be clearly defined so that there are no inequalities in implementation.

Interaction with stakeholders is an important aspect of governance of taxonomies because effective implementation depends on the involvement of various parties. Regulators, financial institutions, the private sector, MSMEs, academics, and civil society must have access to structured communication channels to provide input. These channels must support awareness raising, provide space for technical discussions on taxonomy criteria, and help overcome barriers to adoption that may arise. Thus, transparency and active participation from all parties can increase the effectiveness of implementation of taxonomies.

In addition, the connection between taxonomy and prudential regulations, market supervision, and incentives needs to be clarified to ensure policy alignment. Many countries have adopted mechanisms that require banks to report taxonomy-compliant lending as part of market supervision. This relationship helps create clarity in the application of taxonomy in the financial sector, as well as increasing compliance with sustainable principles. With strong regulatory support, the application of taxonomy can be more easily integrated into industrial and capital market policies.

Regular reviews of implementation of taxonomies are also an important step in identifying and addressing challenges faced in its application. Some common challenges include a lack of awareness in the market, the need for clearer guidance, and uncertainty about independent assurance requirements. In addition, the costs associated with the alignment process can also be an obstacle for an entity in fully adopting the taxonomy. Therefore, regulators must periodically evaluate the effectiveness of implementation of taxonomies and respond to emerging obstacles with adaptive and solution-oriented policies.

Design of Taxonomies

The first step in designing a taxonomy is to clarify the approach to the objective so that it fits the needs of the market and the main users. Each jurisdiction has different needs, in terms of the interests of international investors, national regulators, banks, and capital markets. Therefore, it is important to specifically identify the main objectives of the national taxonomy before designing it. In addition, it is necessary to consider how this taxonomy will be linked to existing instruments and regulations or those to be developed in the future.

Once the objectives have been set, research and comparison with other jurisdictions are crucial steps in understanding the best practices that have been implemented globally. Many countries have developed sustainable finance taxonomies that can be used as a reference in national design. In addition to comparison, an analysis of domestic economic priorities must also be carried out so that the designed taxonomy can be aligned with national policies. The selection of priority local green sectors must consider the contribution to the Gross Domestic Product (GDP), Nationally Determined Contribution/NDC, and the potential transition to a low-carbon economy.

The design of taxonomies process must be carried out in consultation with stakeholders to obtain a broad and inclusive perspective. The consultation may involve a consulting firm or a technical committee responsible for drafting the taxonomy framework. Active participation from stakeholders can be facilitated through various mechanisms, such as webinars, Focus Group Discussions (FGDs), bilateral conversations, and steering committees or expert groups. With this approach, the design of taxonomies can better suit market needs and gain support from the various parties involved in its implementation.

Once the initial design is complete, pilot testing is essential to assess the taxonomys effectiveness and ease of implementation. This pilot exercise allows financial institutions and companies to test the mechanism of alignment with the taxonomy in a real-life scenario. From the results of the trial, various valuable insights can be obtained, including the identification of areas that still require refinement and further clarity. This testing also helps to identify potential challenges in implementation so that they can be overcome before the taxonomy is widely adopted.

The final step in the design of the taxonomy is to finalize, publish, and communicate the final results to the public. Before the official launch, it is important to open a public comment period of 30 to 60 days to get final input from various stakeholders. After revision based on this input, the final version can be published together with the main organization responsible for its implementation. For the taxonomy to be implemented effectively, a broad communication strategy must be implemented through webinars, industry events, and the publication of tools and templates. In addition, it is necessary to prepare a long-term plan for the expansion and revision of the taxonomy in accordance with market dynamics and regulatory developments.

Implementation of Taxonomies

Once the taxonomy has been published, the next step is to build the capacity of the implementing agency so that it can implement the taxonomy effectively. This capacity building is not only limited to the internal staff of the implementing agency, but also needs to be extended to service users and providers, such as consulting firms and second-party opinion providers. For the adoption of the taxonomy to run smoothly, it is important to provide supporting tools, clear guidelines, and a pilot phase that allows relevant parties to understand in depth how the taxonomy works in practice. This capacity building will ensure that the taxonomy can be applied consistently and in accordance with the desired objectives.

The taxonomy can also form the basis for broader regulation in the financial and private sectors. One of the most effective mechanisms for encouraging the application of the taxonomy is to require entities in the financial and private sectors to report their level of alignment with the taxonomy. This not only increases transparency, but also supports the development of clearer sustainable financial instruments. In addition, this taxonomy can be used in prudential risk management, where banks and other financial institutions can utilize the taxonomy to assess credit risk related to financing environmentally friendly projects.

To ensure that the taxonomy is applied in a structured and sustainable manner, it is important to develop a sequential implementation roadmap. This roadmap will provide clarity for regulators and the market regarding the appropriate time for the private sector to align itself with the taxonomy and disclose their alignment. The roadmap also needs to set out what is expected of the regulatory body, when the taxonomy can be mandated, and when there will be updates or extensions to the taxonomy itself. With a clear roadmap in place, all parties involved can prepare for the implementation phase in a systematic and focused manner.

The metrics used to monitor and evaluate the success of the taxonomy must be carefully agreed upon, as this will be the main indicator of whether the taxonomy is functioning as expected. Some countries such as Bangladesh, Mongolia, and China have successfully used the taxonomy to generate long-term data on green loan and bond issuance, as well as to evaluate the relationship with lower credit risk. These metrics provide insight into the effectiveness of the taxonomy and whether any adjustments need to be made to optimize its benefits.

Finally, data collection and communication of the results of implementation of taxonomies are essential to ensure accountability and transparency in the use of the taxonomy. One strategy that can be applied is to require entities to disclose their alignment data publicly, so that all parties can see the progress that has been made. In addition, entities may also be required to report to regulators, who will then publish aggregate data to provide a comprehensive overview of implementation of taxonomies. A detailed analysis of this data over several years will also provide useful insights into the evaluation and development of taxonomies in the future.