Green Financing: GFIT Consults on Singapore and ASEAN taxonomy metrics and activities

This consultation proposes a specific set of metrics for three of the eight sectors to be covered by the taxonomy and the methodology to be used for classifying investments. This update looks at the proposals and considers a couple of risk points that financial institutions should be alert to.

The Green Finance Industry Taskforce (GFIT) issued a second consultation paper, “Identifying a Green Taxonomy and Relevant Standards for Singapore and ASEAN”, on 12 May 2022. The last day for feedback is 23 June 2022. The green taxonomy (Taxonomy) in this second consultation paper expands on the initial taxonomy proposed by providing a specific set of metrics for three sectors and the methodology to be used for classifying investments. This is only the first iteration of the Taxonomy and the GFIT will be conducting further consultations on the following additional matters later this year and in 2023:

• The metrics and activities for an additional five sectors
• Do No Significant Harm (DNSH) requirements and minimum social safeguards
• A penultimate draft of the Taxonomy

The GFIT has stated that it will finalise the full Taxonomy in 2023 and financial institutions should start reporting on the basis of the finalised Taxonomy as from that year as well. The consultation paper does not discuss where reporting should be made. However, in relation to compliance with the Guidelines on Environment Risk Management (Guidelines) issued in December 2020, the Monetary Authority of Singapore (MAS) has stated that financial institutions are expected to make their disclosures in their annual report or sustainability report, or on their website.

The MAS has also stated that the first disclosures under the Guidelines are to be made after 8 June 2022. Accordingly, the Taxonomy will not be immediately relevant for these purposes. Financial institutions will therefore make their first disclosures referencing other frameworks (for example, the TCDF recommendations). In this respect, financial institutions should refer to GFIT’s Financial Institutions Climate-Related Disclosure Document available on the website of the Association of Banks in Singapore, which provides detailed recommendations on disclosures for the purposes of complying with the Guidelines.

What the second consultation paper adds to the Taxonomy

The GFIT had first consulted on a Taxonomy with the publication of its first consultation paper on 28 January 2021 (for more, please read our update “Singapore consults on a taxonomy for the financing of environmentally sustainable activities”). As the Taxonomy will become relevant for disclosure after it is finalised, financial institutions should therefore be aware of what the current draft provides and the direction that the GFIT is heading in its construction. Towards this end, the table below provides a snapshot of the two consultations:

First consultation 

• The Taxonomy will be closely aligned with the EU’s Regulation EU 2020/852 on the establishment of a framework to facilitate sustainable investment but with some adjustments to make it fit for purpose for the ASEAN economies.
• It will cover the following sectors, being the ones most relevant to the ASEAN economies in terms of greenhouse gas emissions or as being relevant to climate change mitigation:
  • Agriculture and Forestry/Land Use
  • Construction/Real Estate
  • Transportation and Fuel
  • Energy, including upstream
  • Industrial
  • Information and Communications Technology
  • Waste/Circular Economy
  • Carbon Capture and Sequestration

• It will classify activities under a “traffic light classification system” of green, amber and red.

Second consultation

• It sets out specifically what activities would be classified as green, amber or red for the following sectors:
  • Construction/Real Estate
  • Transportation and Fuel
  • Energy, including upstream

These are the sectors most relevant to Singapore. The other five sectors will be consulted on later in 2022.

• It sets specific metrics which these activities must meet in order to be considered green or amber. For example, under the energy sector:
  • Green classification: Conversion of natural gas plants to use green hydrogen leading to an emission intensity of less than 100gCO2e/kWh measured during the life cycle.
  • Amber classification: Retrofitting of existing natural gas plants that leads to lifecycle emission intensity meeting specified thresholds of grams of CO2e/kWh generated on a declining basis over a specified schedule.
  • Red classification: Any other activities in relation to natural gas plants.

Intended use of the Taxonomy

It is anticipated that the primary users of the Taxonomy will be Singapore-based financial institutions providing debt and/or equity capital, including both public and private capital. These include equity fund management, debt fund management, alternative investment management, private equity, venture capital, infrastructure financing and investment-linked insurance products, among others.

The financial institutions will apply the Taxonomy primarily to the provision of finance to companies in ASEAN member states (Indonesia, Malaysia, Philippines, Singapore, Thailand, Brunei, Laos, Myanmar, Cambodia and Vietnam), with the main focus on Singapore. This geographic scope refers to the nexus of operations, rather than the jurisdiction of incorporation of the company. For example, entities incorporated in Cayman but with substantial or an overwhelming majority of operations in ASEAN would be covered.

Manner of reporting under the Taxonomy

Financial institutions should report the degree of alignment of an investment portfolio or financial product with the Taxonomy on a weighted basis. The following describes in brief what this would entail:

• How the Taxonomy is to be applied will depend on the type of financing or investment associated with the Taxonomy activity. Accordingly, the same activity may be classified as green for the purposes of a particular investment product or have no impact at all on classification.
• Reporting would be on an overall basis, where the extent of alignment with the Taxonomy takes into account not only what percentage of a specific investment product is aligned on an individual product basis, but also on a weighted basis across the entire portfolio of investments.
• As the investment company’s fund or portfolio may also include investments in companies whose activities are not in any of the eight sectors to be covered in the Taxonomy, those investments would be classified as “ineligible”.

In reporting alignment, financial institutions should also disclose the following information along with the alignment percentages of the product:

• How products have used the Taxonomy to classify investments, on a narrative basis.
• How that usage is consistent with the specified product-level ESG outcomes (for example, in the case of an environmental fund, or a climate fund).
• The percentage of the product that is assessed to be aligned with the Taxonomy.
• The way that data has been utilized, either publicly disclosed, via engagement, or estimated.
• The environmental objectives (and their exposure) to which the product contributes.
• How due diligence was carried out, the technical screening criteria were assessed, and the number of portfolio companies that were estimated to substantially contribute but which failed the DNSH test (and how the financial institution intends to address this failure, either through portfolio construction or engagement).
• Reasons for a low-level of alignment, where the outcome deviates from what might reasonably be expected from the specified product-level ESG outcomes (for example, in the case of an environmental fund, or a climate fund).
• How engagements are undertaken in the context of the Taxonomy (for example, to focus on issuers with low alignment, or to engage for continued momentum from an issuer operating within a “Transition” activity).

Risk points for financial institutions to pay attention to

The application of the Taxonomy is but only one of the components of environment risk disclosure in order to ensure compliance with the Guidelines. Other components would include governance, strategy, and risk management. The Taxonomy will be helpful in bringing transparency and comparative metrics to what is essentially still a heavily descriptive disclosure process. In what is still an evolving landscape, we would highlight the following risk points for financial institutions:

• The assessment of alignment with the Taxonomy lies very much in the hands of the relevant commercial companies being assessed as these matters will be substantially reliant on data produced and provided by these companies. In an ideal situation, a company will produce its analysis in an environmental or sustainability report that financial institutions can simply rely on. A question arises, however, as to the extent of due diligence that is expected of financial institutions in relying on these reports and what they should do if they disagree with the company’s analysis of the alignment; a market practice of comfort letters for such reports has yet to develop. Given that these sustainability reports are not subject to the same degree of audit scrutiny as financial statements, it is unclear how financial institutions are to react in these circumstances and how much they can cite simple reliance on the reports.
• The greater apparent degree of measurability and certainty will also expose financial institutions to greater scrutiny from green and climate activists. Financial institutions, especially prominent ones, can expect greater attention being paid to whether they have made disclosures of alignments accurately and correctly, with corresponding fallout if they are perceived to have inflated or misstated their degree of alignment.

This is still very much an evolving area where there is a steep learning curve taking place in a highly contested and polarised environment. Financial institutions should ensure that they put in place the right processes both in ensuring proper disclosure as well as being able to justify or defend the reports that they issue.