Singapore consults on a taxonomy for the financing of environmentally sustainable activities

The consultation has been launched by the Green Finance Industry Taskforce (Taskforce), which is a taskforce convened by the Monetary Authority of Singapore (MAS). It is part of Singapore’s push to foster a green financing sector and comes hard on the heels of the recent MAS issuance of Guidelines on Environmental Risk Management, which apply to asset managers, insurers and banks. 

The need for a taxonomy 

Current requirements for disclosures relating to sustainability practices and the financing of environmental and sustainability initiatives suffer from a lack of globally agreed standards of environmental sustainability. As a result, both financial institutions and investors have found it difficult to meaningfully ascertain and compare investments in corporate environmental and sustainability activities. The creation of a taxonomy is therefore intended to address this issue by setting a benchmark of activities considered to be ‘environmentally sustainable’. 

In order to give financial institutions and investors the clarity and assurance of consistent global standards, it is imperative that regulators worldwide converge on standards that are, if not identical, sufficiently similar to allow meaningful comparison. Accordingly, an investor considering investments in a financial product from Asia labelled as “green” under Asian rules should feel confident that it meets environmental and sustainability threshold standards that are similar, if not identical, to those from other jurisdictions, for example in Europe. In this way, an investor will know that it is “comparing apples with apples” and not “apples with plastic fruit”.  

Alignment with the EU Taxonomy Regulation

The EU is often considered to be the most advanced in terms of its environmental and sustainability journey, with the EU Taxonomy Regulation coming into force on 12 July 2020 (although it is only expected to apply in practice from 1 January 2022 at the earliest). It is therefore unsurprising that Singapore is proposing to align itself with the EU Taxonomy Regulation for consistency with what is likely to be viewed as the leading international standard at this time. The Taskforce has, however, proposed developing the Singapore taxonomy in a manner which ensures relevance to the ASEAN region and to keep it sufficiently flexible to adapt to changes in the international system.  

As with the EU Taxonomy Regulation, the proposed Singapore taxonomy will evaluate and classify activities based on tolerance thresholds. It will establish clear criteria for determining whether activities are ‘environmentally sustainable’. The basic tests proposed largely mirror those found under the EU Taxonomy Regulation. It is proposed that to qualify as ‘environmentally sustainable’ under the Singapore taxonomy, the activity must meet one of the following objectives:

• climate change mitigation
• climate change adaptation
• protection of biodiversity 
• promotion of resource resilience

Three of the above objectives (climate change mitigation, climate change adaptation, and protection of biodiversity) are also specified in the EU Taxonomy Regulation. However, the objective of promoting resource resilience is not included in the EU Taxonomy Regulation, which instead includes the following three additional objectives:

• water
• circular economy
• pollution control

In addition to contributing to one of the four environmental objectives described above, in order to qualify as an ‘environmentally sustainable’ economic activity under the proposed Singapore taxonomy, the activity must not:

• significantly harm any of the environmental objectives above
• impose a negative impact on communities’ social and economic well-being, unless the trade-offs can be justified in the long run
• breach local laws and regulations

These are similar to the tests in the EU Taxonomy Regulation. It should be noted, however, that the EU tests are more stringent as the EU Taxonomy Regulation specifies that the activity:

• “do no significant harm” to any of the environmental objectives
• be carried out in compliance with minimum social and governance safeguards 
• comply with technical screening criteria to be adopted under the EU Taxonomy Regulation 

Industry sectors to be covered by the proposed Singapore taxonomy

The proposed Singapore taxonomy will also specify specific industry sectors which will then be divided into sub-sectors, in a manner similar to the EU Taxonomy Regulation.

The EU Taxonomy Regulation uses the NACE classification (nomenclature statistique des activités économiques dans la Communauté européenne), which is a European industry standard classification system established by EU law. Given the lack of familiarity in the region of the NACE classification, the Taskforce has proposed a set of industry sectors that can be mapped onto the NACE classification system but that are not identical to the NACE system. The sectors proposed by the Taskforce are: 

• 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

The consultation notes that more work needs to be done to properly define the sub-sectors that fall under each of these sectors. 

Setting of thresholds

The consultation also notes that it will be necessary to establish regional or country-level thresholds applicable to each activity under each of the above sectors. Such thresholds will be set using science-based targets. The Taskforce has also suggested that to aid comparability with the EU Taxonomy Regulation, Singapore should adopt the targets set out in the IPCC 1.5 and IEA 2018 reports for determining sector-appropriate climate mitigation thresholds. 

To see what such thresholds may look like, it may be useful to consider how such thresholds are adopted and set under the EU Taxonomy Regulation’s technical screening criteria (which are still in draft form). With respect to the manufacture of iron and steel, for example, the technical screening criteria require that greenhouse gas emissions from the manufacturing process must be lower than certain specified thresholds and that at least 90% of the iron content in the final product is sourced from scrap steel. How the “do no significant harm” effect of the iron and steel manufacturing is to be determined – using which criteria – is also specified. For example, under the requirement to “not do significant harm to the objective of pollution control”, the manufacturing process must produce emissions within or lower than the ranges specified by the EU for iron and steel production. Only iron and steel manufacturing activities that meet this requirement may be classified as aligned with the EU Taxonomy Regulation. If an iron and steel manufacturing process is being refurbished to be more environmentally sustainable, it can only claim to be aligned with the EU Taxonomy Regulation if the result of that renovation meets this threshold. 

Green, yellow and red activities 

In terms of how the Singapore taxonomy will work, instead of the stricter standard specified in the EU Taxonomy Regulation (which sets out one single threshold), a traffic light system has been proposed as a broad conceptual framework. The system will differentiate between green, yellow and red groups of activities within the focus sectors. The yellow group is intended to cover transition activities for which more granular thresholds and requirements will be developed in the next phase.

The consultation paper provides the following two examples which give a good indication of how the Taskforce sees this system working in practice: 

“A power generation company in ASEAN with significant coal-fired power generation assets seeks to raise capital to fund the transition towards lower carbon power generation. Under the ‘traffic light classification system’ the company’s activities are reviewed and determined to be on an emissions-reduction pathway that is not aligned with meeting the objectives of the taxonomy. Therefore the company is not eligible for classification as ‘green’.”

“An auto-manufacturer’s primary production is internal combustion engine vehicles, and tail-pipe emissions for the fleet are currently relatively high compared to both peers and the current level required to meet a 2 degree transition pathway. However, the company has committed to transitioning 100% of production to electric vehicles by 2030. Under the ‘traffic light classification system’ the company’s activities are considered to be in transition, and meeting the requirements of a ‘yellow’ classification.”

Anticipated future developments

The consultation paper is very much a broad policy document and the real work will come once the Taskforce starts to drill down into the sub-sectors and specify thresholds for qualifying as green, yellow or red under the traffic light system. Furthermore, it may be noted that the EU Taxonomy Regulation deals with many other aspects of disclosure, which have not been addressed in this consultation, including the following examples: 

• Non-financial companies above a certain minimum size are to disclose the proportion of their turnover and the amount of capex and, if relevant, opex aligned with the EU Taxonomy Regulation. 
• Financial market participants offering financial products in the EU will be required to make disclosures, which will be mandatory for certain types of products such as UCITs, alternative investment funds, and venture capital and private equity funds. The financial market participant will be required to state, for each relevant product:

• how and to what extent they have used the taxonomy in the EU Taxonomy Regulation in determining the sustainability of the underlying investment

• to what environmental objectives the investments contribute 

• the proportion of underlying investments that are aligned with the EU Taxonomy Regulation, expressed as a percentage of the investment, fund or portfolio. 

While we are not at that stage yet, it is anticipated that further consultations may consider these issues. 

The Taskforce has also released a Handbook on implementing environmental risk management. Both documents are available on the Association of Banks in Singapore’s website. The consultation closes on 11 March 2021.