A taxonomy for sustainable finance is a set of criteria that provide the basis for an evaluation of

whether and to what extent a financial asset will support given sustainability goals. Its purpose
is to provide a strong signal to investors, and other stakeholders, and assist their decision
making – by identifying the type of information needed to assess the sustainability benefits of an
asset and to classify an asset based on its support for given sustainability goals.

A taxonomy of sustainable finance is a comprehensive review of the financial fields, starting with
the principles and moving through to the systems. It includes a variety of types of sustainable
finance which can be categorized by their understanding on how nature influences the world.
These include:

 Ecological finance
 Environmental banking
 Green capitalism
 Natural economic history

Sustainable finance taxonomies can be essential tools for accomplishing these aims by linking
sustainability goals with high-level policy objectives (for example, carbon emission reduction in
accordance with the Paris agreement). Its goal is to send a strong signal to investors and other
stakeholders, as well as to aid in their decision-making, by outlining the sort of information
required to assess an asset's sustainability benefits and to classify an asset based on its
support for specific sustainability goals. Non-financial data disclosure is required for an efficient
assessment of how an asset meets the requirements laid out in a taxonomy.

Sustainability must be viewed from an interdisciplinary viewpoint that represents both capitalism
and socialist perspectives in order to establish a functioning system that works for all. In order to
meet public demand for ecologically friendly activities, an increasing number of businesses are
embracing a sustainable business strategy.

Ecosystem services have been considered as a good alternative to GDP in order to achieve
long-term economic growth. As a result, an ecosystem service can also be regarded a sort of
sustainable financial innovation that aims to promote social welfare and global equality by
enacting more radical environmental policies. Sustainable development has been defined in
various ways across the literature in different disciplines, but a common agreement in what
makes a development "sustainable" remains elusive.

In economics, sustainable development refers to a situation in which the demands of the

present are addressed without affecting future generations' ability to meet their own
requirements. As a result, future generations will have a material standard of life that is equal to
or higher than the current generation. There are concerns about whether economic
development can be sustained permanently.

The World Business Council for Sustainable Development (WBCSD) defines a "sustainable
economy" as "an economy that is efficient in its use of natural and human resources, and in
which the pursuit of economic objectives does not undermine the health and well-being of
ecosystems".

The UNCTAD and OECD define sustainable development as: "A development that meets the
needs of the present without compromising the ability of future generations to meet their own
needs".

A well-managed economy, according to resource economics, must begin with a well-managed

natural resource. To properly manage a natural resource system, it is required to first identify
the resources, how they are used, and how they will be managed in the future. The major goal
of this approach should be long-term sustainability—creating a resource that will last for future
generations. Carole Perkins and Debra Kranz created the term "sustainable management" in
the 1990s.
Alignment with high-level policy goals

A science-based strategy can be used to translate high-policy goals such as China's ecological
civilisation plan, the Paris Agreement, and the Sustainable Development Goals into specific
aims. This translates high-level sustainability goals into measurable outcomes such as a
benchmark reduction in GHG emissions, a lower rate of deforestation, or a desirable level of
species variety. The summary of these dimensions among the three taxonomies in Table 1
demonstrates that congruence with high-level aims is possible, but not usually a feature of large
taxonomies. An successful taxonomy assists investors in channelling funds into assets that
serve the national long-term goals.

Independence vs. co-dependence

For one thing, the higher the level of complexity of a taxonomy with various objectives, the
higher the expenses of implementation and oversight, and thus the degree of compliance by
financial markets.  For example, whereas the screening criteria for climate change mitigation
include a single metric, namely CO2 emissions, those for other objectives, such as biodiversity,
are guaranteed to be more sophisticated because they are impossible to reduce to a single
metric. More broadly, having a complete framework of definitions and reporting requirements
that supports several, interdependent environmental objectives, as in both the EU and Chinese
taxonomies, entails costs in terms of lowering the signalling value of a taxonomy with a single
independent goal.

Taxonomies typically include multiple objectives, such as climate change mitigation and
adaptation, as well as the sustainable use and protection of water and marine resources, the
transition to a circular economy, waste prevention and recycling, pollution prevention and
control, and the protection of healthy ecosystems.

Static vs. Transition

To present, the vast majority of green finance capital flows have been channelled toward low-
carbon economic activities, with significantly less investment in transition and enabling activities
in carbon-intensive industries such as oil and gas, mining, and heavy industry.

Transition activities, as defined by the EU taxonomy, are activities that contribute to the
transition to net-zero emissions by 2050 but are not currently "green," such as passenger
automobiles or electricity generation from gaseous fuels. The European Commission is taking
early measures to incorporate transition activities into its taxonomy, so encouraging investments
in green technical advancements in carbon-intensive industries.
Given that only a fraction of industries run at or near zero emissions, the transition to a resilient,
sustainable economy necessitates fundamental and grassroots transformation across all
industries, even those with the largest carbon emissions. A lack of transition taxonomies can
result in increased capital costs or even the inability of enterprises to switch to less hazardous
activities. To recognise and promote transition activities, taxonomies can also utilise
forward-looking measures, which are expected impacts inferred from firms’ past
performance.

National vs internationally interoperable

The existing industry classifications used by national statistical agencies, such as the NACE
codes in the EU taxonomy or the Classification of Strategic Emerging Industry (based on the
Chinese Standard Industrial Classification (CSIC)12) in the Chinese taxonomy, are two
prominent examples of the former.

While the NACE and CSIC classifications in the EU and China, respectively, are congruent with
national statistical data and formal legal frameworks, they are not immediately compatible with
widely used classification systems elsewhere, such as the Global Industrial Classification
System (GICS). One step toward taxonomy harmonisation would be for all taxonomies to use
the same industrial classification system, with GICS or the International Standard Industrial
Classification (ISIC) being logical front runners.

Activity vs. Entity vs. Asset

The screening criteria of sustainability-linked bonds are defined at the entity level on the basis of
Key Performance Indicators (KPIs) and Sustainability Performance Targets (SPTs), and hold
the promise of broadening the scope of financing to support the transition of an entity's entire
business model.

To avoid the danger of greenwashing a company's entire profile on the basis of a little initiative,
activity-based taxonomy might be augmented with information on the materiality of sustainable
actions from the entity perspective. However, it is critical for investors to assess the aggregate
impact on sustainability of a corporation's entire spectrum of economic operations, as
addressed in the International Capital Market Association's(ICMA) Sustainability Linked Bond
Principles (SLBP).

Under an activity-based taxonomy, the construction of infrastructure for renewable energy

production, for example, can be labelled green; however, if the project is undertaken by an
energy company that is heavily involved in the construction of new oil refining facilities that are
not aligned with environmental objectives, the entity-level label may differ. The major extant and
currently most generally used taxonomies describe sustainability in terms of the activity or
project itself, rather than the full organisation (often a corporation) doing the activity. Signaling
the environmental benefits of business activities at the project level does not always imply a
corresponding signal at the entity level.

Data Availability and Disclosure

Despite the EU’s Non-Financial Reporting Directive as well as the growing momentum
around the adoption of non-financial reporting standards like the EU Sustainable Finance
Disclosure Regulation (SFDR), the Sustainability Accounting Standards Board (SASB), the
Global Reporting Initiative (GRI) and the IFRS foundation’s work on sustainability-related
disclosure standards, sustainability disclosure at the issuer level is still limited.
Verification

This model has the ability to maintain a consistent level of quality in the verification process
because only businesses with appropriate competence will be permitted, and the gatekeeper
will impose universal criteria on the services they deliver. External review (second- and third-
party) is widely used in the European bond market, however standardisation of verification
techniques across different providers can be improved. As the sustainable finance market
increases in scale, regulators may consider more regulation alternatives to facilitate verification
and deter green washing. The current EU taxonomy legislation does not address the verification
process, but the Chinese taxonomy supports the optional use of independent assessments.