A sustainable taxonomy is a framework used to identify and classify economic activities based on their sustainability attributes
Often recognized as a gold standard in this domain, the European Taxonomy is considered an example of taxonomy development. Its prominence has not only piqued the interest of investors keen on understanding their portfolios’ alignment with this framework but has also interested legislators and countries worldwide. Many are now developing their own taxonomies (Fig. 1), often using the EU Taxonomy as a blueprint.
Figure 1: Overview of Taxonomy Regulations (updated on November 2023)
Given that many financial institutions operate across multiple capital markets, the development of new sustainability regulations must ensure interoperability by aligning foundational principles, objectives, classification systems, and methodologies. As momentum builds around the development of global taxonomies, a question arises: are new sustainability regulations developed with interoperability in mind?
We compared the upcoming Singapore-Asia Taxonomy against its European counterpart. Specifically, we analyzed the ‘greenness’ — or, in taxonomy jargon, the ‘objective alignment’ — of the MSCI ACWI index (representing about 85% of global equity markets), to assess how this figure differs between the two frameworks.
The choice of Singapore is not arbitrary. With its position as a leading financial center, overseeing assets surpassing $5T — the highest for any country currently shaping a Green Taxonomy — it presents a particularly compelling case study.
Near-Identical Eligibility Focus for Both Frameworks
The first step in the assessment of a company’s alignment with a sustainable taxonomy is defining which activities can be eligible. An activity is said to be eligible if it fits the description of any of the activities included in the taxonomy.
In our previous article, we showed the differences in terms of activities included, remarking how, for instance, animal and crop production are included in the Singapore Taxonomy but not in the EU Taxonomy.
However, the impact of these differences on the eligibility of the MSCI ACWI index is minimal:
- 17.2% of the index’s market cap is eligible for the EU Taxonomy. Of this, 98% is also eligible according to the Singapore Taxonomy.
- 82.8% of the index’s market cap is non-eligible for the EU Taxonomy. Of this, 99% is also non-eligible to the Singapore Taxonomy.
This suggests a high degree of compatibility and interoperability between the two taxonomies in terms of included sectors, activities, and how they are defined.
The Impact of the Amber Category on Sustainability Alignment
One notable distinction between the two frameworks is Singapore’s use of a traffic light system to categorize activities’ sustainability alignment:
- Green: Activities or companies aligned with the taxonomy’s environmental objectives.
- Amber: Transition activities or companies that are not fully aligned with the taxonomy’s objectives but are working towards it.
- Red: Activities or companies not compatible with the sustainability criteria of the taxonomy and that have to either improve or be phased out.
Based on our estimates, 4% of the index is aligned with the EU Taxonomy, compared to 3.7% that is “Green” under the Singapore Taxonomy (Fig. 2). The result is explained by the fact that almost 70% of the activities of the Singapore Taxonomy share the same alignment criteria (used to define if an activity is sustainable) of the corresponding activities of the EU counterpart. However, this is not always the case. One notable exception is real estate activities, for which Singapore requires buildings to have a Green Mark certification to be deemed sustainable.
Figure 2: Breakdown of activities aligned with the EU Taxonomy and their categorization under the Singapore Taxonomy. Note: Analysis conducted on the MSCI ACWI Index (All Country World Index), covering approximately 85% of the global investable equity opportunity set. “No Data” represents activities that could not be assessed due to data unavailability
On the other hand, 13.2% of the index is composed of activities deemed eligible for the EU Taxonomy but do not qualify as aligned. As shown in Fig. 3, of that 13.2%, 3.5 percentage points fall under the Singapore Taxonomy Red category (fully not sustainable activities), while the Amber category constitutes almost 6.4% of the index market cap, and the remainder does not have the required data.
Figure 3: Breakdown of activities not aligned with the EU Taxonomy and their categorization under the Singapore Taxonomy. Note: Analysis conducted on the MSCI ACWI Index (All Country World Index), covering approximately 85% of the global investable equity opportunity set. “No Data” represents activities that could not be assessed due to data unavailability
Activities in sectors such as iron and steel manufacturing, and cement are likely to be the most impacted by the Amber classification in the Singapore Taxonomy. Many of these companies are labeled as non-sustainable under EU Taxonomy criteria but may be considered Amber under the Singapore Taxonomy due to their transition plans and strategies.
Take as an example a cement manufacturing company (Figure 4). The share of activities not aligned with the EU Taxonomy, which stood at 70%, reduces to 19% (Red) under the Singapore Taxonomy, since 51% of these activities are now classified as ‘Amber’.
In this scenario, the Amber category can support investors looking to identify future best-in-class companies in the market. The Amber category could also improve how investors perceive these companies, allowing for a more detailed view of their efforts toward sustainability.
Figure 4: Comparison of a cement manufacturing company’s activities in relation to the European and Singapore Taxonomies. Note: Analysis conducted on a Cement Producer with a market cap exceeding $30 billion
Towards an Interoperable Investment Landscape
Recently, the Monetary Authority of Singapore (MAS) rolled out distinct consultations for insurers, banks, and asset managers focusing on climate-related disclosures. The idea of the MAS is to grant financial institutions the flexibility to adopt both Singapore and EU Taxonomies for their product-level reporting.
The EU itself is working towards the extension of the EU Taxonomy with a traffic light system, in part to make it compatible with other frameworks used around the world. This addition would improve transparency and facilitate a broader understanding of sustainable activities.
While there isn’t an explicit agreement on these proposals yet, these initiatives seem to be the signs of a progressive shift toward the applicability of these tools across different regulatory environments.
Recognizing and understanding these opportunities can influence investment decisions. In this intricate web of sustainable finance, tools and platforms like Clarity AI empower investors to navigate with precision, ensuring alignment with global sustainability benchmarks while harnessing emerging opportunities.
