What characterises a good green or sustainable finance taxonomy?

Green and sustainable finance embodies a paradigm shift away from business as usual, and seeks to mobilise capital to simultaneously promote economic growth, environmental conservation and sustainable development. As such, it facilitates sustainable development and finances activities that have environmental benefits and are in line with the ambitions of the Sustainable Development Goals (SDGs). As the importance of green and sustainable finance grows considerably, market participants are increasingly seeking clear, consistent, comparable and reliable information about the green claims of different activities and instruments. This information is crucial to identifying activities and projects that are eligible for financing and comply with green and sustainable finance policies and regulations of the government. Developing green taxonomies can help reduce uncertainty for different stakeholders by providing a common language and framework for identifying and classifying environmentally sustainable activities and assets. This makes it easier for various actors, including central banks, governments and the private sector, to understand, regulate and finance green and sustainable activities. Green and sustainable taxonomies serve as instruments to guide capital allocation toward environmentally friendly and sustainable activities that align with broader environmental and sustainability objectives. They function as classification systems, identifying and categorising activities and investments as either “green” or “sustainable” contingent upon their alignment with specific environmental and sustainability goals and targets. The scope of the taxonomies can encompass diverse purposes, such as climate mitigation, adaptation, water management, circular economy practices, pollution control, and biodiversity conservation. This policy brief examines green and sustainable taxonomies and offers a concise set of recommendations on how to strengthen such taxonomies for policymakers and regulators. Its objective is to highlight fundamental principles and best practices, including a case study of Indonesia’s green taxonomy, and examine key features that characterise a good quality green or sustainable finance taxonomy. It also scrutinises the crucial design considerations for constructing a good quality green or sustainable finance taxonomy. These include clearly outlining objectives, defining users and scope, choosing the correct eligibility methodology and balancing the question of interoperability. The policy brief concludes by summarising potential pathways and recommendations.