This article discusses the requirement for a green taxonomy in India. It recommends practices in the green taxonomies of various countries and international bodies that may be adopted by Indian policymakers while developing the climate finance taxonomy.

Indian green taxonomy-the need of the hour

Taxonomy is defined as a study of the general principles of scientific classification. A taxonomy for sustainable finance lays down a uniform criterion for evaluating and classifying activities and investments, based on their support for sustainability goals. Such taxonomies assist investors and other stakeholders in assessing the environmental impact of their investments.

Pursuant to the Paris Agreement 2015, the Indian Government pledged to reduce the emission intensity of India’s gross domestic product by 45 percent by 2030, from the 2005 level, as its nationally determined contribution. It is estimated that India will require USD 2.5 trillion in investments to accomplish its commitment by 2030.

Indian financial regulators, such as the Reserve Bank of India (RBI), the Securities and Exchange Board of India (SEBI), and the International Financial Services Centres Authority (IFSCA), have taken various initiatives to promote ‘green finance’. However, a hurdle in attracting investments in green financing instruments in India is the lack of a clear definition of ‘green finance’ and a framework providing uniform eligibility criteria for determining if a project can be considered ‘green’. Ambiguity in the understanding of ‘green finance’ leaves room for multiple interpretations of the term and increases the likelihood of greenwashing. Enacting a green finance taxonomy in India will help lay down well-defined criteria for identifying green projects.

Indian regulators are mindful of the need for a uniform green taxonomy. The RBI highlighted that a consistent and comparable taxonomy is essential for a well-functioning green finance regulatory framework and the IFSCA has also stressed the requirement of a green taxonomy in India to attract foreign investments. The Ministry of Finance has set up a task force to conceptualize a framework for sustainable financing in India, including drafting a climate finance taxonomy.

Recommendations from International Practices

Indian regulators can consider the following elements of taxonomies adopted by other countries and international organizations while drafting the climate finance taxonomy:

Transition Activities

The taxonomy adopted by the European Union (EU) has a forward-looking methodology that facilitates transition finance and encourages investments in technological innovations for carbon-intensive industries.

In India, a small number of sectors operate at zero or near zero emissions. To develop an environmentally sustainable economy, grassroots-level changes will be required in all industries. The inclusion of transition activities in taxonomies can help redirect capital towards solutions that will facilitate the reduction of emissions by hard-to-abate industries. This will eventually pave the way for the adoption of low-carbon alternatives or zero emissions by such industries.

Granularity

The Climate Bonds Taxonomy drafted by the Climate Bonds Initiative (CBI) has adopted a traffic light system to classify different projects. The classification is based on the degree to which the identified assets and projects are compatible with the goals set under the Paris Agreement, 2015.

A green light is given for projects that are automatically compatible with the goals. An orange light is given for potentially compatible projects. A red light is issued for projects that are incompatible with the goals set under the Paris Agreement. A grey circle is used in situations where more work is required to determine the color that is appropriate for the projects.

It is recommended, that rather than taking a binary approach and just classifying projects as green and not green, the uniform green taxonomy in India must adopt some granularity in the classification of projects. This will make India’s green taxonomy more comprehensive and allow different classifications of projects based on their impact on the environment.

Entity focus

Most of the taxonomies in place, including the EU and Chinese taxonomy, classify projects as sustainable or green based on the assessment of the activity. However, any taxonomy based solely on the assessment of the activity does not take into consideration whether the other activities of the entity are aligned with the objectives of the taxonomy. Therefore, an assessment of the activity or any asset-based metrics does not effectively curb greenwashing.

For instance, the construction of infrastructure for renewable energy production can be labeled as a green project under an activity-based taxonomy. However, if such a project is undertaken by a company that is primarily involved in carbon-intensive activities, the impact of the renewable energy infrastructure may be diluted. This would defeat the purpose of the green certification given under an activity-based taxonomy and could potentially lead to greenwashing. Therefore, to prevent funding of greenwashing, the taxonomy in India must classify projects as green based on the assessment of the entire business of an entity and not just an assessment of the relevant projects.

Disclosure

The disclosure obligations under the taxonomy adopted in the EU are supplemented by other environmental disclosure regulations, such as the Sustainable Finance Disclosure Regulation (SFDR) and the Corporate Sustainability Reporting Directive (CSRD). Companies under the CSRD are obligated to disclose the extent to which their economic activities are covered by the EU taxonomy in their annual reports. The financial market participants under the SFDR are obligated to disclose how their products align with the EU taxonomy. Further, financial market participants are also required to give periodic disclosures to provide the taxonomy alignment of their investments.

In India, the 1000 largest listed companies are mandated to produce business responsibility reports. However, companies are not mandated to disclose the alignment of their activities or investments with any environmental objectives laid down by the regulators. It is recommended that Indian entities, beyond a certain threshold, must be required to report the nature and extent of the alignment of their activities with the climate finance taxonomy. This will encourage Indian companies to adopt environmentally conscious business practices, which in turn, will aid in attracting environmentally conscious investments.

Key Takeaways

Under the present legal framework in India, the entities are required to formulate a board-approved policy for issuing green financing instruments and facilities in accordance with the Indian green taxonomy. However, in the absence of a green taxonomy in India, the regulators have provided broad categories of activities in which proceeds raised from these green financing instruments and facilities can be allocated.

The lack of a proper green taxonomy framework for qualifying the sustainability of different types of projects leads to greenwashing, undermining the objective of green financing. Companies are increasingly making false or misleading claims regarding their commitment to the environmental pillar of ESG. For instance, in the United States of America, Nike and Delta Airlines were sued in 2023 for greenwashing and misrepresenting environmental claims. The Indian regulators should ensure that companies in India don’t follow the same route.

The challenges surrounding misrepresentation and misleading claims may be resolved by adopting a holistic approach to the classification of projects. This would involve the taxonomy classifying projects based on the impact of the project on the environment and evaluating the impact of other activities carried out by the entity seeking to initiate the project. The concerns pertaining to greenwashing can also be alleviated by prescribing the disclosure of ESG activities as per the taxonomy. 

Further, it is recommended that Indian taxonomy should adopt methodologies that are aligned with those of its counterparts. For instance, the EU taxonomy has adopted the NACE codes and Chinese taxonomy has adopted the Chinese Standard Industrial Classification for the industry classification in the taxonomy. While such standards are consistent with national statistical data and official regulatory frameworks, they are not directly compatible with the classification systems used in other jurisdictions. The lack of interoperability increases the transaction cost for issuers and investors who are involved in making green investments internationally. Thus, it will be in India’s interest to ensure that its taxonomy is interoperable with the taxonomies of other major economies. 

Globally, it has been observed that financial entities prefer standardized taxonomy for identifying green economic activities across different sectors. While India’s taxonomy is still under consideration, it is envisaged that it will play an important role in boosting the popularity of India’s green instruments by providing clarity to investors and other stakeholders and assisting them in identifying the non-financial benefits of a project.  

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Bharucha & Partners – Vivek Mishra and Palak Nangru