South Africa has taken another step towards establishing green finance as a viable option for investors with the recent publication of the Draft Green Finance Taxonomy (Draft Taxonomy) by National Treasury.
Financial institutions across the world are playing an increasingly critical role in environmental, social and governance (ESG) initiatives, leading much of the sustainable investing in our markets. This is within the context of a global initiative to tackle climate risks and ESG issues and individual countries taking decisive actions.
Regulatory requirements a driver
Regulatory requirements are a driving force behind sustainability in the lending market. It is expected that market practice will evolve as regulators enhance rules on disclosure and risk management and develop green taxonomies.
From a South African perspective, several foundational documents inform the domestic regulatory framework to achieve the country’s ESG goals, including the Paris Agreement on Climate Change and the UN’s 2030 Sustainable Development Goals.
However, in May 2020, National Treasury released a technical paper entitled Financing a Sustainable Economy that aimed to increase access to sustainable finance and stimulate the allocation of capital to support a development-focused and climate-resilient economy. Critically, it also recommended the enactment of a taxonomy similar to the EU Sustainable Finance Taxonomy (EU Taxonomy), in force since 12 July 2020.
The Draft Green Finance Taxonomy explained
In line with this recommendation, in June 2021, National Treasury published the Draft Green Finance Taxonomy (Draft Taxonomy), which sets out a more concrete regulatory framework for South Africa’s ESG goals.
The Draft Taxonomy is an official classification document that defines a minimum set of assets, projects, and sectors that are eligible to be defined as ‘green’ in line with international best practice and national priorities. It can be used by investors, issuers, asset owners and other financial sector participants (as ‘users’ of the Draft Taxonomy).
This project aims to adapt international best practice to South Africa’s context and needs. In particular, South Africa’s green economy should be viewed from two perspectives:
- economic activities that are intrinsically aligned to and/or are expected to make a substantial contribution to the future South African green economy; and
- economic activities that presently have significant detrimental environmental impact but are needed as part of the future South African green economy and for which there are presently no known alternatives.
The publication of the Draft Taxonomy was accompanied by the release of a User Guide and a Listing of Developmental Aspects Document. The latter document identifies sections of the Draft Taxonomy that require further technical development, review, or stakeholder engagement.
These documents were developed by a Taxonomy Working Group, chaired by the National Treasury and comprising various financial industry players and other stakeholders such as the National Department of Forestry, Fisheries and the Environment.
The Draft Taxonomy classifies economic activities according to two objectives: being those making substantial contributions to climate change adaptation, and those making substantial contributions to climate change mitigation.
The intention is that a further four objectives will, in time, become part of the Draft Taxonomy. These being: sustainable use of water and marine resources, pollution prevention, sustainable resource use and circular economy and ecosystem protection and restoration.
The Draft Taxonomy provides four fundamental principles to help determine taxonomic alignment of each economic activity under consideration. These include the fact that economic activity:
- contributes substantially towards either mitigation or adaptation;
- meets the applicable technical screening criteria (TSC);
- does no significant harm to any of the other taxonomy objectives (including the additional four objectives above); and
- meets minimum social standards referred to as ‘Minimum Social Safeguards’ (MSS), which, in the South African context, are the standards set by specific human rights and labour-related legislation and international conventions.
In its current form, the Draft Taxonomy has three main sections:
- the matrix, which provides a high-level view of eligible economic activities in each relevant economic sector;
- the catalogue, which indicates basic attributes of the economic activities listed in the matrix, and maps the environmental objectives of each activity; and
- the TSC, which gives in-depth information on the features and requirements of eligible economic activities, including principles, metrics and thresholds for the objectives of substantial climate change mitigation and adaption.
Benefits of the Draft Taxonomy include:
- helping the financial sector with clarity and certainty in selecting green investments in line with international best practice and South Africa’s national policies and priorities;
- reducing financial sector risks through enhanced management of environmental and social performance;
- reducing the costs associated with labelling and issuing green financial instruments; and
- unlocking significant investment opportunities for South Africa in a broad range of green and climate-friendly assets and supporting regulatory and supervision oversight of the financial sector.
The Listing of Developmental Aspects Document identifies sections of the Draft Taxonomy which require further technical development, review, or stakeholder engagement.
This is largely as a result of the fact that the EU released updates to the EU Taxonomy in November 2020 and April 2021. The Working Group is in the process of considering these changes and updates and evaluating how changed criteria can be domesticated for use in South Africa.
One of the critical considerations is whether certain economic activities removed from the EU Taxonomy should similarly be removed from the Draft Taxonomy.
The Taxonomy Working Group has currently requested specific feedback from stakeholders on the following activities which were removed from the EU Taxonomy, but which are relevant for South Africa:
- crop production (growing of perennial and non-perennial crops);
- livestock production; and
- production of electricity, heating and cooling from gas.
The Taxonomy Working Group intends on carrying out further work to expand the Draft Taxonomy and its use, including developing a Transition Taxonomy which references ‘transition activities’ (i.e. activities which support a transition to a green economy). This work should be completed by February 2022.
Given the international trends and the local desire to transition to a sustainable low carbon economy, we look forward to watching the developments and tracking the progress of the Draft Taxonomy.