Sustainable finance in the UK - consultation on value case and useability of a UK Taxonomy

Setting the scene: the UK Taxonomy in a global setting

A taxonomy provides a common framework for market participants to classify economic activities which support climate, environmental or wider sustainability objectives.  By classifying activities, it makes it easier to mobilise more sustainable investment and to reduce the risk of greenwashing, thereby promoting integrity in the sustainable markets. 

Many other countries have taxonomies to support green and sustainable investment, including the European Union (which introduced the EU Taxonomy in 2020) and countries across East Asia, South America and South Africa, and many more countries are considering taxonomies to promote particular investments across their regions.¹  So the UK will by no means be a first mover in this space but will be able to benefit from the learnings of other countries who have introduced taxonomies.

UK consults on a Green Taxonomy

Although HM Treasury only launched the Consultation Paper for a UK Taxonomy on 14 November 2024, the UK has been considering the introduction of a taxonomy since 2021 when it published Greening Finance: A Roadmap to Sustainable Investing. 

Much work has already been completed by the UK’s Green Technical Advisory Group (GTAG) on a UK Green Taxonomy, including in relation to interoperability, “do no significant harm” features, operational considerations (assessing and dealing with data) and use with green products.

The consultation seeks stakeholder views on key design features, interoperability and market and regulatory use cases

The Consultation Paper says that its primary purpose is to “establish whether a UK Taxonomy would be additional and complementary to existing policies” in meeting the objectives of (a) promoting market integrity and mitigating greenwashing and (b) channelling capital in support of the government’s sustainability objectives.

It also seeks views on:

• the market and regulatory use cases for a UK Taxonomy, for example to aid business finance decisions, apply to product disclosures, support investor stewardship and supporting sustainable product development; and
• how to maximise the usability of a UK Taxonomy – including interoperability with other taxonomies and key design features of the UK Taxonomy.

The Consultation Paper does not seek feedback on specific activity-level standards, such as what the UK Taxonomy should say in relation to specific economic activities; instead, it focusses on the nature of the framework that the UK should put in place.

Market and Regulatory use cases for a UK taxonomy

The Consultation Paper seeks to understand how valuable a UK taxonomy would be in the context of wider UK government policy (including sustainability disclosure, transition planning and transition finance and market practices), noting that GTAG identifies the following use cases:

• acting as an input to project and business finance decisions, providing consistent standards to allow meaningful comparisons over time;
• supporting investor stewardship and engagement;
• informing the development of sustainability-focused financial products;
• applying to investment fund and investment portfolio product disclosures; and
• use as part of the government’s wider climate and environment strategy.

The government is seeking input on additional use cases, the balance of costs and benefits across the above use cases and also to understand if there are any other existing or better alternatives to a taxonomy.

The government is also asking for views on how the success of a UK Taxonomy could be evaluated and what measurable key performance indicators could show that a UK Taxonomy is achieving its goals.

A UK Taxonomy to promote transition finance

Following the publication of the Transition Finance Market Review (TFMR), which recommended that the government proceed with a consultation on a UK Taxonomy, the Consultation Paper recognises the potential importance of the inclusion of transition finance within a UK Taxonomy.  The government is seeking views specifically on the question of whether a UK Taxonomy is a suitable tool for mobilising transition finance.

Key design questions

The Consultation Paper seeks feedback on a number of specific design considerations for a UK Taxonomy, including feedback on experiences with other taxonomies, best practice and lessons learned.

• International interoperability

  Market participants in the UK are already complying with a number of other taxonomies, so interoperability and alignment with other taxonomies is clearly an important factor the development of a UK Taxonomy.  In particular, there are (i) many asset managers who are aligning funds with the EU Taxonomy in connection with the Sustainable Finance Disclosure Regulation (SFDR) compliance and (ii) many companies who are reporting under the Corporate Sustainability Reporting Directive and applying the EU Taxonomy. 

  Regardless of the need for international interoperability, any UK taxonomy also needs to reflect locality – that is, the different industries and pathways to net zero that countries determine.

• Environmental objectives and sectoral scope

The Consultation Paper notes that existing taxonomies focus on a number of environmental objectives – most prominently climate mitigation and climate adaptation, but also including biodiversity and ecosystems, circular economy, pollution prevention and control, and sustainable use and protection of water and marine resources. 

Views are being sought on (i) what objectives a UK Taxonomy should incorporate and (ii) on what basis their development should be prioritised.  It will be interesting to see the extent to which nature-related objectives are prioritised in due course.

The Consultation Paper notes that some jurisdictions have taken a staged approach to sectoral coverage, with new sectors added over time – and that there has been feedback that this is more difficult to use and does not allow for a genuine comparison of investments.  The implication, therefore, is that the UK government would prefer to put a comprehensive scope in place at the outset.

• “Do No Significant Harm” Principle

  A key component for other taxonomies is a mechanism to ensure that progress against one environmental objective does not cause significant harm to other environmental objectives, for example, taking measures to protect against flooding, under an adaptation objective, should avoids causing material damage to a local ecosystem. 

  The Consultation Paper seeks to understand how respondents think that the Do No Significant Harm principle should be incorporated and how it would work.

• Business practice safeguards

  Some taxonomies include additional social safeguards relating to basic good business practice, which add an additional due diligence-related test when applying a taxonomy. .  For example, the EU Taxonomy includes minimum safeguards relating to human rights (including labour rights), bribery/corruption, taxation and competition.

  The Consultation Paper asks for feedback on whether these safeguards should be included as a condition of taxonomy alignment or should be separated from a UK Taxonomy (noting that the UK already has existing robust requirements to safeguard against human rights abuses and labour exploitation by UK-based business).

• Taxonomy updates over time

  The Consultation Paper notes that:

  • the underlying criteria in a UK Taxonomy will have to change over time to keep pace with scientific, technological, and policy developments, but that this also needs to be balanced with maintaining stability of taxonomy information for the market and providing certainty for businesses;
  • oother jurisdictions update their taxonomies every three years, and it is specifically seeking feedback on this question; and
  • transitional elements within a UK Taxonomy would be likely to require a more dynamic framework, and asks for views on whether the three-year timeframe would be appropriate for transition plans.
• Governance and oversight

The Consultation Paper seeks views on:

• what the desired level of governance and oversight arrangements would be to ensure that a UK Taxonomy maintains credibility for use in financial markets and across the economy over time. It notes that other jurisdictions have created joint industry and government initiatives to develop and maintain taxonomies, or have looked to international organisations to lead taxonomy development; and
• the options for a UK Taxonomy, including views on the role for government, the private sector and non-governmental organisations.