What Is the Sustainable Finance Taxonomy?

The taxonomy is a voluntary classification system that defines which economic activities and entities are considered:

• 'green' (already aligned with net zero); or
• 'transition' (on a credible pathway to alignment).

It is designed to support Australia's climate change mitigation objectives and is tailored to Australia’s economic structure, sectoral emissions profiles, and unique transition challenges.

AFSI's work on taxonomy development was overseen by the Australian Treasury and key financial regulators.

“What the taxonomy aims to do is put some rigorous content and context behind the term 'green' to support its application to particular economic activities and the entities which undertake them.”

What is the purpose of the taxonomy?

The taxonomy is a science-based framework to classify economic activities that positively contribute to key environmental sustainability objectives. It is designed to facilitate the allocation of capital towards activities supporting Australia’s net zero ambitions. The taxonomy is intended, among other things, to:

• make it easier for financial institutions to identify sustainable investment and lending opportunities;
• enhance comparability between investment products and portfolios; and
• provide greater confidence in and assurance over sustainability claims.

In particular, on greenwashing, AFSI says that:

Sustainable finance taxonomies strengthen investor confidence in claims, mitigate greenwashing, and make it easier to compare investment products and sustainability disclosures both within and across jurisdictions.

What sectors of the economy does it cover?

The taxonomy covers six priority sectors:

• agriculture and land
• electricity generation and supply
• transport
• manufacturing and industry
• construction and buildings
• minerals, mining and metals

These sectors match those for which the Australian Government is developing industry sector emission reduction plans which we expect to be released soon.

How does it work?

For each sector, the taxonomy lays out detailed technical screening criteria that define thresholds and conditions which must be met for entities or activities to be described as 'green' or 'transition'. For example:

• In the energy sector, various types of renewable generation and certain grid-supporting technologies can qualify as 'green'.
• In industry, activities like low-carbon cement or steel production may qualify as 'transition' if, among other things, they meet emissions intensity benchmarks and have credible decarbonisation plans.

This sector-specific granularity is useful for responsible investment professionals conducting taxonomy-alignment assessments or advising on sustainable finance instruments (e.g. green bonds). It should also:

• enhance disclosures and reporting under evolving regulatory frameworks, and
• support engagement with issuers and stakeholders on credible transition plans.

For example, under the new mandatory climate reporting regime in Australia, AASB S2 requires reporting entities to disclose:

(a) the amount and percentage of assets or business activities aligned with climate-related opportunities; and

(b) the amount of capital expenditure, financing or investment deployed towards climate-related risks and opportunities.

Use of the taxonomy to inform those disclosure is not mandatory, but it is likely to be adopted by some entities as a valuable way to demonstrate how their business activities and investments are moving toward alignment with climate-related opportunities year-on-year.

The taxonomy incorporates a Do No Significant Harm (DNSH) framework to ensure that climate-aligned activities do not undermine other environmental objectives, such as biodiversity or water quality.

In addition, the taxonomy mandates minimum social safeguards, including:

• respect for human rights;
• First Nations engagement; and
• cultural heritage protection.

These safeguards align with global ESG expectations and provide a baseline for responsible investment.

What about greenwashing?

As set out above, one of the purposes of the Taxonomy is to mitigate 'greenwashing' by providing clear definitions of what constitutes a 'green' or 'transition' activity. This should help investors and businesses distinguish genuine sustainable investments from misleading claims, preventing the misallocation of capital and fostering trust in sustainable finance.

It is worth remembering, however, that the ACCC's guide to making environmental claims explicitly recommends against using overly broad or vague terms. It singles out 'green' as a particularly dangerous term, conveying 'sweeping benefits that can mean different things to different consumers'. What the taxonomy aims to do is put some rigorous content and context behind the term 'green' to support its application to particular economic activities and the entities which undertake them. That is useful and important but the taxonomy is not a magic bullet. In other words, it doesn't actually give entities a 'safe harbour' (that will need a regulated 'product labelling' regime which is also in development as part of Australia's Sustainable Finance Roadmap).

The taxonomy is a tricky beast – nearly 200 pages, with complicated and likely contestable technical screening criteria. You need to read and understand it to know what 'green' means when applied to a particular activity or entity. In addition, it is fair to say that a reasonable member of the class of persons to whom a 'green' representation is ultimately made may not be taken to have done so.

Pilots and implementation

A pilot program involving major financial institutions — including banks, super funds, and government agencies — is currently underway. These pilots will test the taxonomy’s application in:

• lending and investment decisions;
• product labelling; and
• portfolio alignment assessments.

Insights from the pilot will inform future iterations of the taxonomy, including the expansion of the taxonomy to cover climate adaptation, nature, and circular economy objectives.

To better understand how the Taxonomy can impact your investments and business practices, get in touch with a MinterEllison expert today.