Ahead of COP26, most developing countries, including those in Asia, are gearing up for another round of intense negotiations over the distribution of climate mitigation costs between the global north and the south. With all Group of Seven (G7) nations having committed to net zero greenhouse gas emissions by 2050, the pressure is on emerging economies to follow suit.

However, if there is no further support to finance climate change mitigation or adaptation efforts, many developing nations will not be willing or able to commit to significantly higher emissions reduction targets. At COP26, they will aim to hold developed countries accountable for falling short on their 2009 pledge to mobilise USD 100bn a year by 2020 to help developing countries respond to climate change. Access to green capital is no doubt crucial for Asia’s transition to a low carbon future. However, that assumes that the region has a robust regulatory and financial framework to deploy it, which is not necessarily the case.

A taxing tale of taxonomies

Despite the surge in green capital allocation across the Asia Pacific in recent years, regulators in several jurisdictions have lagged their EU peers in formulating taxonomies or classifications of economic activities that align with their broader climate or sustainability objectives. Jurisdictions also have substantively differing interpretations of what qualifies as “sustainable” business activity. These divergent interpretations of sustainability will impede companies’ ability to quantify their sustainability performance or communicate effectively with investors and regulators. Consequently, it will also hinder their access to capital.

In most cases, regulators in the Asia Pacific have been inclined to follow the course adopted by the EU in its taxonomy templates to drive green finance. The EU’s experience in climate stewardship and industry best practices can be instructive for other regions. Nonetheless, there is growing uncertainty as to how classification systems constructed from a European perspective may affect businesses in the Asia-Pacific region. For instance, the EU’s agriculture-related green taxonomy criteria focus mainly on greenhouse gas reduction, whereas sustainable farming practices and biodiversity-focused techniques are agricultural priorities in Asian markets.

The EU’s disclosure regulations also have very stringent classifications for green versus non-green activities. Applying these principles in the Asia-Pacific region would mean that sectors and companies that do not meet the highest standards of “green” activity will be prevented from receiving funding on all their projects. This is problematic as it would exclude those that have the potential to significantly scale up their sustainability practices. Such factors risk discouraging investment in transition activities, which are crucial for decarbonising emerging markets in the Asia Pacific.

Beyond benchmarks relating to sustainability, there are significant divergences in global regulations when it comes to environmental, social and governance (ESG) risk assessment standards and priorities. For example, the UK emphasises climate risk mitigation in its regulatory statements, whereas regulators in Singapore and Hong Kong have focused on broader environmental considerations. The regulations also vary in terms of the scope of examined exposures, timeframes, and granularity of analyses.

Asia’s policymakers in recent months have stepped up efforts towards international coordination on taxonomies, as evidenced by the ongoing talks between the European Investment Bank and People’s Bank of China to align their definitions of green finance. Nonetheless, we are a long way away from developing a common global framework that allows flexibility for regional specificities. It would therefore be imperative for Asian investors to examine global green finance regulations within the context of local operational realities in the coming years. This would enable them to make informed comparisons between different needs of developed and emerging markets.

Sustainability reporting conundrum

Asia’s slow progress in developing robust region and industry-specific sustainability definitions and metrics can have other unintended consequences. The currently fragmented global ESG reporting regime has created a dynamic ecosystem of standard setters, data aggregators and third-party risk providers. Depending on their proprietary processes of aggregating data and rating companies, these entities often define ESG topics differently and apply varied approaches in their ratings and assessments.

The range of methodologies means the information provided to investors about a company’s sustainability performance can be skewed. These issues pose unique challenges to companies in Asia. Businesses are likely to receive mixed signals about what actions are expected of them, and which will be valued by the market. Consequently, they will set their ESG reporting priorities either to counterbalance or reinforce the narrative told by the ESG ratings and analytics providers. Their actual ESG performance will therefore neither be reflected in the issues that are most material to company performance nor accurately reflected in share prices.

These issues have the potential to erode the long-term efficacy of green finance in Asia. To mitigate the impact of such challenges, foreign investors and companies will need to map their exposure to market-related ESG issues and focus their risk management on what matters most in the local context. This will involve a risk-based approach to third party and supply chain screening, and efforts to identify and gather the appropriate data to inform their ESG reporting priorities and processes.

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