A Defining Challenge for Global Green Finance

Imagine you’re an investor who wants a more environmentally-friendly portfolio. How do you know if your investment is “green” enough, or whether your investment is “green” at all?

This gets to a perennial problem for green finance—deciding what constitutes green. At a basic level, green finance usually refers to financial investments that flow to environmentally-friendly activities and low-carbon technologies. But across the financial world, there’s growing momentum to come up with more rigorous, transparent standards and definitions for green finance.

If the world is going to mobilize the massive amount of private capital needed to address climate change, it will need a common understanding—and a common language—for what is being financed.

Last week, the UK Treasury  announced  the formation of a new independent body that will oversee the development of a “green taxonomy” of environmentally sustainable projects, following a similar effort from the European Union. Back in March, the governor of the People’s Bank of China, Yi Gang, said that “the primary goal of the central bank over the next five years was to implement and standardize a green finance system in the country in coordination with global partners,” according to the  Financial Times . This isn’t merely an academic exercise. If the world is going to mobilize the massive amount of private capital needed to address climate change, it will need a common understanding—and a common language—for what is being financed.

It matters that investors have confidence that their money isn’t being “greenwashed,” going into investments that are erroneously labeled green without verification. Furthermore, investors need coordinated international standards and definitions to reduce the inefficiency, complexity, and transaction costs that result from fragmented green standards.

However, figuring out what counts as green can be a tricky exercise. China, for example, has issued several  frameworks  for defining green finance—one for green bonds, green lending, and green industry. But these frameworks are not fully harmonized amongst themselves, nor with international standards.

Investors need coordinated international standards and definitions to reduce the inefficiency, complexity, and transaction costs that result from fragmented green standards.

The European Union is grappling with its own set of issues. Its EU Taxonomy for Sustainable Activities mandates that projects that receive the green label will need to satisfy some environmental metric, such as climate change mitigation or biodiversity protection. But there is still intense  disagreement  over how certain industries and projects, such as nuclear and gas-fueled power generation, should be classified. Moreover, many EU companies do not collect good quality data on environmental metrics, making compliance with the taxonomy difficult.

The good news is that there is now unprecedented global momentum to define green. China recently  announced  that it is working with the European Union to converge their green taxonomies. The United States and China will  co-chair  the G20 sustainable finance study group this year, and green standards are poised to be on the agenda at the upcoming G20 summit this October.

Still, much more work needs to be done. At the national and subnational level, there needs to be a bigger push for disclosure and good quality data collection. There also needs to be a greater emphasis on incorporating biodiversity impacts into green definitions and standards. At the international level, the drive for harmonization of green standards needs to overcome some considerable political obstacles and vested interests from industry lobbies. But if firms, civil society, and policymakers around the globe succeed in harmonizing the many definitions and approaches to green finance and develop a common understanding in the process, it will be an important step forward in the road to net zero.