The new ASEAN Taxonomy incorporates a ‘coal phase-out’ classification to support more transition finance

The recently updated, second version of the ASEAN Taxonomy for Sustainable Finance fills many of the gaps that were present in the original version, and highlights some topics that future versions will address. It also provides a clear outline for the conceptual framework to guide alignment of responsible finance across a diverse range of countries.

As a start, the new ASEAN Taxonomy provides clarity on how different degrees of ‘greenness’ should be interpreted. It remains up to each ASEAN member state whether to adopt its Foundation Framework (FF) or the Plus Standard (PS). The former offers the simplest type of traffic light taxonomy, under which economic activities are categorized as either ‘included’ or ‘excluded’ from the taxonomy. The middle ground (‘amber’) is reserved for activities that are otherwise ‘green’ but cause some harm which is still to be remediated.

 ‘Green’ activities must meet one of four environmental objectives without adverse impacts to the other three. These are: decarbonization pathways; climate change impact mitigation and adaptation; natural capital and biodiversity; and transition to the circular economy. They also must meet environmental criteria relating to doing no significant harm (DNSH), remedial measures to transform (RMT), and social aspects (SA).

DNSH and social aspects are a common feature of many taxonomies, and these include requirements relating to social safeguarding around human rights and labor rights. It is also common for taxonomies to require that the achievement of one environmental objective has no negative impact on another.

The RMT, however, are somewhat unique for the ASEAN Taxonomy in that they allow for mitigation efforts to offset harm being caused. This flexibility is necessary for the range of developing, emerging and high-income countries that make up the ASEAN region.

The ASEAN Taxonomy also expands the range of taxonomies further through the Plus Standard. To the green & amber colors (red being activities that don’t align with the taxonomy), the PS adds a second tier for amber to differentiate between ‘transitioning’ activities that do mitigate harm (Tier 2) and those that do not (Tier 3). The top tier (Tier 1) includes ‘green’ activities that don’t have unremediated harm attached to them (otherwise they would be included in Tier 3).

A unique feature of the ASEAN Taxonomy is the explicit categorization of coal phase-out activities in the ‘green’ and ‘amber’ categories. For phase-out that is complete by 2040 the taxonomy allows for ‘green’ classification, while later phase-out by shortly after mid-century is categorized as amber and includes the possibly contentious allowance for new coal plants installed by the end of 2027. The IEA, by contrast, has said in its Net Zero by 2050 report that “from today, [there should be] no further final investment decisions for new unabated coal plants”, so there are conflicts already between the ASEAN Taxonomy and guidance from international organizations such as the IEA.

The hopes for the traffic light system that the ASEAN Taxonomy uses, and the inclusion of coal-fired power retirement, is that it provides guidelines for what speed of transition away from currently producing plants is sufficient to get a ‘green‘ or ‘amber’ classification. Without financing for the transition that focuses on the communities affected, there is likely to be a slower transition than is needed to meet Paris Agreement and global Net Zero goals.

The taxonomy also contains automatic inclusion as ‘green’ for plants subject to the Energy Transition Mechanism (ETM) and Just Energy Transition Partnership (JETP). This is designed to accelerate development of these programs by widening the range of investors and financial institutions that can participate. The inclusion of many coal phase-out projects in the taxonomy classified as either green or amber is a trade-off based on an expectation that favorable classification of these projects will remove the barriers to financing the transition away from coal.

The purpose of including a wider range of activities in the taxonomy compared to, for example, the European taxonomy is that a narrower taxonomy may not cover as much of an emerging or developing country’s economy when compared to a developed economy like those in Europe. Having a wide spread of green and unsustainable activities that each account for a sizeable share of total economic activity can lead to a dichotomy in financial markets.

On the one hand, ‘green’ finance is attracted to a limited range of projects for which opportunities may not grow as quickly as the investable capital seeking ‘green’ investments. On the other hand, investors and companies that aren’t focused on sustainability may have no incentive to engage with sustainable and responsible finance because the gap between current opportunity and the thresholds is too wide to be bridged.

The ASEAN taxonomy addresses this with the intermediate ‘amber’ classification. It also allows more variation in the technical screening criteria evaluation for the Foundation Framework and Plus Standard classifications. Finally, individual ASEAN member states are able to decide their own schedules for the phase-out of Tier 3 (‘amber’ projects with unremediated harms) and move at a different pace for different activities.

The overlapping layers, not to mention intersection of the ASEAN-wide taxonomy with individual country-level taxonomies, leaves something to be desired in terms of simplicity when compared to ‘bright green line’ taxonomy, where activities can’t be different ‘shades of green’. The flip side of the complexity of a traffic light system that makes allowances for different national-level priorities is that in some respects it better reflects the realities of the global economy.

Although the transition is often talked about as being a singular process, it will unfold in different ways in different countries based on different starting positions and historical emissions. The necessity of the goal of rapid transition is indisputable, but the process and timeframe for getting there – including making that process equitable – is more complex than it is often portrayed. There is utility in having clarity about what the expectations and standards for the transition are in different regions in order to advance the negotiation towards operationalizing the targets and pathways that have been laid down in the Paris Agreement and subsequently.