Defining green: Malaysia’s big step towards sustainability

Climate change presents both risks and opportunities for financial institutions and the financial system as a whole. Banks lend to many industries that are physically affected by extreme weather events caused by climate change. Rising sea levels, changing weather patterns and severe flooding can destroy infrastructure, disrupt supply chains, and affect the ability of borrowers to repay loans. 

On the other hand, climate change also presents opportunities to increase the range of financial products and services for renewable energy, green buildings, and climate-smart agriculture and cities. This is important because the financial sector has a key role to play in directing capital flows to support activities that can help countries transition to a low carbon economy.  

But how do banks decide where to lend if they don't know what is green, environment- or climate-friendly? How can corporates issue green bonds if they cannot distinguish between green and non-green? How can asset managers respond to their clients’ preferences for green investments if there is no formal and agreed-upon definition?  

A green taxonomy – a classification system that identifies activities or investments that deliver on priority environmental objectives – fills that gap by helping financial sector participants, whether banks, financial institutions or investors, determine whether an economic activity or project qualifies as environment-friendly or not. Such a system allows them to tag their assets consistently and engage in accurate and transparent tracking and reporting.

Malaysia zeroes in on climate risk
On December 27, 2019, the central bank of Malaysia – Bank  Negara Malaysia (BNM) – launched a discussion paper for the development of a national green taxonomy. This followed Governor Nor Shamsiah Mohd Yunus’s keynote speech at the Regional Conference on “Climate Change Risks and Opportunities: Respond, not React” on September 25, 2019. 

BNM worked with the World Bank and the Malaysian Securities Commission (SC) to develop the principles that would support the Malaysian green taxonomy and help Malaysia’s financial sector classify green assets transparently and consistently. BNM is inviting feedback on the paper from relevant stakeholders. 

Green taxonomy: The missing link
The need for a green taxonomy in Malaysia became apparent during the development of Value-Based Intermediation guidelines, which aim to encourage banks and financial institutions to consider sustainability when assessing transactions.  Local Islamic banks identified the absence of a green taxonomy as a major hurdle in implementing sustainable finance in Malaysia. Without a formal, agreed-upon and practical taxonomy, market actors have to make a judgement call on what’s green and what’s not, which leads to a lack of comparability, transparency and accountability. 

Some regulators around the world have already focused on this issue. On March 9, 2020, the European Union (EU) Technical Expert Group on Sustainable Finance published a report that contains recommendations relating to the overarching design of an EU Taxonomy. Currently the EU Taxonomy only focuses on climate change mitigation and adaptation although other environmental objectives are expected to be tackled in the near future. 

The Green Finance Committee of China Society of Finance and Banking, a subsidiary of the People’s Bank of China, published a Green Bond Endorsed Project Catalogue in 2015 defining the scope of green investment projects for banks. There are a number of other green taxonomies in China issued by different authorities for different jurisdictions. 

The Bangladesh Bank developed guidelines for green banking and identified green products eligible for financing by banks and financial institutions in 2017. 

A Malaysia-specific taxonomy
Malaysia’s financial sector regulators have decided to develop their own taxonomy, while learning from other international and national experiences. It will be important, however, to ensure that the taxonomy is aligned with international best practices and science-based definitions to avoid Malaysian financial institutions, issuers and asset managers from being left behind as the rest of the world converges towards a global standard. 

This is where the World Bank, with its global reach and convening power, adds value. In the coming weeks, the Bank is launching a global guide on how to develop a national green taxonomy based on lessons learnt from engagements with a number of countries, including Malaysia. 

The Bank is also leveraging its experience in sustainable development, including issuing fixed income securities with triple-A risk-adjusted returns, pioneering the issuance of Green and Blue bonds; intermediating disaster risk transfer transactions to help countries adapt to climate change; and advising governments on the development of sustainable bond markets. In Malaysia, specifically, the World Bank facilitated the issuance of the first green sukuk in the world.

Sustainability is the currency of the future and charting the path towards greener development will be key for any country keen to pursue and further that goal.  For Malaysia, this step is a key move that could spell more progress for sustainable development and the process of greening the financial sector.