Leakage in the Common Ground: How Misalignment in Sustainable Finance Taxonomies Impacts Cross-Border Capital Flow

Abstract

There is an urgent need to direct capital towards climate change mitigation in emerging markets. To enable this, developed countries can endorse the common ground between their taxonomies and those in emerging markets while potentially creating policies and investment incentives to guide global capital in that direction. However, little is understood about the impact which taxonomy misalignment may have on the effectiveness of endorsing the taxonomies of emerging markets. In response, we analyze how misalignment can occur between taxonomies and construct a micro-economic model, to show that four ratios (green bond price ratio, supply elasticity ratio, taxonomy misalignment ratio and preferential treatment ratio) should be considered to ensure the policy is not counter-productive to climate change mitigation.

Keywords: Green finance, sustainable finance, common ground, taxonomy, misalignment, leakage, cross-border capital flow

JEL Classification: G15, G18, F35, F42, Q50