Abstract
Our paper analyzes whether and how a planner should design a taxonomy for sustainable investment products in the presence of traditional tools for environmental regulation. Barring policy failures for environmental regulation, such a taxonomy can only achieve positive real effects if financial constraints prevent firms from supplying the socially optimal quantity of output. Then, the planner effectively exploits warm-glow sustainability preferences by retail investors to subsidize firms' sustainability investments, thereby relaxing financial constraints. We characterize how the optimal cut-off determining eligibility for a ESG fund interacts with environmental regulation, social costs of externalities, shifts in social preferences, and social norms.