Around the globe, a third of all professionally managed assets, or roughly USD$30 trillion, are now subject to environmental, social, and governance (ESG) criteria, which represents an increase of more than 30% since 2016.1 ESG concerns continue to gain importance in Canada. In particular, sustainable finance has also gained tremendous momentum and institutionalization in the investment, capital markets, and lending communities.
What has changed in recent years is the increased focus placed on environmental and social issues by the investment community, and in particular, by large institutional investors. Banks, pension funds, companies and issuers alike are being pressured by their shareholders, members and investors, and by NGOs, to direct investments to companies viewed as having positive environmental and societal impacts and to “disinvest” from industries and jurisdictions perceived to have negative impacts.2
The following article will provide a high-level overview on sustainable finance and the current trends in Canada.
While there is no agreed upon definition or harmonized measurement of sustainable finance, the Expert Panel on Sustainable Finance has summarized the concept as “capital flows (as reflected in lending and investment), risk management (such as insurance and risk assessment), and financial processes (including disclosure, valuation and oversight) that assimilate environmental and social factors as a means of promoting sustainable economic growth and the long-term stability of the financial system.”3 More generally, sustainable finance is the process of integrating ESG criteria when making decisions in the financial sector and business decisions for the benefit of stakeholders and society. The ultimate goal is to transition to a more sustainable and lower-carbon economy, which is increasingly viewed as critical to the long-term success of businesses, economies and society.
There has been a significant increase in sustainability reporting regulations around the world, both in the form of “soft laws” (such as statements of principles agreed to by nations or industry sectors) to actual legislative requirements (“hard laws”). However, there is no universally agreed framework to measure and report ESG, which makes it difficult for companies, lenders, investors and other stakeholders to make meaningful assessments and comparisons. There is clearly a need for coordination and a need to ensure that the data being provided is relevant, useful, and assessed in the proper context.
Sector-specific reporting such as Sustainability Accounting Standards Board (SASB) and the Global Reporting Initiative (GRI) have become prominent in the energy and mining sector and appear to be emerging and applied to other ESG reporting. According to the Global Initiative for Sustainability Ratings, there were over 125 providers of ESG data by 2016. While the categories and methods of establishing these ratings typically differ from one provider to another, they all strive to measure a company’s performance along the three measures of environment, social and governance.4 Some of the most commonly used providers include: MSCI, Sustainalytics, Bloomberg, Refinitive and FTSE Russell.5
At least six Canadian banks have added ESG components to their chief executive officers’ compensation frameworks, putting them in a small minority of companies that tie executive pay to such measures.6 We expect to see this trend to continue and expand beyond the executive level. On the path to net zero greenhouse emissions and other ESG goals, banks have been providing new products in support of sustainable business practices including:
Green loans are intended to finance or refinance various sustainability or green projects thus allowing companies to align their financing with their sustainability strategies, and facilitate and support environmentally sustainable economic activity. Using a loan to fund green projects is not new but in 2018, the Loan Market Association and the International Capital Market Association (ICMA) developed the Green Loan Principles, a standardized industry framework to finance projects that provide clear environmental benefits.
GSS Bonds are intended to contribute to new and existing projects that have environmental and social benefits, and are usually structured to align to the ICMA bond guidelines and principles: Green, Social or Sustainability and the Green Loan Principles. Sustainability-linked bonds aim to further develop the key role that debt markets can play in funding and encouraging companies that contribute to sustainability (from an environmental and/or social and/or governance perspective). These bonds often align with the ICMA Sustainability-Linked Bond Principles.
Transition financing is intended to help high-carbon companies transition to lower-carbon business models. To support the growth of climate transition finance in line with the 2°C global warming limit goals of the 2015 Paris Agreement, ICMA and Climate Transition Finance published the Climate Transition Finance Handbook and several transition financings either do or should incorporate the recommendations contained therein.
Canada’s Minister of Environment and Climate Change, and Minister of Finance jointly appointed the Expert Panel on Sustainable Finance (the Panel) in April 2018 to explore this field, and to make recommendations to scale and align sustainable finance in Canada.7 In 2019, the Panel made a series of recommendations, one of these recommendations was to launch a Sustainable Finance Action Council. In its 2020 fall economic statement, the Canadian government allocated $7.3 million dollars over the next three years to this Sustainable Finance Action Council.8 The goal of this council will be to develop a well functioning sustainable finance market and to attract sustainable finance into Canada in order to enhance climate disclosures and ensure access to sustainability data and climate risks.
In 2020 the Bank of Canada published a report stating that there will be significant economic risks from climate change and the transition to a low-carbon economy. As a result of this report and the warning of adverse consequences for delayed actions, the Bank of Canada is heavily investing into its work on climate change in 2021. It has since launched a project with the Office of the Superintendent of Financial Institutions (OFSI) with a handful of Canadian financial institutions as participants. Building on previous work on climate-change scenarios for the global economy, the Bank of Canada and OSFI will first develop a set of climate-change scenarios that are relevant for Canada. Using these scenarios, participants will explore the potential risk exposures of their balance sheets. The Bank and OSFI will publish a report, planned for the end of 2021, sharing details on the specific scenarios, methodology, assumptions and key sensitivities.
The 2021 United Nations Climate Change Conference (COP26) will be taking place from November 1-12, accompanied by the COP26 Private Finance Agenda. The goal of this Agenda is for every professional financial decision to consider climate change, particularly by incorporating a form of climate risk management on the pathway towards zero greenhouse emissions by 2050.9
ESG and sustainable finance are predicted to make big waves in 2021, and will be only increasing in popularity in years to come. As the government moves towards the goal of net zero emissions by 2050, it will be important for banks and businesses to stay on top of these developments in order to remain competitive.
Special thanks to Miranda Neal, an articling student in the Dentons Toronto office, for her assistance in preparing this article.