Fund managers are increasingly looking to incorporate ESG and environmental impact considerations into their portfolios, but they need clear definitions to understand what they are investing in – and to ensure those bonds, stocks or indexes live up to their promises.
The sustainable finance sector has been growing in popularity, and as more firms factor climate change risk into their bottom line, Canada is working to find its place in the world of ESG (environmental, social and governance).
“Many of those taxonomies are just leaving blank or excluding many of the key parts of the Canadian economy,” said Laura Zizzo, founder and CEO of Mantle314, a climate risk management consulting firm.
“The made-in-Canada approach … is key to the international conversation so that we can allow these sectors that are seen as sort of a ‘bad’ sector to contribute and to transition,” she said.
That international conversation has been going on for years and includes initiatives such as the United Nations-supported Principles for Responsible Investment and EU Green Bond Standard, among others.
But while those efforts to set up standards and create definitions for ESG and sustainable finance (known as a taxonomy) include global input, they’re largely centered on Europe and European economies.
In 2019, a Canadian expert panel on sustainable finance released a report noting the lack of transition activities for heavy industries in the existing taxonomies, which is a problem for the country’s sustainable finance efforts.
It found Canada would benefit from having input into a green taxonomy that incorporates the Canadian perspective.
The Canadian Standards Association has taken on a lead role in those discussions, as per the expert report’s suggestion that the agency work with the federal government to develop a clear taxonomy for green and low-carbon economy transition fixed-income products.
Discussions are in very early stages as of this writing, and remain open ended.
The goal isn’t necessarily to create a separate standard for Canadian issues, but rather to understand what’s needed and what can be adapted from existing taxonomies to create a definition that makes sense for Canada, and one that allows the country to participate in the ongoing international ESG discussions.
“It’s very similar to what we’ve seen in the green bond space, the emergence of the idea of a transition bond, or something that’s a bit broader,” Zizzo said.
According to Divya Bendre, who leads Sustainable Bonds advisory for HSBC in the Americas, the main concern when it comes to a Canadian taxonomy is around the proliferation of competing and sometimes conflicting standards, which is confusing for market participants. Some Canadian issuers who are active in both domestic and international capital markets are also concerned about the risk of the Canadian standards being perceived as a “light green”.
“What they (the issuers) would like to see is the development of standards for activities and sectors that are key to the North American economy and have a credible role to play in the global low carbon transition. We have seen the emergence of a few green/climate taxonomies that have enabled near-global market consensus in several key sectors. Multi-stakeholder efforts, like those led by the Climate Bonds Initiative, are ongoing to further enhance this consensus and extend it to other sectors. However, it is true that European and Asian perspectives have driven much of the dialog to date in the green bonds market. For activities that are more prevalent or even unique to our region, North American stakeholders should put a position out there saying: ‘This is how it should look like based on our specific industry experience,’” said Bendre.
They also worry about “green washing,” or the inclusion of sectors that aren’t really green, she adds, noting that HSBC is agnostic on whether Canada needs its own taxonomy.
“What they (the issuers) would like to see is that – if there isn’t an activity in Europe (that) exists in North America – they would like North America to put a position out there saying: ‘This is what we think it should mean based on our deep industry experience,’” said Bendre.
“But they don’t want to be fighting over a particular definition, especially when there’s near-global agreement on certain concepts.”
Zizzo also worries that if there’s a rush to come up with a Canadian taxonomy, the definitions will be too narrow.
Any Canadian taxonomy would need to be fluid and see an initial iteration that will change as the knowledge about climate change evolves, she said.
“We shouldn’t just be applying existing green bond principles; we should be really thinking broadly about how we want to facilitate financial flows and the things that are going to be good for the future,” Zizzo added.
“There’s a real opportunity for those who want to contribute to start being part of the conversation, both in Canada and internationally.”