Although Canada’s policy-makers often like to boast that this country sets high standards in realms such as peacekeeping and setting global policy, Canada is not a leader in sustainable financing. This country is proving to be a world-class polluter – and a second-rate funder of climate-change solutions.
The federal Expert Panel on Sustainable Finance published a discussion paper in late October that examines the prospects for transforming Canada’s resources-heavy economy into a greener, cleaner model. The driving force behind the transformation is the Paris Agreement – an international pledge to try to limit global warming to 2ºC above pre-industrial levels by curbing carbon emissions.
To get there, Canada has committed to cut greenhouse gas (GHG) emissions to 30% below 2005 levels by 2030 – a challenge that could require investment of upward of $2 trillion in that period. (The estimated global investment requirement to meet the goals of the Paris Agreement is $100 trillion.)
Figuring out what needs to be done to finance this economic transformation is the expert panel’s primary goal. The panel plans to host consultations on the issues raised in the discussion paper, with the goal of providing the federal government with recommendations by next spring.
The resources-heavy nature of Canada’s economy means this country ranks as the fourth-largest emitter of GHGs among the countries that make up the Organization for Economic Co-operation and Development (OECD), despite being the 11th-largest economy. In per capita emissions, Canada trails only the U.S. and Australia, with per capita emissions in 2015 coming in at 20 tonnes of carbon dioxide (CO2) equivalent compared with the OECD average of 12.1 tonnes.
According to the expert panel’s report, Canada’s biggest culprit is the oil and gas industry, which accounts for 26% of annual CO2 emissions. Although emissions from the other major sources of CO2 emitters – electricity generation, transportation, buildings, heavy industry and agriculture – are projected to decline in the years ahead, the oil and gas industry’s are projected to grow.
The high carbon intensity of Canada’s economy is reflected in the composition of the stock market and investment funds focused on Canada. The report indicates that the companies that compose the S&P/TSX 60 index are consistent with a scenario in which average global temperatures rise by 4.6°C by 2100, according to Mirova, an investment-management division of Paris-based Natixis Distribution LP focused on responsible investing (RI).
Furthermore, the report notes, estimates from New York-based asset-management giant BlackRock Inc. states that MSCI Canada index-based ETFs have higher carbon intensity than most of the other ETFs BlackRock reviewed. That intensity is due to the index’s high exposure to the resources sector.
Moreover, the expert panel’s report indicates, Canada trails its counterparts in Europe in making investments in clean energy (such as wind, solar and biofuels), investment that would aid the transition to an increasingly energy-efficient, low-carbon economy.
On other measures, Canada’s financial services sector trails the world’s leaders in sustainable financing. Overall, the expert panel’s report concludes, Canada lags first-world economies in scale and the pace of growth in these matters, even though such financing is increasing.
“While Canada is making progress, it is not as far along as many of its G7 peers, [which have] more cohesive strategies in place,” the expert panel’s report states.
For starters, Canada’s Big Six banks rank in the middle of the global pack in the proportion of revenue derived from “green” lending – and are behind the world’s leading banks by a “substantial margin,” the report states.
For example, Bank of Montreal (BMO) is by far the leader among Canada’s banks, with an estimated 1.1% of revenue coming from green loans; followed by Bank of Nova Scotia, at 0.5%; and Royal Bank of Canada, at 0.3%. But even BMO is well behind Citigroup Inc., the global leader, which generates an estimated 3.4% of revenue from green lending.
Canada’s asset-management industry also trails the world’s leaders in adopting RI practices, the expert panel’s report states. The share of assets under management (AUM) held in Canada that adhere to RI principles rose to 38% in 2016 from 31% in 2014 – ahead of the global average but well behind Europe, where more than half of AUM follows RI principles.
Canada ranks 10th globally in green bond issuance, the report notes, lagging the relative size of the Canadian debt market, which ranks eighth in the world.
The expert panel found that the weak momentum in Canada for sustainable financing stems from both a lack of understanding about the size of the potential market and the speed of change that will be needed for Canada to meet its Paris Agreement commitments.
The underlying uncertainty about the need for – and potential payoff from – investments in projects and technologies that could help transform Canada’s economy onto a more sustainable long-term footing discourages sustainable investing and finance.
Several factors reinforce traditional investing approaches, the expert panel’s report suggests. For example, the trend toward passive investing produces strong flows in Canada into index-based funds that are very carbon-intensive. This trend, in turn, reinforces corporate strategies that are not consistent with a transition to a low-carbon economy.
“Traditional market-based benchmark indices remain a dominant driver of investment allocation,” the expert panel’s report notes. “Most benchmarks today are not constructed with climate or sustainability criteria, nor is there transparency into their climate impact or carbon exposure. As a result, many of the core benchmark indices currently in use are believed to represent 4ºC-5ºC scenarios.”
At this point, many investors aren’t adjusting their strategies with an eye toward the long-term effects of climate policy. Instead, investors plan to shift their portfolios when the effects of climate change become more tangible, the report states.
Similarly, the absence of established metrics for factoring in sustainability considerations, combined with lack of expertise among lawyers, consultants, auditors and credit-rating agencies that support the financial services sector, is stalling the growth of sustainable finance, the report suggests: “Client and shareholder engagement on resiliency and climate issues is relatively low. There is limited scrutiny or pressure from financial regulators on these topics, and low knowledge and capacity on the part of auditors and advisors.”
In addition, the expert panel’s report notes: “Outdated perceptions about the materiality of [environmental, social and governance (ESG)] issues within the scope of fiduciary duty may be hindering responsiveness to risks and opportunities.”
The growth of financing with an ESG component in Canada is likely to remain halting without prerequisites that encourage change, the report states. These include greater certainty regarding climate policy, such as a price for carbon emission costs; more accessible data on emissions and climate that can be used to inform investment, lending and insurance decisions; and more stringent demands from regulators for climate-related financial disclosure.
To that end, the Canadian Securities Administrators (CSA) is looking to toughen issuers’ climate-related disclosure obligations. Earlier this year, the CSA published a review of climate-related disclosure, which found that investors believe corporate disclosure related to sustainability to be inadequate.
As a result, the CSA indicates it will consider whether new disclosure requirements are needed; and that it will develop guidance and other educational resources for issuers designed to enhance disclosure about the risks, opportunities and financial impacts of climate-related issues.
The expert panel’s report points out that tougher demands from regulators and investors are likely to push issuers and the financial services sector at large to devote more attention to climate-related issues. But the report also states the introduction of a price on carbon emissions is a critical condition for the financial services sector to embrace sustainability: “A clear price on carbon is arguably the most direct measure for persuading markets to make more sustainable choices.”
The federal government plans to put a price on carbon emissions in 2019, but until that actually happens, the report suggests, the market will remain skeptical: “While Canada is well positioned to play a leading role in sustainable financ[ing], it will require more systematic uptake by top-level leaders across sectors and an overall financial [services] system that considers sustainable growth a normal aspect of everyday decisions and business practices.”