June 25, 2019

Canada's Expert Panel Report On Sustainable Finance: What's In It For Asset Owners?

“This final Report lays out a package of recommendations aimed at ‘connecting the dots’ between Canada’s climate objectives, economic ambitions, and investment imperatives. The recommendations  seek to leverage Canada’s financial acumen to facilitate and accelerate market activities, behaviours, and structure that—at scale—could put Canada and its key industries at the forefront of the transition to a climate-smart economy.”

Tiff Macklem, Andy Chisholm, Kim Thomassin, Barbara Zvan“Mobilizing Finance for Sustainable Growth”June 2019

Connecting the Dots

The advent of climate change and its related risks and opportunities is eliciting a range of responses around the world, with the Northern European countries leading the way. A little over a year ago, the Expert Panel on Sustainable Finance was given the task to set out what Canada would need to do to catch up with these leaders. After an interim report last Fall, the 4-person Panel released its 59-page  Final Report on June 14. As advertised in the title, this Letter assesses the contents of the Report through the question: “what’s in it for asset owners?” The question is addressed not only from the perspective of asset owners in Canada, but from those outside as well.

The Report is clear about its vision for Canada: to be a leader in the global transition to a low-emissions future, and a trusted source of climate-smart solutions, expertise, and investment. It is also clear about what that will take: a committed alliance between the business, government, civil society, and investment communities. Specifically, the Report makes 15 recommendations organized in three parts.

The 15 Recommendations

PART I. The Opportunity

Change the climate change conversation from burden to opportunity by doing three things:

1. Map Canada's transition path to a sustainable economy: there is a general lack of appreciation for what it will take to achieve an 80% reduction in emissions by 2050. An explicit 30-year transition path would create greater clarity and impetus.

2. Create 'green' savings incentives: the important thing here is to create a direct, visible connection between people saving for the future and Canada's climate objectives.

3. Create a Canadian Sustainable Finance Action Council: with a cross-departmental secretariat to advise and assist the Federal Government to implement the Panel's recommendations.       

PART II. Foundations for Creating Scale

Invest in five essential building blocks to scale and 'mainstream' sustainable finance in Canada:

4. Create the Centre for Climate Information and Analytics: the scope of the Report's system-wide recommendations require a central, authoritative source of climate information and decision analysis.

5. Implement the Task Force for Climate-Related Financial Disclosures (TCFD) recommendations: define and pursue a Canadian approach to doing this.

6. Clarify the scope of 'fiduciary duty': specifically, what is required related to climate change-related issues?

7Foster a knowledgeable financial support eco-system: dimensions of such an eco-system include education, consulting, audit and disclosure.

8. Embed climate risk into the supervision of the financial system: including in monitoring, regulation, and legislation.

PART III. Financial Products and Markets

Given Canada's unique economic make-up, the Panel identified seven opportunities to develop and scale-up market structures and financial products:

9. Foster transition-oriented financing: through green bonds and loans, and through setting a global standard for such financings.

10. Integrate ‘sustainability’ into asset management: this should become      ‘business as usual’ rather than seen as an extraneous, non-integrated    activity.

11. Foster clean-tech financing: lever Canada’s comparative advantages.

12. Foster transition in the oil and natural gas sectors: low emissions and      cost-competitiveness are the keys.

13. Foster building retrofitting: accelerate its development across Canada.

14. Foster sustainability in the infrastructure sector: alignment with                Canada’s long-term growth objectives and leveraging private capital are the keys.

15. Foster the financing of the electricity grid of the future: once again,          leveraging private capital is key.

All this was discussed at an event at Queen’s University in Kingston, Ontario titled “Green Finance: New Directions in Sustainable Finance Research and Policy” immediately after the release of the Expert Panel Report. The 70 attendees were an interesting international mix of academics, government officials, and members of the finance industry.

<Integrated Reporting> is a Strong Recommendation Enabler

One of the discussion topics at the Queen’s event was “Taxonomies, Disclosures, and Fiduciary Duty”, where I argued that the broad adoption of the <IR> Framework by asset owners would be a powerful enabler for a number of the Panel’s recommendations. Readers will recall that the essence of the Framework is to tell an organization’s value-creating story by addressing six questions:

  1. Why do we exist, what capitals do we have access to, and how do we create value with them?
  2. How are we governed?
  3. What is our business model?
  4. How are we performing?
  5. Looking ahead, what risks and opportunities do we see?
  6. What is our value-creating strategy and resource allocation for the future?

Let’s map the Panel’s sustainability-related recommendations to the <IR> Framework:

Recommendation #5: "Implement the TCFD recommendarions". The recommended framework for these climate-related disclosures is very much like that of <IR>. My argument continues to be why focus exclusively on great climate-related financial disclosure? Why not integrate it into great value-creation disclosure for the whole organization?

Recommendation #6: "Clarify the scope of fiduciary duty". The meaning of 'fiduciary duty' is increasingly being determined by 'reasonableness' judgements rather than by prescriptive regulation. The presence of evidence that a risk (e.g., climate-related) is material, means it automatically becomes a fiduciary duty to ensure that risk is captured in an asset owner's business model. The <IR> Framework facilitates this automatic inclusion.

Recommendation #7: “Foster a knowledgeable financial support eco-system”. Broad adoption of the Framework would help expand and strengthen the financial support eco-system. For example, reporting on the sustainability performance of a pension organization’s asset portfolio requires the provision of assurance that the metrics being used (e.g., for carbon emissions) are fair and reasonable. This is just one example of a new demand requiring a supply response from the financial support eco-system.

Recommendation #8: “Embed climate risk into the supervision of the financial system”. As per the comments on ‘fiduciary duty’ above, the ‘reasonableness’ argument requires climate risk be embedded into the business models of financial institutions. As a consequence, it must also be embedded into the supervision of the financial system. If that is not already the case, then the financial system supervisors have some quick catching up to do.

Recommendation #10: “Integrate ‘sustainability’ into asset management”. Our April Letter showed how the Cbus Super Fund has been doing this by explaining what ‘value-creation’ means to them, how their governance structure and their business model both support sustainable value-creation, that they have been successful in actually doing so, and how they plan to continue to be successful in the future. Our May Letter summarized the recommendations for the NY State Common Fund to become a sustainable investment organization, including a 10 year plan to actually get there.

Recommendations #11-15: the Cbus Super Fund business model and the recommended business model for the NY State Common Fund logically lead to the seeking out opportunities in clean-tech and in sustainable real estate and infrastructure investment opportunities.  

I conclude that many of the Panel’s recommendations map nicely into the <IR> Framework and that hence, broad adoption of the Framework by asset owners would be a powerful Panel recommendations enabler. However, the taxonomy part of the discussions at Queen’s University was another story…..

Troubling ‘Transition Taxonomies’ 

‘Transition taxonomies’ received a good deal of attention in the Panel’s Report and also in the Queen’s University conference. To understand why, both words need an explanation:

‘Transition’: a good part of the Report is framed in the context of a ‘Mid-Century Transition Path’. Specifically, it is the period between now and actually achieving a sustainable economy by 2050.

‘Taxonomy’: a classification tool that leads to a standardized definition of a ‘green’ (i.e., environmentally-friendly) investment set by a Taxonomy Technical Committee (TTC).

And why all the attention? Because there are multiple TTCs at work around the world, leading to the possibility of multiple definitions as to what constitutes a ‘green’ investment (good!), or a ‘brown’ investment (bad!). The Expert Panel’s Report explained why this multiple definitions possibility is especially troubling for Canada with its ‘dirty’ Oil and Gas sector a proportionately much larger part of its economy than is the case in most other countries. It could lead to a situation where investments to materially reduce GHG emissions in the Oil and Gas Sector would still be labelled ‘brown’ by a non-Canadian TTC.

This in fact appears to be the case according to the just-released 414-page Taxonomy Technical Report by the European Union. One of its step-by-step paths for a financing to get a ‘green’ rating goes as follows:

  • Is the target for the financing already low carbon?
  • It is OK for the answer to be ‘NO’ as long as the outcome of the financing is a significant reduction in GHG emissions.
  • However, there is another test the investment must pass: “Does the investment lead to a lock-in into carbon-intensive assets?” If the answer is ‘YES’, the investment fails the ‘green’ test.

In words, “the Taxonomy will not include efficiencies in activities which ultimately undermine climate   mitigation objectives…..such as coal-powered electricity generation”. Given this example, it is safe to assume that anything involving oil would meet the same fate.

Both the Panel Report and participants in the Queen’s University conference flagged this as a material challenge for Canada. It would not be a good thing for the country to have all of its Oil and Gas sector    investments geared to reducing GHG emissions labelled as ‘brown’ rather than ‘green’. So what to do? The Panel suggests Canada forms its own Taxonomy Technical Committee with a mandate to consult widely within Canada, compare broadly what is being done outside Canada, and partner/integrate the development of Canada’s taxonomy with those of countries with similar challenges.

Academics to the Rescue?

To their credit, the Queen’s University conference organizers assembled three interesting research-oriented academic sessions over the course of the almost 2-day event. The topics ranged widely from predicting the variation in weather patterns, to measuring the impact of weather events on the liquidity and solvency of financial institutions, to the performance of ESG ratings as risk metrics, to climate change as a driver of strategic asset allocation, to the financial impacts of fossil fuel divestment strategies, to the relationship between share ownership structures and corporate sustainability, and to how investment managers accommodate societal issues in their decision-making.   

These presentations were an important reminder of the role good research should, and often actually does play in making good policy and business decisions. They are also a wake-up call for those academic institutions and faculty members who have avoided the sustainable finance area as a field of study thus far. These institutions and faculty members risk being left behind in an increasingly important field of study in the years and decades ahead.  

What’s in the Report for Asset Owners?

In conclusion, by offering a ’to do’ list of clear action steps, the Panel’s Report is highly relevant for asset owners both inside and outside Canada. The time to leave these steps for another day has passed. The time to act is now.

Keith Ambachtsheer


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