The Future of Sustainable Finance in Canada

Recently, the Office of the Superintendent of Financial Institutions published a Guideline on Climate Risk Management for the financial industry. The main points of the guideline are that the Canadian financial industry should minimize its climate-related risks and tie executive payments to meeting climate-related objectives. Furthermore, they should disclose their climate strategies and their emissions, including financed emissions.

In general, this seems to be a decent approach to climate risks for the financial industry – one of the main topics of sustainable finance. However, it also demonstrates that the general state of sustainable finance in Canada can be described as “too little, too late.” If this was published in 2016, one year after COP 21 in Paris and in parallel with the Recommendations from the Task Force on Climate-related Financial Disclosures, it would have demonstrated leadership. However, it was published at the beginning of March 2023.

In contrast, the European Union, for instance, released its Sustainable Finance Guidelines two years ago. It includes a clear guideline on what is accepted as sustainable finance and what is not, in contrast to mainly asking the financial industry to start disclosing their climate-related financial risks. Furthermore, the goal of this activity is to make sustainability considerations an integral part of the EU’s financial policy to support the European green deal.

The State of Sustainable Finance in Canada Today

What is missing in Canada is exactly this connection between financial activities and policy to support a transition to a low-carbon economy. What we have instead is an approach that mainly addresses sustainability and climate change from a financial risk perspective.

“We have seen an increase in fossil-fuel finance by some of the major Canadian banks since COP 21 in 2015.”

Thus, the Canadian banking industry officially supports a transition to a low-carbon economy and even net-zero activities. On the other side, however, we have seen an increase in fossil-fuel finance by some of the major Canadian banks since COP 21 in 2015. These activities put Canadian banks continuously on the radar of organizations that analyze financial activities that contradict climate goals and even caused the Canadian Competition Bureau to investigate one of the major banks over false or misleading environmental claims.

Furthermore, we have not seen the implementation of any proposals to use sustainable finance for a transition to a low-carbon economy in Canada. These proposals include those of the Expert Panel on Sustainable Finance and the Capital Mobilization Plan by the Institute for Sustainable Finance. They present great ideas, but what is missing is their transformation into practice.

Also, in the growing field of green bonds, Canada does not play a major role. Globally, Canada is ranked 11^th regarding green bond issuances. Furthermore, the Canadian focus is on so-called transition bonds that finance industries’ transition toward reduced emissions that do not have to be in line with global and domestic climate goals. This means that this focus has not been useful because transition bonds use weaker sustainability criteria than green bonds.

“Canada is seen as a laggard rather than a leader in sustainable finance.”

Finally, as demonstrated above, climate-related risks are still not seen as risks that should be regulated by the financial supervisor. The guideline describes these risks as unique and not useful for a one-size-fits-all approach. This is just a denial to accept sustainability risks as real for the financial industry. No regulator or supervisor would argue that, for instance, capital requirements are unique and that each bank should come up with its own strategy to manage them.

As a consequence, Canada is seen as a laggard rather than a leader in sustainable finance. Exceptions might be sustainable finance approaches used in international development finance, impact investment, and sustainable finance activities of several Canadian credit unions.

The Challenges for Sustainable Finance in Canada

Hence, what are the challenges of sustainable finance in Canada? With regard to climate finance, the challenge is the same as the one that exists for Canada’s climate change strategy: the importance of one of the highest emitting industries in Canada and the world – the Canadian fossil-fuel industry, and the failure to address climate-related issues of the industry appropriately.

Even bigger than the fear that the Canadian financial industry might suffer from climate-related risks is the fear to harm the fossil-fuel industry. There is no sustainable finance-related strategy on how to transition this industry to a low-carbon industry except for carbon capture and storage, which will not solve the problem and is expensive.

Consequently, a guideline about which industry activities are in-line with climate goals and consequently should be financed might make more sense than a disclosure and strategy guideline for the financial industry as published by the Office of the Superintendent of Financial Institutions.

“Though innovation that addresses emission reductions is supported, the implementation of big projects addressing sustainability and climate change is missing.”

Another challenge is missing government initiatives that create collaboration between public and private financiers with regard to sustainable development and climate change. We need to keep in mind that Canada is ranked 203 out of 209 countries in the world regarding per capita greenhouse gas emissions. To increase this ranking, collaboration is needed.

However, though innovation that addresses emission reductions is supported, the implementation of big projects addressing sustainability and climate change is missing. Why should private banks, lenders and financiers put their money into sustainable projects and activities if the government is not doing it? This challenge, however, might create opportunities.

Opportunities for Sustainable Finance in Canada

The problem of transitioning the fossil-fuel industry should be seen as an opportunity. It might allow for investments that support a real transition in line with official climate goals.

In terms of implementation, what about a model that is used in other countries that has a public financier collaborating with the financial industry in financing sustainability-related activities, such as the installation of heat pumps, large-scale public transport infrastructure such as a rail corridor between Windsor and Ottawa, or renewable energy projects, for instance, in places that rely on fossil fuel production? Such activities would help align the financial industry with climate and sustainability goals and help to reduce financial risks for private and public partners.

“The income generated by the carbon tax could be used to support sustainable finance activities to reduce emissions.”

Another opportunity might come from carbon pricing and the Canadian carbon tax. The income generated by the carbon tax could be used to support sustainable finance activities to reduce emissions. As mentioned above, this might take place through a public-private partnership.

Furthermore, Canada is among the leaders regarding the United Nations Sustainable Development Goals (SDG). This might be an opportunity to come up with financing mechanisms for the SDGs that are urgently needed in the fields of economic, environmental, and social sustainability.

In recent years, ESG (environmental, social, governance) indicators have become a major part of conventional finance, for instance, for institutional investors. Though it is still unclear what the effects of this integration are, it might present a good opportunity to grow sustainable finance.

Finally, Canada still has a stable financial sector. We should try our best in keeping it stable but should also introduce sustainable finance.

What Canada Must Do for a Sustainable Economy

It will not be easy for Canada to become a leader in sustainable finance. However, a first step might be to accept the challenges as opportunities. For instance, we need to address the elephant in the room: climate change related to fossil fuel production and use. We need collaboration between the federal and provincial governments, the financial sector and high-emitting industries to mobilize sustainable finance for a real transition to a sustainable economy.

“We do not need more workshops, panels and working groups discussing new sustainable finance ideas; we need to apply them.”

This will include implementing ideas that already exist but have not been translated into practice. Innovation is not the problem of sustainable finance, it is scaling it up. We do not need more workshops, panels and working groups discussing new sustainable finance ideas; we need to apply them.

We also need to develop strategies to invest in the SDGs where we are still facing challenges, such as climate action, life on land and partnerships for sustainable development. These are goals Canada needs to work on and consequently require financing. Again, these might be sustainable finance opportunities, not risks.

To build on current development, Canada needs to analyze the effect of the increasing use of ESG approaches in finance. We need to test whether these approaches really create a change to a more sustainable direction and how supervisors and regulators can monitor whether the ESG approaches are used in a serious way or not. To do so, we need to test whether they really contribute to achieving sustainable development.

“Canada needs to implement measures to prevent greenwashing and the reporting of mainly positive sustainability indicators.”

With the increasing use of sustainable finance approaches, Canada needs to implement measures to prevent greenwashing and the reporting of mainly positive sustainability indicators. At first, sustainability reporting needs to be mandatory. Only then can reporting organizations be held responsible for their disclosure. There must be regulatory consequences if, for instance, the main part of a financial portfolio is exposed to climate risk, but the reporting organizations only report on a small part of their green investments.

However, reporting is not the only problem here. We need to introduce sustainability performance measurements that are in line with scientific climate goals. If financiers report about their sustainable finance activities, we should not focus on how they report them but on what the consequences of their performance are. Hence, we need to implement sustainability-related risk indicators and make them relevant for financial regulators’ risk assessment.

There are also sustainable finance opportunities through Canadian Crown Companies, such as Export Development Canada, Business Development Bank of Canada, the Canada Pension Plan Investment Board and others. Luckily, we see some great sustainable finance initiatives in these organizations, but there is still room for improvement. Strict sustainability criteria should be used to make sure that only clients that are in line with sustainability and climate goals are financed.

To summarize, there are many challenges related to sustainable finance in Canada. However, if we see the transition to a sustainable and low-carbon economy as an opportunity, Canada might be able to play a stronger role regarding sustainable finance.