The Big Read

Canada’s largest companies are changing how they invest because of climate change

GATINEAU, CANADA - MAY 8, 2017: The severe flooding on the Quebec side of the swollen Ottawa River. Pointe Gatineau is one of several areas in North America that has suffered flood conditions. Paul McKinnon /

Laura Zizzo recalls a time when sustainable finance was a fringe concept—something that, to companies and investors, implied sacrificing returns for virtue.

The risk-management consultant was studying environmental science at the University of Waterloo about 20 years ago, shortly after the Kyoto Protocol was adopted, advising countries to dramatically reduce carbon emissions by 2050—something they have largely failed to do. “I did the math and said, ‘By 2050, I’ll be in my late 60s,’” said Zizzo. “This is my working life. I’m just gonna work on this challenge.” Back then, people thought Zizzo’s passion around climate change was “cute,” she says. Now, she says she counts some of the country’s biggest financial institutions among her clients.

In the last two decades, the narrative around sustainable finance—that is, how companies assess and limit their impact on the environment and society—and its relation to the economy has flipped. Rather than it being a risk to the bottom line, it’s increasingly seen as vital to it.

But there’s still confusion around how to quantify sustainable finance, why organizations should pay attention to it and what difference it would make for those that do.

That’s why, in spring 2018, the federal government assembled the four-person Expert Panel on Sustainable Finance, tasked with finding ways to make sure money in Canada was flowing to companies that are transitioning Canada’s resource-heavy economy to a low-carbon one. In a press release announcing the initiative, the government warned of “more intense forest fires, storms, and floods” hitting the financial sector if nothing was done.

On Friday, the panel will publish its final report, more than a year after launching a consultation of stakeholders in Canada’s business and financial communities on the economic threats of climate change.

The Logic has learned the report will offer recommendations on standards for tracking and reporting how climate change could impact businesses, making climate considerations part of companies’ routine disclosures to investors, and how taking action on environment, sustainability and governance (ESG) is part of, rather than antithetical to, companies’ fiduciary duty.

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Talking Point

Sustainable finance is no longer a fringe concept: 93 per cent of the largest 250 firms by revenue report their sustainability results. And, the Canadian government, the five largest banks in the country and six of the eight largest pension funds are now abiding by global standards on climate-related investing. Despite the growing consensus, there are no uniform standards governing climate-related investing around the world. The federal government convened an expert panel to try and bring clarity to some of these issues, which will recommend how to formalize climate change investing reporting Friday.

It’s also expected to urge Canada to catch up with its peers—as other G20 countries introduce policies and float regulations on the file—according to Zizzo, who attended a meeting last week at which panel members Tiff Macklem and Barbara Zvan briefed stakeholders on what’s expected in the report.

“There’s the potential for capital to flee Canada,” says Zizzo. “We’re such a small part of the global economy. If we don’t have a strong sustainable finance message, there will be competitiveness concerns for the full economy; investors will just look elsewhere.”

Sustainable finance has moved in from the fringes: 93 per cent of the largest 250 firms by revenue report their sustainability results. And, at the start of 2018, nearly US$31 trillion of funds were held in global sustainable investments—up 34 per cent from 2016—about a third of all assets under management, according to a report by the Global Sustainable Investment Alliance.

“There’s a shift away from this idea that it’s an advocate issue, to now, it’s a business issue,” says Zizzo.

Broadly speaking, sustainable finance means evaluating how a company’s business activities integrate environmental, social and governance standards with the goal of creating long term benefit for both shareholders and society. The federal government is particularly focused on assessing the impacts of climate change when making financial decisions. In May, the Bank of Canada issued a report warning, for the first time, that climate change threatens the economy in a number of ways: “These include physical risks from disruptive weather events and transition risks from adapting to a lower-carbon global economy.”

The mainstreaming of financial climate risk traces back to Mark Carney and Michael Bloomberg. In 2015, the Bank of England governor and former New York City mayor spearheaded a global initiative called the Task Force on Climate-Related Financial Disclosures (TCFD), and its landmark 2017 report. The document lays out 15 climate-related metrics—like emissions levels, water and land use—for organizations to measure and report on, and includes recommendations on how to gauge climate risk.  

The steps organizations take to comply with the guidance is different depending on the industry and company. For a pension fund, it could mean minimizing its investments in energy companies. For an energy company, it could mean developing cleantech to transition away from fossil fuels. For governments, it might mean funding cleantech initiatives.

Since the TCFD released its recommendations, 785 organizations worldwide have agreed to support them.

Canada ranks sixth—behind Japan, the U.K., the U.S., Australia and France—by number of organizations complying with the standards. Its five largest banks and six of its eight largest pension funds are on the list; so is the Government of Canada, the City of Vancouver and the National Bank of Canada.  

Early reports on the TCFD and other ESG initiatives, however, suggest signatories aren’t keeping their commitments.

Only around 25 per cent of companies surveyed for the TCFD’s latest status report disclosed information on five or more of the 11 recommended disclosures, and just four per cent of organizations reported information aligned with at least 10 of the disclosures.

A barrier to reporting, according to 42 per cent of respondents, is the lack of standardized climate-risk metrics in their industries.

“We have a situation where there’s a major disconnect between what information companies are putting out into the marketplace and what is investor-useful,” says Milla Craig, founder and president of Millani, a consulting firm that advises organizations on how to integrate ESG into their businesses.

It’s a problem several players are trying to solve, including the European Commission, which is seeking to pass laws around ESG disclosure. The proposed regulations would create a classification system that details what qualifies as environmentally sustainable economic activity.

“What does it mean, who does it apply to?” says Christine Rhodes, head of EY Canada’s climate change and sustainability services, of the slippery term “sustainable finance.”

The expert panel is expected to offer guidance on how to develop a classification system—or taxonomy—that will answer these questions in a way that’s unique to Canada, rather than leaving companies to emulate policies being crafted overseas.

The Canadian Standards Association (CSA)—which sets standards on things like bridge construction, handling dangerous equipment and environmental protection—has already begun work on this. In April, it formed a task group to study how Canada can create its own standard that suit its economy, while also complying with international standards. “Most green taxonomies developed around the world do not recognize several Canadian natural-resource sectors as being Green or In Transition,” the CSA stated in a notice about the initiative. That distinction could deter global investors from considering Canadian energy companies, for example, even if they’re lowering emissions or transitioning to greener ways of doing business.

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Another barrier to the financial sector’s open embrace of ESG is the lingering concern that it will hurt the balance sheet—or, at least, that investors will perceive it that way.

The Canadian Securities Administrators asked stakeholders about the issue in April. The industry association, which represents financial regulators in every province and territory, held 50 consultations, reviewed 78 issuers on the S&P/TSX and surveyed nearly 100 issuers on the Toronto Stock Exchange about ESG disclosure. According to its 2018 report, respondents were concerned about their fiduciary duty; that “some of the demand for climate change-related information is driven by considerations other than investment considerations, and therefore may not be aligned with the interests of shareholders.”

“One of the biggest issues for the investor community is they have always argued that their fiduciary duty was such that they just needed to look for performance,” says Craig. “There have been some regulatory changes that say, ‘Actually, you can look at not just financial performance, but you should also be looking at these other [ESG] issues.’”

The European Commission, in its 2018 sustainable finance report, recommended that asset managers and institutional investors make ESG factors part of their fiduciary duties. Canada’s expert panel is expected to recommend the same in its report on Friday. “It’s not this other thing you do when you’re done the business stuff,” says Zizzo. “There’s a fiduciary duty to think about these longer-term risks on behalf of beneficiaries … there’s still some confusion around that.”

Like the TCFD, most sustainable-finance initiatives are voluntary. That, too, disincentivizes some organizations from participating. The UN Principles for Responsible Investment (PRI) is taking steps to change that by making TCFD-based reporting mandatory for PRI’s over 2,250 signatories, which together hold US$83 trillion in assets.

Such policies will impact Canada’s financial system, whether or not the country establishes its own policies, says Rhodes. “Canadian companies operate globally—they have global investors, our pension funds are global powerhouses, so we’re all extremely intertwined,” she says. “If you have investors in the EU or other places that are moving forward—who have higher expectations, different expectations about the way in which climate risk or other ESG risk are being managed and reported on—if Canadian companies don’t take notice of that, they’re absolutely at risk.”

Earlier this week, Norway’s sovereign wealth fund—which manages US$1 trillion in assets including 263 investments in Canada worth more than US$28 billion combined—won approval from board members to divest from firms that do oil and gas exploration and production. Companies with renewable energy divisions, including BP and Shell, get to stay in the pension fund’s portfolio.

The expert panel’s mandate was to provide the federal government with recommendations on what it should and can do to encourage sustainable finance. But even if it does recommend regulatory changes, Ottawa may not have much power to enforce them; in Canada, securities are regulated at the provincial level. That doesn’t mean regulation is out of the question. In its 2018 report, the Canadian Securities Administrators floated the idea of requiring disclosure on how companies identify and manage climate-related risks.

“I don’t think, unfortunately, we can rely on policy and politics alone in this challenge, because of the way that democracy is sometimes slow,” says Zizzo, harkening back to her work on Ontario’s cap-and-trade program in 2009; it was signed eight years later, only to be cancelled the following year.

While Zizzo says many companies are still learning the nuances of sustainable finance, many are at least trying to align their businesses with climate priorities, like the Paris Agreement, which aims to limit global warming to less than 2 C above pre-industrial levels. “I finally feel like there’s other people screaming on the top of this sinking ship with us,” she says.