Sustainable Finance: Canadians, Take The Wheel

Essay by Sean Cleary and Ryan Riordan

Earlier this spring, the most in-depth analysis to date on Canada’s changing climate provided clear evidence that Canada is warming twice as fast as the global average. As we increasingly experience the physical impacts (flooding, extreme weather, forest fires), we will experience the financial impacts as well in the form of increasing market risks and unprecedented investment opportunities.

For the financial sector, this is a pivotal moment where it can realign its structures to ensure global capital flows toward solutions that will protect Canada’s economy and prosperity. Canada’s financial community, however, has yet to fully grasp the numerous challenges and opportunities that climate change presents for us in the transition to a low-carbon economy.

On June 14, an independent panel of experts released recommendations on what Canada’s financial system needs to do to support this transition. The key message: we must empower our financial sector to design a made-in-Canada sustainable finance system so that Canadian firms can compete successfully among their global peers over the long term.

In its simplest definition, sustainable finance means aligning all of our financial systems and services to promote long-term environmental sustainability and economic prosperity. That includes channelling investments toward climate solutions and managing climate-related financial risks.

Canada has the talent, resources, and institutional muscle to define sustainable finance for our economy. We need to grow and harness that capacity now if we want to captain our own ship through one of the most significant global economic transitions in history.

Mitigate The Pain, Realize The Gain

According to the Economist Intelligence Unit, a 2C global warming scenario will trigger global financial losses of roughly US$4.2 trillion. With 6C of warming, those losses balloon to $13.8 trillion. That represents about 10 percent of the global assets currently under management.

Losses at this scale will have wide-reaching implications for investors and the asset-management industry. Everyday people who depend on investment income for their retirement will find themselves in dire straits. That includes every Canadian counting on the Canada Pension Plan.

On the flip side, there is tremendous value — some $26 trillion worth — to be gained by shifting economies to avoid worst-case climate scenarios. This represents massive and economy-wide investments in opportunities such as climate-smart infrastructure, emissions-reducing technology, and updated electricity grids. Global investors are already mobilizing capital to take advantage of these opportunities.

The question for Canada is: how do we attract global investment while, at the same time, protecting Canadian assets, investors, and firms from risk?

In essence, this is what sustainable finance is about — harnessing our financial systems to help accelerate the activities, decisions, and structures that will put the Canadian economy ahead of the curve without ignoring the environment.

Living Under Someone Else’s Rules

Other global players are already acting. The European Commission has spent the past two years mobilizing expertise to build a financial system that supports sustainable growth. It has made significant progress in establishing disclosure rules for climate-related financial risk and creating unified definitions (a taxonomy) on what can be considered environmentally sustainable economic activity.

This includes defining the labels and criteria for green financial products, which will, among other things, significantly shape the direction of the rapidly expanding green bond market.

The problem is these rules and definitions are being developed elsewhere and are unlikely to benefit Canada. They may even penalize us, because they are designed for economies significantly different from our own.

For example, there is a current gap, and huge opportunity, to pioneer financial mechanisms and incentives to expedite the sustainable transition of higher-emitting sectors such as oil and gas and agriculture. This requires our leadership.

Rules and definitions are being established elsewhere that may penalize Canada because they are designed for economies significantly different from our own

If we allow others to direct the innovations in sustainable finance, we will find ourselves without the financial tools and structures that Canada’s resource-rich economy needs to determine its own path through a global transition.

The expert panel’s report is our wake-up call. It is time to catch up and get ourselves to the table. Our financial sector — and the broader ecosystem including our accountants, lawyers, and actuaries — needs to start answering some big questions.

What does meaningful, responsible, and consistent disclosure look like in a Canadian context? How do we create incentives and opportunities to draw in private capital to boost clean-tech innovation across our economy and to invest in climate-resilient infrastructure? How do we better assess risk and the value of assets through a climate-smart lens?

We must, and can, build the knowledge and capacity of our financial system to rise to these challenges. We can do this by investing in the research, education, professional training, and collaboration necessary to lift our current generation of professionals to the next level, while preparing an emerging generation to lead.

The Smith School of Business at Queen's University is taking a leadership role in building that capacity through the commitment to establish Canada’s first Institute of Sustainable Finance. As the hub for collaboration and information on sustainable finance in Canada, the Institute will pursue a mission to align mainstream financial markets with Canada’s transition to a prosperous sustainable economy. Hosted at Smith, the Institute will span a continuum of expertise from across varying disciplines, including finance, economics, environmental studies, political science, and others. Its goal is to foster innovative research, education, external collaborations, and partnerships.

For those in the financial sector, sustainable finance is about the future of their industry. For all Canadians, it’s about the future of our economy and well-being. Let’s get started now.

Dr. Sean Cleary, CFA, is BMO Professor of Finance at Smith School of Business at Queen’s University and executive director of the newly-established Institute for Sustainable Finance based at Smith.

Dr. Ryan Riordan is an associate professor and Distinguished Professor of Finance at Smith School of Business at Queen’s University and research director of the Institute for Sustainable Finance.