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TMX POV - Earth Day 2021: Taking Stock of Sustainable Finance in Canada and the Road Ahead

TMX POV - Earth Day 2021: Taking Stock of Sustainable Finance in Canada and the Road Ahead

Earth Day 2021 provides a timely opportunity to reflect on the state of sustainable finance and Environmental, Social, and Corporate Governance (ESG) in Canada. Having been involved in sustainable finance and carbon markets for over 15 years, it's remarkable to see what's happened in the past two to three years; as detailed in my previous TMX POV, sustainability has gone from niche to mainstream.

As impressive as the last few years have been, it very much feels like things will only accelerate from this point as more companies bring sustainability into the core of their strategies. We are seeing a growing number of companies making commitments to decarbonize, while at the same time new companies are emerging seeking to develop the technologies and inputs that will enable this decarbonization.

Investors, for their part, are clearly recognizing the value of sustainable business models. A recent study published by The Ontario Securities Commission (OSC) found 33 per cent of self-directed investors said available ESG information helps them make better investment decisions. And on our markets, TSX & TSXV's Clean Technology sector has experienced a 125% increase in capital raised in 2020 vs 2019.

Through these developments, a critical question remains: How will the market evolve from here? The following is by no means a comprehensive list, but is intended to highlight some broad themes that are likely to emerge or become more prominent during the balance of 2021 and beyond.

ESG Disclosure

ESG disclosure has been a consistent theme for at least the last five years and this is set to continue. A recent study by Millani, an ESG and sustainability strategy consulting firm, revealed that in 2019 71% of S&P/TSX Composite Index constituents provided a dedicated ESG report, a 48% increase over 2018. This percentage will likely continue to grow in 2021 and there will likely be greater disclosure from small and mid-market cap firms outside of this index as well.

Improved consistency, standardization and comparability of disclosed ESG data has long been on the wish list of investors. The International Financial Reporting Standards (IFRS) Foundation's recent announcement of the formation of a Sustainability Standards Board should, in time, begin to deliver on this need. Ideally this future standard will eliminate the confusion and burden placed on disclosing companies by replacing the multitude of existing standards, questionnaires and templates with a single harmonized standard. In the meantime, organizations such as The Sustainability Accounting Standards Board (SASB) and The Task Force on Climate-related Financial Disclosures (TCFD) continue to enjoy strong support from investors seeking ESG and climate risk related information.

Net-Zero Investing

The Net-Zero Asset Managers Initiative, which has garnered commitments from over 73 asset managers representing $32T under management, is a great example of this net-zero investing trend. Investors who join this initiative are committing to bringing their portfolios to net-zero by 2050. This is naturally driving investors to look for opportunities to reduce or remove greenhouse gas (GHG) emissions from their portfolios which in turn drives up pressure on companies and assets they invest in to begin to reduce or eliminate emissions, bringing us to our next trend.

Carbon Neutral Commitments

Globally, over 1000 corporations and 126 sovereigns, including Canada, have made net-zero carbon commitments to be met by 2050. Some of Canada's largest public companies from the financial, energy and mining sectors are among the corporations that have made such commitments. This trend seems likely to accelerate in 2021 and beyond as investors and consumers increasingly expect companies to have formal plans in place to address their GHG emissions and move to a lower carbon trajectory.

Interestingly, carbon neutral commitments are also appearing at the product level. Evolve Funds Group recently filed a preliminary prospectus to launch two carbon neutral ETFs which will utilize carbon offsets against the emissions of the companies in the underlying index. This approach builds on earlier low carbon ETFs, such as Desjardins RI Canada Multifactor - Low CO2 ETF which has attracted over $250mm in AUM.

Transition Finance

Transition finance has a particular relevance to resource-intensive economies such as Canada's. Transition bonds and loans are intended to provide capital to enable companies to invest in projects and initiatives that will lower their GHG emissions and accelerate the transition to net-zero. There are a number of efforts in flight to create a transition taxonomy under which these bonds and loans will be issued and in 2021 it is possible that we'll see the first transition labelled bond or loan appear in Canada.

In addition to explicitly named transition bonds/loans, sustainability-linked bonds are also being leveraged as a vehicle to finance the low-carbon transition. Rather than being linked to specific projects or initiatives, these bonds/loans are linked to the achievement of a specific target, such as a percentage reduction in GHG emissions.

Carbon Pricing and Trading

Globally, the carbon market has quintupled in the last five years, reaching an overall market size of nearly $300 billion USD according to a recent report by financial analysis company Refinitiv. The bulk of this is in the European cap and trade market, but the North American markets, namely the Western Climate Initiative cap and trade market (California, Quebec and Nova Scotia), have grown steadily as well, approaching $26 billion USD according to the same report.

In Canada the federal government has provided a clear carbon price signal out to 2030 when it is forecast to reach $170/tonne. It has also announced the launch of a federal carbon offset program which will help to drive low cost emission reductions from the Canadian economy while potentially providing some cost relief.

The voluntary carbon market is also expected to take flight. The Task Force on Scaling the Voluntary Carbon Markets, a group headed by Mark Carney, recently issued a report calling for the rapid scaling of these markets. A recent report from McKinsey & Company forecast these markets to grow to potentially $100 billion by 2030. This forecast market growth is driven by aforementioned carbon neutral and net-zero carbon commitments by corporates and sovereigns. Overall, carbon pricing and trading are very much entering the mainstream.

All said, the next few years are shaping up to be a period of increasing innovation and transformation as the low-carbon transition begins to take hold. I for one am excited about what the next 15 years will bring!

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Andrew Hall

Director, Sustainable Finance
TMX Group

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