September 10, 2019
As climate change impacts continue to create havoc around the world in the form of extreme weather changes, the global financial sector is starting to pay attention to what this means for financial stability and future risks. One important development in 2019 has been the identification of climate change as an overlooked threat to the stability of the financial markets. Now important reports like the World Economic Forum’s Global Risk Report as well as financial system reviews from major central banks are finally calling climate change a systemic and financial risk to global stability.
It is in these turbulent times that most countries are trying to map a transition pathway to what the new green economy might look like, and more sustainable economic growth. However, given that a societal-level transition is needed as quickly as possible, the scale of funding required to finance this transition is massive.
The Canadian “Just Transition” Story
For Canada alone, the need is even greater as the economy relies on natural resources and some of these assets are under risk of becoming stranded due to changing financial values and investor preferences – especially with investors opting for responsible investments and incorporating environmental, social and governance (ESG) criteria.
With Canada now warming at twice the global rate, it becomes even more likely that extreme weather events like wildfires, flooding and heatwaves, will also impose a financial burden on the Canadian economy. This is why heavily emitting Canadian industries (backed by the Canadian financial sector) like mining, pulp & paper as well as the oil and gas sector among many others, are in need of a clear yet fast transition strategy towards becoming low-carbon.
Although the government has started addressing this transition through the creation of an expert panel on sustainable finance, the work needed is in terms of a policy overhaul and a clear financial sector strategy to reach Paris Agreement targets. For example, investment in climate resilient infrastructure alone will cost about $186 billion in Canada. Such opportunities can be looked upon as the future where investment needs to be redirected so as to create innovative green industries and finance projects which help transition Canada’s economy.
Overview of the Best Low-Carbon Pathways
Keeping this scenario in mind, we looked into the public policies that the Canadian financial sector might be interested in, in order to implement the transition. Our research started with a comprehensive review of international best policy practises that implemented a strategic pathway for a low carbon sustainable finance transition.
We found a total of 26 strategic policy measures that were currently being implemented across the world – ranging from more financial safety-nets like public guarantee funds to more voluntary measures like climate-related disclosures. Out of these 26 measures, we organized strategies into 13 categories based on type (risk or opportunity), characteristics (type of instrument, stakeholders or voluntary/mandatory etc.) and products & services (asset management, green bonds, sustainable stock indices etc.). These measures are detailed in our CIGI report titled, “Strategies for Integrating the Canadian Financial Sector into Financing the Low-Carbon Economy Transition”.
Our review found that in order to change the financial sector, countries either mandated centralized guidelines through a top-down policy approach or opted for a more voluntary and financial incentives route to encourage proactive behaviour change. However, it was clear that the best way to get financial sector buy-in was to see what worked in the context of that country.
Surveying the Canadian Financial Sector
Hence, we took our study to the next stage by conducting a Canadian financial sector survey of practitioners, to see what strategic policy measures seemed most favourable in the domestic context. Our survey was based on five attributes – usability or general usefulness of the strategy, incentive to increase private sector involvement, creating new business opportunities, improving risk management and increasing reputational benefits.
Our participants ranged from seven financial sub-industries – such as commercial banking, credit unions/co-operatives, insurance, institutional investors, asset management, pension funds and industry associations.
Not surprisingly, the results of the survey highlighted that the financial sector preferred backing policies that encouraged more climate-related business opportunities – especially creating new asset classes or scaling up debt finance through green bonds. It was highlighted that the government needed to provide public guarantees or first-loss insurance for innovative sectors like clean technology that have more early-stage risks.
The institutional investors particularly expressed the need to clarify the connection between low-carbon finance and fiduciary duty as well as improve risk management strategies. Furthermore, having standardizing performance indicators as well as clear guidelines to assess risk and opportunities from climate change were perceived to be useful transition tools.
Overall, we found that the Canadian financial sector preferred to remain autonomous in addressing sustainability transition challenges. However, this may soon be changing given the increasing systemic risk exposure that climate change brings every year to major Canadian financial players like the insurance industry or pension funds, which are now looking at the long-term impacts of climate change on financial stability.