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Sustainable Classification System (Green Taxonomy)

February 8, 2019

A Canadian-Specific Standard is Needed

Today, the term sustainable finance refers mainly to public and private funds earmarked to support a transition to a low carbon and resilient economy. This consists of funding activities that will help the current economies mitigate climate change and adapt to a new climate reality in the near- and long-term future. One of the key steps to getting sustainable finance off the ground is a consistent, transparent and practical definition for what constitutes sustainable or climate-friendly activity. This concept has been referred to as a sustainable or green classification system or taxonomy. It is the key ingredient for operationalising the transition to a low carbon and resilient economy in line with the Paris Agreement.

What is Sustainable Taxonomy?

This is a system that provides standard definitions of activities and projects that contribute to a sustainable economy.  While sustainability encompasses a broad range of activities across environmental, social and governance topics, the main priority amongst these activities has been climate change. In general, clear definitions facilitate effective measurement and accounting for various activities, which, in turn, enables accurate tracking and reporting. Current systems within the financial sector do not specifically differentiate sustainability-related activities and therefore, make it difficult to track related financial flows. Therefore, a robust taxonomy is a foundational element for sustainable finance.

Accurate labeling enables the financial sector to more strategically identify and address sustainable growth prospects with a reasonable view of relative risk and opportunity.”

Interim Report Of The Expert Panel On Sustainable Finance, 2018

Is there an Existing Definition for Sustainable Activity?

Current efforts for defining sustainable activities stand on the shoulders of pioneers in sustainable development. For example, multi-lateral development banks have been working on definitions for green bonds since 2007-08. Some of the more recent green bond-related market initiatives are the Climate Bonds Initiatives and Green Bond Principles, but there are also emerging classification systems for other financial activities such as FTSE Green Revenues Classification System.

Some regulators are taking leading roles in transitioning their economies to focus more on sustainability. As part of EU Sustainable Action Plan, the European Commission is working on the development of EU green finance taxonomy specific to sustainable activities. Its first attempts to outline the taxonomy can be found here. The Commission will first define economic activities relative to climate mitigation and adaptation and plans to eventually expand to cover activities relevant to water and marine resources, circular economy, waste prevention and recycling, and pollution and healthy ecosystems.

China also has its own taxonomy for Green Bonds guidelines and has recently made efforts to align it with Western approaches by removing ‘clean coal’ from its guidelines.

Why should Canada Participate?

While the existing efforts in the development of sustainability-related taxonomy are setting a much-needed foundation for sustainable finance, each jurisdiction has a unique economy with different perspectives on possible pathways to transition. For Canada, capturing the transition activities for its carbon intensive sectors is key. Existing taxonomies tend to take a conservative approach to a commonly accepted definition of sustainable/green/climate-friendly economy where transition activities of the fossil fuel industry, for example, are not considered to be sustainable.

A recent study prepared by EY and Corporate Knights commissioned by Toronto Finance International (TFI) confirms that a comprehensive taxonomy is a major gap in development of sustainable finance in Canada and has listed it as a number one priority in its recommendations. The Interim Report of the Expert Panel on Sustainable Finance also identified the gap in existing and emerging taxonomies relative to lack of transition activities for heavy industries and points out that this gap can hinder acceptance of sustainable finance in Canada.

Some work on this is emerging in Canada (see Corporate Knights’ first attempts to such classification), however, there is much work ahead to make this practical for the finance industry.

Lack of sustainable finance standards … was identified by the vast majority of interviewees as one of if not the biggest challenge to overcome.”

Capitalizing on Sustainable Finance, 2018

A key element missing from these emerging frameworks is the notion of transition-oriented activities that fall outside of standard “green” criteria. This has important implications for Canada’s carbon-intensive sectors. It means that potentially productive projects, such as an initiative by a gas company to improve the efficiency or emissions profile of its production process, may be out of scope.”

Interim Report of The Expert Panel on Sustainable Finance, 2018

Next Steps

There is an urgent need to bring Canada’s perspective to the development of consistent, transparent and practical sustainable taxonomy. There are pockets of knowledge on sustainable finance and taxonomy across the country, but a collective effort and uniform voice that represents Canada is clearly lacking.

The Canadian financial sector can lead the development of sustainable finance and taxonomy standard through an organised collaboration in the form of a working group. Such working group can share existing knowledge and support the development of best practices as it represents a key long-term opportunity for the Canadian economy. A recent example of a successful industry working group is the United Nations Environment Programme Finance Initiative (UNEP FI) pilots for the implementation of TCFD recommendations. The working groups were convened by an independent party with expertise in this emerging topic, it pulled together a diverse group of stakeholders and promoted collaboration. The Canadian financial sector responded well with good participation in all three working groups for banksinvestors and insurers.