Soon the Canadian Standards Association (CSA) will release its work on what’s called a “transition taxonomy,” essentially a definition-setting exercise for what kind of projects should qualify for transition financing, a branch of “sustainable” financing.
The stakes are high. Finance is under increasing pressure to move money away from activities causing the climate crisis and towards those that give us a fighting chance of meeting the goals of the Paris Agreement – to keep global temperature rise well below two degrees and preferably closer to one point five.
Banks and investors are responding by creating billions in financing accessible to green projects, but there isn’t consensus on what should qualify. This is where taxonomies come in, to come to agreement on what “sustainable” financing means, and also what is “transition” financing for projects that are on their way to sustainable but not there yet.
The devil, as always, is in the details, and with so much money at stake it’s little wonder that there’s pressure to game the definitions to serve the status quo. And this brings us to Canada’s experience to date defining transition finance, and several tough questions:
1. Why did people accept the flawed starting point?
The genesis of the CSA’s transition taxonomy can be traced back to the Expert Panel on Sustainable Finance, created by the Government of Canada and chaired by Tiff Macklem from the board of Scotiabank who would go on to become the Governor of the Bank of Canada.
In its final report, the Expert Panel argued that the emerging international definitions of sustainable finance would exclude Canadian heavy industry and recommended that Canada therefore create its own definitions of “transition” finance so that it would qualify.
Stepping back, this is in fact quite brazen, akin to saying we’ll lower the bar so that we’ll qualify. Yet, this became the accepted direction given by the Expert Panel and permeates the resulting process and product.
2. Why did the process move behind closed doors, run by those with vested interests?
Sustainable finance taxonomies are a matter of public policy, therefore requiring open and transparent deliberation accessible to a wide range of actors. Yet, the Expert Panel sent the work of developing a transition taxonomy to a closed-door process of industry actors convened by the CSA. Around the table are industry and banking representatives heavily vested in Canada’s carbon-heavy status quo, together with civil servants from federal and provincial natural resource ministries.
The CSA released no drafts for public comment, nor did it invite any academics or NGOs to the table who represent different interests.
The CSA is then supposed to send its work to the Sustainable Finance Action Council, another body that finds its genesis in the Expert Panel. But the Expert Panel recommended an Action Council composed of “prominent industry, financial, academic and civil society representatives.” Instead, the government appointed only financial industry representatives, again shutting out civil society and leaving the impression that those vested in the status quo get to make the rules governing themselves.
3. Will Canada become known for giving carbon lock-in a green seal of approval?
The CSA’s work will soon become public, but given the flawed starting point, it’s highly likely that its transition taxonomy will sanction what’s known as “carbon lock-in,” which occurs when investing in carbon-intensive systems perpetuates or delays the transition to low-carbon alternatives.
For example, investing in pollution abatement at an oil refinery may reduce emissions at the refinery itself, but since 70-80% of the emissions occur at the tailpipe, we are locking in those latter emissions by requiring a return on the refinery investment rather than investing in switching to low or no emission fuels. In some ways this is the opposite of transition, keeping capital stuck in fossil fuels when all credible net zero scenarios show we need to be dramatically reducing their production and use.
The EU’s sustainable finance taxonomy safeguards against this directly when defining what qualifies – and doesn’t – as transition financing. It defines transitional activities as:
a) Those for which no low-carbon alternatives are available and have emissions profiles as best in sector; and
b) Those that do not hamper the development and deployment of low-carbon alternatives; and
c) Those that do not lead to lock-in of carbon intensive assets
Indeed, it is probably these safeguards that led the Expert Panel to charge the CSA with developing a different transition taxonomy. What this means is that the CSA may sanction transitional activities that actually hinder the transition, not only perpetuating fossil fuel production under the guise of making it slightly better, but also giving it a green seal of approval for investors.
Bigger picture, this will also be a drag on Canada meeting its climate targets, with capital misallocated to activities that lock in carbon.
4. Will Canada’s trading partners and international investors stand for greenwashing?
In 2021 it came to light that Canada’s major banks extended a billion dollar “sustainability-linked” loan to Enbridge, a pipeline company. How the loan was sustainability-linked was not disclosed, and Enbridge stated it “does not intend to allocate the net proceeds specifically to projects or business activities meeting environmental or sustainability criteria.”
At the time, Enbridge was embroiled in controversy over its Line 3 expansion project, equivalent in emissions impact to 50 new coal fired power plants and opposed by local First Nations who went to court to try to stop it. Given the fungibility of capital inside Enbridge and everywhere, the “sustainability-linked” loan helped finance this project, possibly among the least sustainable activities one could imagine at this point in history.
It was up to the banks to put their green label on the loan, but if the CSA’s transition taxonomy ends up sanctioning this kind of activity, there will be legitimate allegations of greenwashing ringing out from protests outside banks, to boardrooms where investors with honest intentions to reach net zero find Canada’s approach wanting, to EU regulators who are confronted with a competing taxonomy so much weaker than their own.
Far from settling things with a taxonomy, Canada will have just created more uncertainty.
5. When will Canadian authorities take charge of a credible and democratic sustainable finance taxonomy process?
In September the Institute for Sustainable Finance at Queens University put out a report concluding that “accelerated action and execution is needed” in Canada. Other research (here and here) has concluded the Bank of Canada and the Office of the Superintendent of Financial Institutions (OSFI) are not yet using the tools at their disposal to green the financial sector.
In general, Canada is lagging behind. A major reason is that Canada’s government and financial regulatory bodies have preferred to outsource this conversation to bodies like the Expert Panel, the CSA, and the Sustainable Finance Action Council rather than taking responsibility for the process themselves. This must change.
A legitimate process will be like that seen in the EU. It will be democratic, welcome diverse voices, and avoid the dynamic where the sectors most in need of change are writing their own rules. It will be properly sanctioned with a clear pathway for adoption and enforcement. And on sustainable finance, Canada needs an overall taxonomy and not just one for transition finance.
It’s time to go back to the drawing board to get this right. The entire premise of sustainable finance is at stake.