Sustainable finance is beginning to hit the mainstream. Recently, I had the chance to sit down with sustainable finance expert Dr. Sean Cleary, to take a deep dive into a way of investing that is poised to become “the new normal.”

What is sustainable finance?

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

As such, it requires integrating sustainability considerations into the traditional roles of the financial sector, which include managing capital flows (lending and investment), risk management (such as insurance and risk assessment) and financial processes (including disclosure, valuations, and oversight). Ultimately, it’s about setting us up, from a financial systems perspective, to avoid the economic risks and seize the opportunities of a global transition, which is already underway.

In terms of government and the private sector, who do you see as responsible or are the key agent for change? What is each party currently doing and what should they focus on in the future?

Both the private sector and government have important roles to play, with numerous issues that require action by both parties. We need our leaders across finance, industry, and government to work together to help Canada grasp the lucrative opportunities and manage the risks of a low-carbon transition.

The final report of the Canadian Expert Panel on Sustainable Finance identifies a number of key actions as part of their 15 recommendations. In fact, the report specifies which parties should logically take the “lead” on each of their recommendations. In most instances, the report identifies the need for government and the private sector to work together. This includes action on issues such as clarification of fiduciary duty, engaging institutional investors in the financing of Canada’s electricity grid of the future, and aligning the country’s infrastructure strategy with its long-term sustainable growth objectives and leveraging private capital in its delivery.              

Some issues require policy action and/or clarification in order to promote required actions by the private sector, while many require joint or parallel efforts. For example, the private sector has expressed a strong desire to receive more comprehensive and consistent information related to climate change that is required to make investment and lending decisions and to deal with risk management issues.

Along these lines, the recommendations of the Task Force for Climate-Related Financial Disclosures (TCFD) continue to garner growing support from the private sector, particularly from financial institutions (FIs).

What does this mean for the individual investor? How can they take action across their own personal portfolios?

It is as simple as doing some preliminary research, including having a talk with your financial advisor or plan manager regarding how well your investments are aligned with your sustainable investing preferences, and if they are designed to capitalize on the widespread transition currently underway. There is a widely growing list of sustainable investment alternatives available to individual investors, from ETFs to traditional funds to alternative investments, several of which provide impact investing opportunities. The main force driving this growth has been strong demand from customers and investors. For example, a 2019 survey by the Responsible Investment Association (RIA) indicated that 72 per cent of investors were interested in responsible investing that incorporated ESG considerations, up from 60 per cent in 2018.

Just as institutional investors can become better informed about climate-related opportunities and risks in order to adopt appropriate investment approaches, so to can individual investors. Building and growing this capacity is a key part of our mandate at the Institute for Sustainable Finance.

Relative to other developed countries, how would you grade Canada’s efforts at addressing structural reforms to our economy?

There are several examples of sustainable finance in action in Canada:

• More than 35 Canadian organizations were official supporters of the TCFD.
• Several large Canadian companies, including the big banks, pensions, and insurance companies, have initiated successful green bond issues.
• Over 120 Canadian asset owners and managers are signatories of the United Nations-supported Principles for Responsible Investment (UNPRI).
• The Canadian Responsible Investment Association (RIA) reported that firms responsible for managing C$2.1 trillion in assets engaged in “responsible” investing by the end of 2017.

While these are notable efforts, Canada needs to up its pace if we don’t want to fall behind. Major global investors and financial institutions have accepted the reality of climate change and are already shaping markets for a massive low-carbon transition. 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 taxonomy (definitions) on what can be considered environmentally sustainable economic activity.

Now more than ever, we need our leaders across finance, industry, and government to collaborate in the collective effort to tap into unprecedented investment opportunities while protecting Canadian assets, investors, and firms from climate risks.

You frame the problems surrounding climate change as a massive opportunity – how so?

There is tremendous value — some US$26 trillion worth — to be gained by shifting economies to avoid worst-case climate scenarios. For example, just this fall, a group of the world’s largest asset-holders responsible for over US$2.4 trillion in investments committed to carbon-neutral investment portfolios by 2050. Thirty-three banks with a combined US$13 trillion in assets committed to align their portfolios “to reflect and finance the low-carbon, climate-resilient economy required to limit global warming.” At home, the Caisse de depot et placement du Quebec (CDPQ) has committed to increase low carbon investments by 50 per cent by 2020.  The Ontario Teachers Pension Plan has mapped its own low carbon economy transition framework, and is encouraging “proactive and positive corporate behaviour” and disclosure of climate-related information.

Global investors are already mobilizing capital to take advantage of these opportunities. So, in this context, the biggest opportunity for Canada is really to take the reins and determine our own path through this global transition. We have the talent and resources to design a made-in-Canada sustainable finance system that will enable our firms to compete.

What are the risks of inaction? Can you quantify them and how they will impact the trajectory of the Canadian economy?

The risk of inaction is increasingly clear. In its 2019 financial system review, the Bank of Canada warned that climate change is one of six key vulnerabilities in the Canadian financial system. This echoes the sentiments of its global central bank counterparts as evidenced by the formation of the Network of Central Banks and Supervisors for Greening the Financial Systems (NGFS), which has grown to 42 members on five continents since 2017.

According to the Economist Intelligence Unit, a 2°C global warming scenario will trigger global financial losses of roughly US$4.2 trillion. With 6°C of warming, those losses balloon to US$13.8 trillion. That represents about 10 per cent 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 are depending on investment income for their retirement will find themselves in dire straits. That includes every Canadian counting on the Canada Pension Plan.

In this sense, the risk of inaction for Canada is that if we don’t find our own approach, the countries defining new models will do it for us. Many of them do not have resource-based economies like ours, so we can’t count on their models to work for us. The longer we delay, the more we risk.

Can you provide an overview of your background and what led you to focusing, in part, on sustainable finance?

As an active researcher, I have published numerous articles in top academic journals, mainly related to empirical corporate finance issues, which includes recent work examining the impact of corporate governance and CSR on companies and their performance. I have also been involved in building programs that have an emphasis on the interaction between industry and academia.

For the last year and a half, I have been part of the team to establish the Institute of Sustainable Finance at the Smith School of Business at Queen’s University. The Ivey Foundation and the Smith School of Business provided the vision for an institute of this nature, which allows us to build the much-needed capacity in one of the most significant fields of our time. As each day passes, my appreciation grows for the importance and the sense of urgency associated with the need for relevant research, education, and collaboration in the area of sustainable finance.

What knowledge or advice would you like to impart on your students as they head into the workforce?

More than knowledge or advice, I would like to pose a question of what our choice is ahead of us: Do we want to be decision-makers or decision-takers on how we steer our economy through this transition? Simply put, I see a massive opportunity for a made-in-Canada sustainable finance system that will help Canadian firms be more competitive on the world’s stage. I hope my students are excited to be a part of this as they head into the workforce.

About Dr. Cleary
Dr. Sean Cleary is the BMO Professor of Finance, Smith School of Business, Queen’s University, as well as the executive director of the Institute for Sustainable Finance, and the founding director of its Master of Finance program. He holds a Ph.D. in finance from the University of Toronto, an MBA, and the Institute of Corporate Directors (ICD.D) designation. He is a CFA charter holder, is a current member of the CFA Society Toronto Advisory Council, and is a former member of the Board of Directors for CFA Society Toronto and the Atlantic Canada CFA Society (where he served as president).