Canada's new "taxonomy" project: 4 principles to judge it by

Canada is starting work on its taxonomy of sustainable finance.

The world’s green and sustainable bonds market has been a phenomenon of recent years, growing from USD100 billion (CAD140bn) outstanding at the time the Paris Climate Agreement was signed a little over 10 years ago, to now close to USD8 trillion (CAD11tn) in size. With that has been the growth of commercial green loans — China, for example, now has some one million of these — and the popularisation of green finance in general.

 Financial markets thrive on standards, on clear rules, and under-pinning the growth of these markets has been a global effort to ensure and maintain the climate credibility of this finance. 

 This has led to the development of taxonomies of sustainable finance that function as climate-focused “shopping lists for the future”, to help investors, banks, corporates and government agencies quickly understand what sorts of investments are consistent with climate science. 

 The first taxonomy was developed by the Climate Bonds Initiative in 2012 to underpin its green bond certification scheme; China took the idea and backed it with regulation in 2015; the European Union followed a couple of years later; and now over 50 countries have official taxonomies, typically promulgated by financial system regulators.

 Lessons have been learnt from this flurry of effort, and so we propose four principles to assess and track the development of Canada’s effort:

 1. The taxonomy should be simple, interoperable, and usable

 The taxonomy should be simple, in that it should rely on clear definitions rather than complex processes that are challenging to implement. It should be interoperable with global taxonomies and sustainability reporting systems, without lowering the bar or creating inconsistency. And, it should be usable, being the first step towards further reporting expectations.

2. It should be consistent with climate science

 Eligible activities under the taxonomy need to align with emission reductions consistent with limiting global warming to 1.5°C. The importance of this target has been underlined by reports from the Intergovernmental Panel on Climate Change. 

 Yes, it looks like we are about to hit average global warming of 1.5°C, which means we have globally failed to reduce emissions as fast as our scientists advised. That means we are going to have to cut emissions even faster to have a chance of avoiding catastrophic warming.

3. The taxonomy's transition guidance needs to be suitably ambitious, in line with credible reference pathways

 The transition label should only apply to activities for which there are no viable alternatives in the medium or long-term, like steel or fertiliser. Eligible transition activities should only apply to sectors with credible pathways to decarbonize.

 Guidance should reference credible pathways, such as the International Energy Agency's (IEA) Net Zero by 2050, which makes clear there can be no room for new fossil fuel supply or unabated generation projects and where electricity generation in developed countries reaches net-zero emissions by 2040. Similar principles have been articulated and endorsed by over thirty Canadian climate and finance organizations at Credible Taxonomy.

4. It should detail how it will “Do No Significant Harm”, and uphold Indigenous rights

 We need to build stronger and more resilient economies and societies if we are going to prosper despite increasingly severe climate impacts. That will mean making sure we “do no significant harm” while building a new economy, including respecting and upholding First Nations rightsholders, biodiversity protection and inclusive transition measures like minimum labour rights. 

 Simple really.

 The science is pretty clear about what needs to be done to avert catastrophic climate change. The role of the taxonomy is to take that science and turn it into a useful tool for investors to understand what’s climate-action-consistent, and for governments to align their support measures. If we do that we have a chance of getting capital to go where it needs to go if we are to have a viable future. Similar principles have been articulated and endorsed by over thirty Canadian climate and finance organisations. 

 The Taxonomy Committee’s methodology paper is out for public comment.  Check it out www.businessfuturepathways.ca.