A wind turbine at sunset near the Transalta McBride Lake wind farm project near Ardenville, Alta., on Oct. 4, 2022.Guillaume Nolet/The Globe and Mail
Julien Beaulieu is a doctoral researcher at Imperial College London and a law lecturer at the University of Sherbrooke.
After years of debate, the federal government has finally released its plan for a Canadian sustainable finance taxonomy. We will have to wait a few more months to see if its final criteria make environmental sense. But the bigger issue is whether this voluntary taxonomy will have any market impact.
A taxonomy is like a dictionary: it defines terms to ensure that everyone speaks the same language.
In the financial context, a taxonomy can help mitigate investor confusion and greenwashing risks by establishing common definitions and standards for commonly used sustainability expressions. For example, it can state that only projects aimed at achieving significant GHG emissions reductions can be labelled as “green” or “sustainable” and funded through taxonomy-aligned financial instruments.
As with any dictionary, a taxonomy will only be useful if its definitions are used in real life. Nobody cares about a 17th-century dictionary that defines outdated words. This is the main risk facing Ottawa’s new taxonomy: How will the feds ensure that their dictionary is put to use?
For now, compliance with the sustainable finance classification will be voluntary, allowing companies and investors to keep using their own taxonomies and labels. For example, companies may continue issuing “green” bonds to fund oil and gas projects, even if these projects are not aligned with taxonomy’s criteria. Similarly, fund managers may continue to advertise “green” investment funds even if such funds do not invest into taxonomy-aligned assets.
The Sustainable Finance Action Council – an advisory body appointed by the federal government to develop proposals for a taxonomy – had already warned of this risk in its 2023 Roadmap Report. As explained by SFAC, a voluntary taxonomy can lead “companies, especially those in higher-emitting sectors [to] bypass the rigours of the taxonomy in favour of continuing to raise capital for transition purposes through the use of traditional financial instruments.”
To prevent the emergence of competing labels with weaker criteria and monitoring processes, Canada’s financial regulators – including the Office of the Superintendent of Financial Institutions and provincial securities agencies – should integrate the taxonomy into financial rules as soon as possible.
This integration should be done in two steps.
First, financial institutions, listed companies and fund managers should be required to disclose whether their activities are aligned with the taxonomy’s criteria. For example, investment funds and financial institutions could be asked to disclose the percentage of their Canadian assets that meet the criteria of the taxonomy. Similarly, listed companies could be required to indicate whether they plan to use the proceeds from public offerings to finance projects that comply with the taxonomy’s definitions.
A similar approach already exists in Europe under the Corporate Sustainability Reporting Directive, which requires organizations of a certain size to report on metrics that reflect their alignment with the EU Taxonomy, such as the proportion of taxonomy-aligned capital expenditures and the turnover derived from taxonomy-aligned activities.
Second, financial actors should be prohibited from advertising a product, project or entity as “green” unless it meets certain taxonomy alignment criteria, which would effectively establish a labelling regime for sustainability claims. For example, investment funds labelled as “green” could be required to hold a minimum percentage of assets certified as green under the taxonomy. Funds could still decide to adopt sustainable investment approaches that are not based on the criteria of the taxonomy, but in that case, they would be prohibited from using the terms “green” and “transition” in their marketing materials.
This approach would be consistent with the naming rules proposed in the EU, Britain and the U.S., where percentage-of-asset thresholds for sustainability labels already exist or are being considered.
Additional policies could also be considered by the federal and provincial governments to foster the adoption of the taxonomy, such as incorporating its criteria in public procurement rules, using it to develop public investment programs and requiring state-owned entities to report on their taxonomy alignment.
As key building blocks of Canada’s anti-greenwashing agenda, these measures would likely obtain wide support from the public. In a 2022 survey of Canadian retail investors, 75 per cent of respondents indicated being concerned about greenwashing, and 78 per cent showed support for more stringent and heightened regulation in the financial sector to address greenwashing.
For years, various stakeholders – from NGOs to financial institutions – have called for a sustainable finance taxonomy. Now that it’s here, policy makers must act quickly to ensure that it does not become yet another voluntary environmental measure that fails to deliver results.
