Canada’s New Taxonomy Roadmap Report: What it Means for The Future of Sustainable Lending
In May 2021, the Sustainable Finance Action Council (SFAC) was mandated to provide advice and recommendations to Canada’s Deputy Prime Minister and Minister of Finance and the Minister of Environment and Climate Change on defining green and transition investment (taxonomy). Following this, the Taxonomy Technical Experts Group (TTEG) was convened to prepare the Taxonomy Roadmap Report, which was endorsed by the SFAC in September 2022. The report contains 10 recommendations addressing the merits, design, and implementation of a green and transition finance taxonomy for Canada. In this blog post, we will explore what the Federal Government’s new Taxonomy Roadmap Report means for the future of sustainable lending and sustainable loans in Canada.
What is a Taxonomy and Why is it Important?
A taxonomy is a classification system that provides a standardized approach for benchmarking economic activities that are consistent with domestic and global climate goals. Taxonomies provide greater certainty about whether economic activities are aligned with credible, science-based transition pathways. They also liberate and accelerate the deployment of climate capital, mitigate greenwashing risks, and promote the integrity of net-zero transitions. A sustainable finance taxonomy in Canada can provide a standardized approach for benchmarking economic activities that are consistent with domestic and global climate goals.
The Importance of Designing the Taxonomy Correctly
The design of the taxonomy ultimately has significant implications for its overall effectiveness, credibility, usability, and interoperability. Therefore, the TTEG considered how the Canadian green and transition finance taxonomy should be designed to maximize opportunities and minimize risks. The taxonomy framework architecture was developed in partnership with the Canadian Climate Institute.
Corporate Green and Transition Loans
Similar to green and transition bonds, corporate borrowers seeking green and/or transition loans to fund taxonomy-eligible projects are likely to follow established global process guidelines, including the Green Loan Principles published by the Loan Market Association (LMA), Asia Pacific Loan Market Association (APLMA), and the Loan Syndications and Trading Association (LSTA). Corporate borrowers typically begin the loan origination process by preparing a green and/or transition loan framework, which will contain many of the same elements as its bond counterpart.
Reflecting the borrower’s financing objectives and sustainability strategy, the framework would identify the categories of green and/or transition projects that would be eligible for loan financing, as well as the corresponding screening criteria based on the taxonomy’s specific and DNSH (do no significant harm) requirements. It would explain the internal governance process to evaluate and select eligible projects, the systems to monitor and track the loan proceeds, and the frequency of reporting to lenders on how the loan proceeds have been allocated.
The borrower may choose to publicly release the framework or limit its distribution to prospective lenders only. The framework may be standalone or integrated as part of a larger framework that covers several green and/or transition financial instruments. Borrowers may have some or all aspects of the framework reviewed by an external party (e.g., second-party opinion), but this may not always be undertaken, especially in instances where lenders are satisfied that borrowers have adequate internal expertise to self-certify the veracity of their proposed frameworks.
Following its adoption, the framework would be integrated into the formal green and/or transition loan (contractual) agreements between the borrowers and lenders. Although there is no market standard for the content of green and/or transition loan agreements, the Green Loan Principles guidance indicates that these agreements should clearly set out the eligible green/transition project categories in the use of loan proceeds provisions, provide the information undertakings/covenants of the borrower, outline the reporting requirements, and establish the consequences for non-compliance. These agreements are legally binding documents that provide a structure for the lending relationship, ensuring that the borrower meets its financing and sustainability objectives while mitigating risks for the lender.
In addition to the contractual agreements, borrowers seeking green and/or transition loans may also obtain external verification or certification of their green and/or transition projects. This process is similar to obtaining external reviews of green and/or transition bond frameworks and is often referred to as a “second-party opinion.” A second-party opinion provides an external assessment of the borrower’s green and/or transition loan framework, confirming that it aligns with the Green Loan Principles, LMA, APLMA, and LSTA guidelines, and is in compliance with the taxonomy’s specific screening criteria.
Green and/or transition loans offer an alternative financing option for corporate borrowers seeking to fund their taxonomy-eligible projects. Following established global process guidelines, borrowers can develop green and/or transition loan frameworks that align with their sustainability strategies and financing objectives. Integrating these frameworks into formal contractual agreements provides a structure for the lending relationship, ensuring that borrowers meet their financing and sustainability objectives while mitigating risks for lenders. External verification or certification of these frameworks can provide additional assurance to investors that the loan proceeds are being used in a manner that aligns with their sustainability objectives.
The Potential of Sustainable Lending and Sustainable Loans
The adoption of a sustainable finance taxonomy in Canada has the potential to significantly increase investment in green and transition projects, as it provides a standardized approach for evaluating the climate credentials of economic activities. It also helps to mitigate greenwashing risks, promotes the integrity of net-zero transitions, and provides greater certainty about whether economic activities are aligned with credible, science-based transition pathways.
Moreover, by setting screening criteria for sustainable loans, the taxonomy will enable investors to direct their capital towards projects that align with their sustainability objectives. It will also provide borrowers with guidance on how to structure sustainable loans and develop frameworks that can help attract more sustainable investment.
The Federal Government’s new Taxonomy Roadmap Report is a significant step towards scaling up climate investment in Canada and achieving a net-zero economy by 2050. The taxonomy will have significant implications for the effectiveness, credibility, usability, and interoperability of sustainable lending and loans in Canada. Ultimately, the adoption of a sustainable finance taxonomy in Canada has the potential to significantly accelerate the transition to a net-zero economy by mobilizing and accelerating the deployment of capital in support of achieving climate objectives. It will help to promote the integrity of net-zero transitions, mitigate greenwashing risks, and provide greater certainty about whether economic activities are aligned with credible, science-based transition pathways.