Today, this call for climate-related transparency is being echoed in the financial community. The technical nature of the challenge, coupled with the fact that many find the world of finance rather opaque to begin with, means that this climate transparency is far from a mainstream concern. But it should be. Transparency is fundamental to our fight against climate change, and without it your retirement savings could be at risk.

Large investors and asset managers are trained to deal – even capitalize – on risk, but they need consistent and reliable information, which is currently lacking in the climate space. Individuals might want this information because they don’t want to invest their money in areas misaligned with climate action. Boards of directors need this information to guide corporate strategy and oversee risk-management policies. Society as a whole needs this transparency to guide capital toward the best available solutions for climate change.

So where are these transparency gaps and what can be done to bridge them?

After more than 50 interviews with financial experts, Smart Prosperity Institute and Barb Zvan, CEO of the Ontario’s University Pension Plan, and member of the Expert Panel on Sustainable Finance, released a report in which transparency challenges and potential solutions are grouped into three distinct pillars:

1) Fostering low-carbon markets and investments

Increasingly, investors want to know if their portfolios are aligned to low-carbon industries and activities. But do you know just how “low-carbon” your investments are?

This question is difficult to answer because it’s unclear how to classify certain types of investable activities. If a company is using progressively better technologies to lower emissions, and is cleaner than its competitors, how do you label its endeavours?

Different classification systems are available worldwide to help solve this challenge (the EU taxonomy, emerging Canadian transition-linked taxonomy, climate bond taxonomy, etc.), but more work needs to be done around how these taxonomies are related, and how to label an investment portfolio under each. Tracking the environmental impacts of financial products (such as bonds) that use classifications such as “green” or “transition-linked” is also crucial.

At the same time, building the business case for clean investments will require better information on comparability and impact. For instance, consistent labelling around the energy efficiency of buildings, and how retrofits and climate-resilience measures lower costs over the long-term, would help boost investments in those buildings.

2) Supporting climate-related disclosures

If investors, individuals, boards and society at large want greater transparency around the risks posed by the climate crisis – and the opportunities presented by the resulting policy and societal shifts – corporate climate disclosures are key. The Task Force on Climate-related Financial Disclosure (TCFD) developed recommendations for how companies, corporations and investors can self-report on their climate risks and opportunities, and these are quickly becoming the global standard. The challenge is that TCFD disclosure is voluntary in Canada, and so companies often pick and choose what, and how, they report.

“We hear it from investors, and everyone else, that the quality of the climate-related data out there is poor,” said one report interviewee. “When it does exist it’s pretty heterogeneous, it’s hard to compare like-for-like, even within the same sector.”

To make TCFD reporting easier, and increase the consistency of data, we need to build a critical mass or even rules around the most common metrics, agreeing on methodologies for reporting areas such as indirect emissions, like those arising through supply chains or waste disposal.

Other ways to support TCFD include providing a clear methodology for companies to showcase their climate-related pledges, describing a clear sense of impact, ambition and progress – and highlighting how those compare to their peers. Support for forward-looking scenario analysis is also needed. This means simplifying the exercise of “what ifs” when it comes to climate change, by providing information on how key indicators are likely to change under standard scenarios, such as carbon prices, consumption patterns and energy prices.

3) Recognizing physical risk

The last pillar is an essential first step in building climate resilience: we need better information about the physical impacts of climate change on our built environment and supply chains.

This means more granular, up-to-date, forward-looking information on climate hazards like floods, forest fires and coastal erosion, and the steps taken to alleviate those hazards. Building resilience will help communities access better insurance, loans and mortgages over the long-term and will help identify sectors or industries requiring transitional strategies in anticipation of our changing climate.

By bridging the transparency gap in sustainable finance, we will have the right information to address climate risks and harness clean growth opportunities – ultimately giving us the best chance of building resilience and succeeding in the low-carbon transition.

Katherine Monahan is a senior research associate at the Smart Prosperity Institute and co-author of the new report “Bridging the Transparency Gap in Sustainable Finance”.

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According to the 2018 Responsible Investment Association (RIA) trends report, more than 50% of Canadian assets under management now integrate at least one type of RI strategy. From 2010 to 2017, RI assets grew by more than 400%. They doubled again in 2019. The RIA is currently collecting data for its 2020 update; expect even further gain¬s. The demographic most interested – also millennials. According to an Environics survey published last year by Mackenzie Investments, they are twice as likely to be interested in RI as baby boomers.

Unfortunately, too little of this RI is getting to climate solutions.

The International Energy Agency reports that investment in the global renewable power sector has experienced small declines each year since 2017. Due to COVID-19, power sector investment is likely to fall by another 20% and efficiency investments over 10% this year. So how does one explain exponential growth in RI yet declining growth in climate solutions investment? Traditional investment products are increasingly being tattooed with labels like “sustainable,” “ESG” and “low carbon.” In our opinion, it’s creating as much confusion as the three-winged eagle inked onto the shoulder of (insert actor’s name here). It’s diverting “willing” capital away from the climate solutions we so desperately need.

Greenchip and other organizations have estimated that global investment of around $2.5 trillion is needed each year through 2040 to limit warming to 2 degrees Celsius above pre-industrial levels. Energy transition investments in 2019 were about $940 billion – we have an annual investment gap of at least $1.5 trillion. And each year that we fall short, the gap just gets bigger. It means that a very uncertain future becomes even more certain.

The problem starts with the taxonomy of “ESG.” The term is often used to capture the entire spectrum of responsible investments, but this is misleading. ESG is instead only one RI strategy of many. ESG is by definition a set of (unstandardized) standards that help score the environmental, social and governance behaviour of individual companies. In practice, ESG integration is a tool that can help identify and manage corporate behavioural risks.

Because of the “E” in ESG, it often leaves investors believing ESG strategies will be overweight in companies selling environmental solutions. This couldn’t be further from the truth.

A quick look at the top holdings of most so-called ESG funds will identify well-known banks, pharma companies and consumer technology stocks – businesses that have little to do with climate change, most of which are already spinning cash and don’t need capital investment. Recently, Greenchip studied the full holdings of the largest global ESG funds. We found that only 5 to 15% of their revenues might be attributed to climate solutions sales, but the higher end of this range is probably a stretch.

Most concerning is that ESG strategies are getting the vast majority of RI investment. According to the Global Sustainable Investment Alliance, almost $18 trillion had been allocated globally to ESG strategies by 2018 versus only $1 trillion to thematic “solutions” investments – 18 to 1! The biennial survey will be updated later this year, and the chasm will surely have widened even further.

Another label we find problematic is “low carbon.” These strategies rarely capture the emissions buried in supply chains (known as Scope 2), or worse, downstream emissions (known as Scope 3). It means the emissions from an oil producer might be captured for their extraction and refining, but carbon accounting generally fails to account for the emissions when their refined fuel is combusted.

A recent Economist essay offered an excellent example of how low-carbon accounting can steer investors in the wrong direction with this: “Apple has only a tiny fraction of Samsung’s operational emissions; but Samsung makes things, while Apple has others do that for it.” Accounting myopic focus on operating (Scope 1) emissions can distort investment decisions.

For Greenchip, the main problem with low-carbon strategies is that they also divert capital away from the very solutions they hope to address.

Envision building a large wind farm with all those blades and towers, transmission lines or a new subway system. Manufacturing this equipment and erecting this infrastructure is a pretty carbon-intensive exercise. We often say, “You need to get a little dirty today to build the cleaner economy of the future.” Low-carbon investing (and often the E in ESG) focuses only on the initial pollution that building this infrastructure creates and not on long-term emissions reductions. In our experience, when an investment committee says they want to see a carbon audit of our portfolio, we probably are going to lose that mandate.

We think there is a more effective way to measure impact than ESG scores or carbon audits: solutions revenues. Every six months, Greenchip attributes all the revenues in our portfolio holdings to specific environmental solutions. As of June 30, 2020, every dollar invested in our fund produced $1.86 in the past year of environmental solutions sales. So, of the $200 million that we oversee, about $370 million is helping to close that $1.5 trillion gap. Our focus on revenue measurement also enables us to attribute portfolio revenues to five United Nations Sustainable Development Goals (SDGs). Simply reallocating even a small portion of the least effective ESG and low-carbon strategies to those focused on thematic “solutions” would go a long way to closing the climate investment gap.

Greenchip still sees value in ESG integration, measuring carbon, engagement, proxy voting and so on. We use all of these tools. They help us mitigate risk and are part of our diligence process. Around the edges, we know better corporate behaviour matters. That said, too often the investment industry is using these labels to “greenwash” traditional allocations of capital. Otherwise, how can one explain the paradox of exploding RI fund flows with declining rates of environmental solutions investment?

John Cook is the president and CEO of Greenchip Financial Corp.

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