Managing Climate Risk in Institutional Investment Portfolios: Case Studies
January 27th, 2021 | Dr. Tessa Hebb, Peter Ellsworth
As we flip the calendar on 2020, a year forever marked in our collective memory due to the global health pandemic, many of us are now asking: “how do we build back, and create a better future?”
With federal and provincial governments having already spent hundreds of billions so far on helping Canadians and businesses survive the economic devastation caused by the pandemic, and many more years of record government debt and deficits to come, will there be anything left in the vault for the next global crisis? How can our governments prepare for the inevitable climate crisis to come, without adding to the record mountain of debt and deficits?
Interestingly, some clear and pragmatic solutions were proposed in 2019 by an expert panel in sustainable finance. This expert panel, chaired by Tiff Macklem, now the Governor of the Bank of Canada, and consisting of some of the top finance minds in Canada, made certain recommendations to the federal government on how to mobilize private capital, spur sustainable growth and address climate change.
While this report, Mobilizing Finance for Sustainable Growth, is a thoughtful and comprehensive roadmap connecting the dots between Canada’s climate objectives, economic ambitions and investment imperatives, four recommendations within the report addressed solutions on how to mobilize capital from the private sector to build a sustainable and resilient economy for the future. These recommendations focused on utilizing tax and investment incentives within the tax code to catalyze private capital to invest in the green economy, specifically the (1) expansion of registered savings plans for climate conscious products, (2) use of tax credits for investors, (3) tax exemptions for green bond investors and (4) increased interest deductibility for green bond issuers.
Before diving into these recommendations, the use of targeted tax and investment incentives historically have shown to be very successful in catalyzing, building and supporting various industries in Canada. For example, the principal residence tax exemption and first time homebuyer incentive are essential in encouraging home ownership formation. The scientific research and experimental development tax credit and various provincial venture capital tax credits provide critical investment incentives for technology and biotechnology investors. Flow-through programs mobilize risk capital for the mining and oil and gas sectors. Accelerated depreciation tax credits motivate manufacturing companies to invest in new equipment. Even registered plans such as RRSPs and TFSAs encourage individuals to save for their retirement and provide a way to supplement their CPP. These targeted incentives do not require direct government funding and is a smart way of directing needed capital into creating employment and building industries.
1. Expansion of registered savings plans
Recommendation 2.1 of report encouraged government to “create a financial incentive for Canadians to invest in accredited climate-conscious products through their registered savings plans.” Specifically, the panel recommended the program provide: (i) taxable income deductions greater than 100% on eligible contributions combined with (ii) an extended fixed-dollar contribution limit accredited climate conscious investments.
2. Use of tax credits for investors
Recommendation 9.2 (b) of the report also further encouraged the use of tax credits, whereby bond investors would receive tax credits in place of interest payments so that issuers do not have to pay a full market interest rate on their green bonds.
3. Tax exemption for green bond investors
The report also recommended the consideration for tax exemptions to green bond investors, where investors would not pay income tax on interest from the green bonds that they hold.
4. Increased deductibility for issuers
The report also suggest providing green bond issuers with increased interest deductibility whereby issuers would receive a multiplier on the interest deductibility of their green bond issuances.
The report further encourages to “work with financial sector leaders to accelerate Canada’s supply of liquid green and transition-linked fixed income products” through a range of temporary issuance based incentives.
Adoption of these recommendations would incentivize Canadian investors to invest in Canadian businesses that contribute to a sustainable and environmentally resilient future, while also helping improve their competitiveness. For example, RE Royalties Green Bonds or CoPower Green Bonds will be used to finance investments made in renewable energy generation, energy efficiency management and sustainable infrastructure.
It would in turn provide innovative companies with the necessary capital to bring their products and solutions to market, create high quality employment, enrich communities, and build sustainable ecosystems. This flow of capital will supplement government efforts in ensuring we meet our climate goals on time and will not require direct government funding into the sustainable economy.
As we approach the one-and-a-half-year mark of the expert panel’s report on sustainable finance, it is important that the recommendations made not be lost or further delayed within the internal bureaucracy of governments. The climate crisis is already here and will get increasingly more devastating with each passing year. Further studies to be actioned later will only exacerbate what is already an urgent situation.
As 2020 has shown us, global life altering events like a pandemic or climate change, have a way of redefining economies and societies. While sustainable finance is not a panacea to the climate crisis, it is a vaccine to protect us from the devastating effects of climate change.
RIA Disclaimer
The views and opinions expressed in this article are solely those of the authors and do not necessarily reflect the view or position of the Responsible Investment Association (RIA). The RIA does not endorse, recommend, or guarantee any of the claims made by the authors. This article is intended as general information and not investment advice. We recommend consulting with a qualified advisor or investment professional prior to making any investment or investment-related decision.
Author
Bernard Tan
Chief Executive Officer and Co-founder
RE Royalties
