Governments around the world are committed to meeting their climate change objectives. The ability to achieve lower carbon emissions rests on a successful transition to renewable power and lowering emissions in transportation and manufacturing. The world will need a massive quantity of critical metals and securing the primary supply will be key. Meeting that demand will require significant capital, which we believe will create a multi-decade investment opportunity. Historically the mining industry has not been embraced by responsible investment approaches, however lowering carbon emissions cannot happen without the mining industry providing the crucial inputs. We believe there is the potential for a strong alignment between supporting the energy transition and earning strong investment returns.

Growth in Electric Vehicles

While there are many areas that are transitioning toward lower emissions, for this article we focus on electric vehicles (EVs) to illustrate the complexity and scale of the transition challenge for the mining industry. EV production and demand are growing rapidly. According to Thunder Said Energy, electric vehicles accounted for 12.5% of all new global vehicles in 2022, and is projected to be 50% in 2030, or 65 million units [1].

EVs require certain critical minerals that internal combustion engine (ICE) vehicles do not, such as lithium, cobalt, graphite, nickel and others as components for their batteries. Based on market expectations for EV adoption, battery metals are expected to require significant supply growth in order to meet demand expectations. The annual growth rates in demand for most battery metals including lithium, graphite and cobalt are in the 5-10% range, which is unprecedented. Let us not forget the uranium needed for nuclear power plants, which will be required to increase the base load power supply.

Source: Benchmark Mineral Intelligence, May 2023

In addition to cobalt, nickel, lithium and graphite, the world will need more copper for wiring. EVs have a higher copper intensity than ICE vehicles and will be required for the build- out of charging infrastructure. According to CRU and BMO Capital Markets, copper content per light duty vehicle is 3-4x the amount per current ICE vehicle, with next generation EVs hoping to get that down to 1-3x by 2030 [1]. By 2030 total vehicle demand for copper between EVs and ICE vehicles is expected to double [2].

Raw material availability will set the pace and the mining industry may struggle to deliver

In a transition of this scale, there will be setbacks that disturb the supply-demand balance. Production growth along the value chain will need to be synchronized to avoid constraints . The issue is that mining capacity has a long lead time and is on a different timeline to global battery demand, EV charging station capacity and even EV penetration. It takes 2-5 years to build a battery plant, while mines require 5-25 years to develop. For this reason alone, the road towards lower emissions may be bumpier than people expect.

Today, China dominates every segment in the battery supply chain and political tensions are accelerating. In response, Western governments are scrambling to be self-sufficient and independent. The U.S. Inflation Reduction Act (IRA) is the most publicized legislature geared towards security of the energy transition value chain, but other counties are following suit. Effectively, there will likely be two parallel markets for many of the critical metals, and the West will need to catch-up.

Raw material extraction is always complicated but there is additional complexity associated with the growth rates required for energy transition. For instance, processing of critical metals is often problematic, as there is a uniqueness to each deposit which requires advanced engineering. Many of the metals are also located in jurisdictions with geopolitical risk, which adds an extra layer of uncertainty. Overlaying risks, including the lack of technical expertise, will potentially compromise the ability to meet demand.

Obtaining permits can also be extremely complex and time consuming. Today’s world has a heightened focus on Environmental, Social License and Corporate Governance (ESG) factors and new mining projects cannot be rushed through for the sake of satisfying any urgency on the demand side. The industry will need to ensure that all aspects of their mining projects are satisfied.

Another startling metric outlined by Benchmark Mineral Intelligence (BMI), an industry think tank, is the number of new mines that will be required to supply the planned battery gigafactories. BMI estimates that between now and 2035 the planned battery plant capacity will require ~ 50-100 new mines to be built in each of the key battery metals. The industry has never seen growth rates like these [1].

Source: Benchmark Mineral Intelligence

The investment opportunity

Investing in this complex and dynamic environment is difficult, but the opportunities are meaningful and this, we believe, will keep investors drawn to the space. Most importantly, the growth in demand is significant and necessary with enormous capital needs. This is a multi-decade global transition at its infancy and, as this dynamic environment evolves, there will be significant investment opportunities, as well as benefits for society.

BMI calculates that at least $514 billion will be required by 2030 to facilitate a 3.7x facilitate increase in storage capacity. An additional $406 billion will be required between 2031-2035 [1]. Wood Mackenzie, meanwhile, forecasts a total investment of US $1.2 trillion by 2050 to achieve the Accelerated Energy Transition (AET) -1.5-degree Celsius climate change target [3].

It is highly unlikely that the individual supply chain components will increase in tandem. As the world scrambles to transition quickly, there will likely be surpluses and shortages at any point in time. Therefore, diversification through all parts of the supply chain is a prudent approach.

We evaluate potential investment opportunities based on technical quality of the projects, quality of the management and economic robustness. Our active approach to investing in the mining industry can help contribute to overcoming some of the challenges while generating attractive returns for our investors.

Sources

[1] Thunder Said Energy

[2] BMO Capital Markets

[3] Benchmark Mineral Intelligence

---

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.

Canada’s recent development of a green and transition finance taxonomy is part of a rapidly evolving global landscape. There is growing recognition by many jurisdictions of the need for robust classification frameworks as a means to address the challenges of financing the transition to a more sustainable economy. By providing clear definitions and technical thresholds, taxonomies are a tool to prevent greenwashing and enable investors to make informed decisions that realistically consider the sustainable growth prospects of an economic activity.

Canada’s Taxonomy

Leading Canada’s taxonomy development is the Sustainable Finance Action Council (SFAC), an advisory body convened by the federal government whose members include 25 of Canada’s largest institutions in the banking, pension and insurance industries. In March of this year, the SFAC released its Taxonomy Roadmap Report to the public. Under the report’s proposed framework, an economic activity can be taxonomy-eligible either as “green” or “transition,” – the specific requirements of which will be determined by science-based screening criteria and emissions thresholds. Issuing companies must also have company-level net-zero targets, transition plans and climate disclosures in line with emerging domestic regulatory requirements and international best practices in order to be taxonomy-eligible. The green category encompasses projects with low or zero Scope 1, 2 and 3 emissions that are expected to experience a significant growth in demand in the global low-carbon transition, such as green hydrogen production and zero-emissions vehicle manufacturing. The transition category includes projects with well-defined lifespans, seeking to decarbonize sectors that historically have high Scope 1, 2 or 3 emissions. Examples of transition activities could include carbon capture, utilization and storage upgrades to existing oil sands production as well as the electrification of steel production.

Having the transition category in Canada’s taxonomy is particularly helpful given the local economy’s heavy reliance on natural resources . In 2023, the oil and gas sector made up 7.2% or $168.2 billion of Canada’s nominal GDP while accounting for 27% of its total greenhouse gas emissions. The oil and gas sector employs 593,000 people and the steel sector employs 123,000. The transition category within the taxonomy acknowledges the importance of incentivizing the decarbonization and shift toward greener technologies, practices and business models within these industries, while maintaining economic stability and job security to ensure a just transition to a low-carbon economy.

Opportunities for Investors

Despite not being legally binding, the standardized framework of the taxonomy is expected to bring about new and exciting opportunities for investors.

The taxonomy will encourage companies to disclose the environmental impacts of their businesses and products in a more effective manner. Referencing the taxonomy’s science-based criteria and emission thresholds, investors can more readily assess the sustainability impacts of an investment and companies’ business activities. This will create new opportunities for institutional investors to conduct taxonomy-focused stewardship to systematically address issuers’ sustainability issues . The taxonomy will also provide investors with opportunities to contextualize reported financed emissions through taxonomy-related ratios at the firm and/or fund level.

Most importantly, the taxonomy will provide a clear and standardized framework for Canadian issuers to consider issuing labeled (i.e., green and/or transition) bonds under a structure that will prevent accusations of greenwashing, incentivizing more development of green financial products. Overall, the enhanced transparency, credibility and accountability in the financial market brought by the taxonomy is expected to increase investor demand for green financial products, such as green bonds and sustainability-labeled funds, leading to the growth of sustainable investment opportunities in Canada.

Green bond issuance as a percentage of total bond issuance by all issuers and each type of bond issuer in the EU, 2014-2022

Source: European Environment Agency, June 14, 2023.

Since the EU Taxonomy was implemented in mid-2020 as part of the European Green Deal – a set of policies designed to help Europe reach its climate targets by 2030 and become the first climate-neutral continent – the EU has seen a rapid increase in green bond issuances. Total bonds issued increased from 4% in 2019 to 7.8% in 2021 and 8.9% in 2022. Corporate green bonds in particular have increased from 4.1% of total corporate bonds issued in 2019 to 11.0% in 2022. While this rapid growth could be attributed to many factors within the European Green Deal, the EU Taxonomy undeniably plays a part in the EU’s sustainability efforts.

To examine how investments can align with the Canadian taxonomy, below is a sample four-step framework for fixed income investors to determine whether a corporate or sovereign bond is green- or transition-eligible under the taxonomy:

1) Evaluate the issuer’s company-level climate strategy to determine whether it has net-zero targets, transition plans and climate disclosures in place that are in line with current domestic regulatory requirements and international best practices.

2) Assess the issuer’s green/transition bond framework against existing industry standards, such as the International Capital Market Association Green Bond Principles and the Climate Bond Initiative.

3) Analyze the underlying projects that will be financed through the bond proceeds to determine whether the projects meet the green or transition eligibility requirements, following science-based criteria and strict emission thresholds under the taxonomy.

4) Assess the underlying projects that will be financed through the bond proceeds against the “do no significant harm” criteria to ensure alignment with existing Canadian law (e.g. environment, labour and Indigenous rights).

Conclusion

Reaching Canada’s net-zero emissions targets will require substantial investment from both the public and private sectors. In order for Canada to achieve net-zero emissions by 2050, it has been estimated that annual investment will need to grow from $15-$25 billion per year to $125-$140 billion per year. The taxonomy is expected to provide new opportunities for investors to mobilize and align capital in ways that promote transparency, credibility and accountability in the sustainable finance space and support Canada’s transition to a low-carbon economy.

Contributor Disclaimer

The information contained herein is for information purposes only. The information has been drawn from sources believed to be reliable. Graphs and charts are used for illustrative purposes only and do not reflect future values or future performance of any investment. The information does not provide financial, legal, tax or investment advice. Particular investment, tax or trading strategies should be evaluated relative to each individual’s objectives and risk tolerance.

This material is not an offer to any person in any jurisdiction where unlawful or unauthorized. These materials have not been reviewed by and are not registered with any securities or other regulatory authority in jurisdictions where we operate.

Any general discussion or opinions contained within these materials regarding securities or market conditions represent our view or the view of the source cited. Unless otherwise indicated, such view is as of the date noted and is subject to change. Information about the portfolio holdings, asset allocation or diversification is historical and is subject to change.

This document may contain forward-looking statements (“FLS”). FLS reflect current expectations and projections about future events and/or outcomes based on data currently available. Such expectations and projections may be incorrect in the future as events which were not anticipated or considered in their formulation may occur and lead to results that differ materially from those expressed or implied. FLS are not guarantees of future performance and reliance on FLS should be avoided.

The statements and opinions contained herein are those of Kate Tong and John Mchughan and do not necessarily reflect the opinions of, and are not specifically endorsed by, TD Asset Management Inc.

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.

The term, “Just Transition,” was originally coined by labour unions looking to incorporate social dialogue and rights in the workplace and to help counter the idea of decent work and environmental protection being at odds (the “jobs versus environment” dichotomy). Internationally, this concept was affirmed at the 2015 Paris Agreement and gained further momentum at the 26th Conference of the Parties Climate meeting (COP26) in 2022.

The hope of a “Just Transition” approach is that the transition to a low-carbon economy will be more positive than those of the past.

The Risks of an “Unjust” Transition

Achieving a low-carbon economy will require economic, industrial, and technological shifts – shifts that a majority of society has yet to ever experience. Such large-scale shifts will require intensive system-wide change, with the largest burden disproportionately placed on Indigenous peoples and frontline communities.

Globally, governments have been looking to securitise key industries needed for the low-carbon transition which could lead to the exacerbation of negative social externalities. Additionally, transitioning out of high carbon industries could lead to economic and workforce instability – with concern for workers and communities on job transferability and community impact . With that in mind, it is evident that the private and public sector will need to collaborate to encourage the transition towards “sustainable” jobs and economy.

The Global Just Transition

As is most likely evident, the Just Transition will differ depending on several factors including, but not limited to, an organization’s size, demographics, strategy/business, and location. Embarking on a “Just Transition” will require the reconciliation of several complex challenges, including job security, rising energy costs and security issues, financing the transition, the impact on Indigenous communities, and equal access to clean energy .

How are North American government/regulatory stakeholders supporting the “Just Transition”?

Canada:

In Canada, rulemaking around the Just Transition has taken a top-down approach, starting at the federal level, and cascading down to the provinces. Over the past few years, the Federal Government has put forth several regulatory measures to enable a Just Transition, including the release of The Just Transition Act (2021) – strengthening their pledge to transition to a clean and inclusive economy. As Canada has committed to achieving net-zero greenhouse gas (GHG) emissions by 2050, a key piece of the puzzle will be winding down fossil fuel-related projects in a way that considers potential economic impacts. Additionally, Minister Jonathan Wilkinson is progressing with the introduction of “Just Transition” legislation – one of the major mandates meant to be achieved in 2023.

United States of America:

In contrast, the United States has followed a more fragmented approach, with many of the policies and programs originating at the state/regional levels.

Various states within the nation’s largest coal-producing and consuming regions have introduced laws—all within the past 5 years—around the Just Transition to support workers and revitalize local economies. In Colorado, for example, the State’s General Assembly passed a bipartisan House Bill in 2019 that framed the Just Transition as a moral imperative and established a plan for how it will help workers transition to new, green jobs, and to channel investments into coal communities. A handful of other US states have since also followed suit, passing similar laws, and initiating state-level plans for a Just Transition.

In contrast, the US Federal Government has been slower in acting on the Just Transition. In 2021, a Just Transition for Energy Communities Act was introduced by democratic Representatives in Congress but did not receive a vote. The Act aimed to establish a federal program to provide payments to States and Tribes to support transition and economic development efforts. Since then, no further Just Transition bills have been introduced at the federal level.

How Companies and Investors Can Aide the Just Transition

As public transition policy gradually accelerates at the national level, at the corporate level, there is growing expectation for companies to account for, and address, the impact that their climate transition has and will have on their workforce and communities. Companies that fail to do so risk “not only stranded assets but also stranded workers and communities, along with the loss of their social license to operate” . This risk impacts not only individual companies but investment portfolios as well.

As a result, as we move further into the global net zero transition, investors are increasingly expecting companies to disclose and act on their transition impacts (e.g., through reskilling and retraining workers) and to institute policies and governance mechanisms to underpin this process. Although efforts to categorize company progress on the Just Transition remain nascent, Climate Engagement Canada and Climate Action 100+ have both recently updated their respective Net Zero Benchmarks to include new and detailed criteria around this issue.

Supporting a Just Transition is increasingly both a business and moral imperative. Greening the economy must occur in a way that is both fair and inclusive to ensure that no one is left behind. More public policy is needed to support communities and corporations in addressing the transition impacts and to help companies to define medium- and longer-term transition priorities.

---

Contributor Disclaimer

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.

The content of this article (including facts, views, opinions, recommendations, descriptions of or references to, products or securities) is not to be used or construed as investment advice, as an offer to sell or the solicitation of an offer to buy, or an endorsement, recommendation or sponsorship of any entity or security cited. Although we endeavour to ensure its accuracy and completeness, we assume no responsibility for any reliance upon it.

This document may contain forward-looking information which reflect our or third party current expectations or forecasts of future events. Forward-looking information is inherently subject to, among other things, risks, uncertainties and assumptions that could cause actual results to differ materially from those expressed herein. These risks, uncertainties and assumptions include, without limitation, general economic, political and market factors, interest and foreign exchange rates, the volatility of equity and capital markets, business competition, technological change, changes in government regulations, changes in tax laws, unexpected judicial or regulatory proceedings and catastrophic events. Please consider these and other factors carefully and not place undue reliance on forward-looking information. The forward-looking information contained herein is current only as of [insert date]. There should be no expectation that such information will in all circumstances be updated, supplemented or revised whether as a result of new information, changing circumstances, future events or otherwise.

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.

As an increasing number of investors are paying attention to the outcomes of their investments, we are seeing more intense media scrutiny on corporate ESG-related claims. It is unfortunate that a few notable scandals in recent years have caused mistrust and concern among investors around the accuracy of environmental, social or governance (ESG) claims.

The Responsible Investment Association found that concern about greenwashing is the biggest obstacle to the growth of responsible investment (RI). It is crucial that industry actors take steps to be as clear and accurate as possible in their ESG claims. An important question to consider is “how can we build trust?”

Building Trust

Regulatory authorities around the world have taken action to curb concerns around greenwashing and supervise ESG-related claims.

In early 2022, the Canadian Securities Administration (CSA) published a staff notice outlining their ESG disclosure expectations for investment funds. It includes expectations on how funds present their ESG approaches in advertising.

While regulators are addressing greenwashing from a policy perspective, industry players and fund managers also have an important role to play. They can be leaders in maintaining the public’s trust on ESG claims and facilitate clear communication.

This is why it is essential to raise awareness about the public’s concern around greenwashing among anyone involved with the promotion of responsible investment. It is a vital step in ensuring authenticity and avoiding risks.

Responsible investment training courses for industry professionals, and advisors in particular, are multiplying. It is crucial not to forget about communications and marketing professionals, and anyone making public-facing claims while promoting RI. Awareness about the risk of the perception of greenwashing and RI knowledge should be integrated into the entire business line to ensure consistent and accurate ESG communications.

An ESG-related Guide for Communicators

To address this gap, Desjardins has developed a guide to help teams not specializing in RI address the do’s and don’ts of ESG-related communications. The recommendations include the following tips for communicators:

1. Ask questions

When creating communications about RI, put yourself in the shoes of an investor who may question the claims. Can the claims be substantiated? Do they reflect current policies? Could the claim be interpreted as exaggerated or misleading?

2. Manage expectations

While we are often proud of the outcomes our RI products can have on environmental, social or governance issues, we must avoid over-promising or over-selling what they actually achieve. Exaggeration or puffery leads to mistrust. When in doubt, limit claims to information you can verify.

3. Use simple, understandable language

Retail investors rely on us as RI experts to give them the information they need to make informed decisions. They may not have the specialized language or know all the terminology that we do, so keeping language simple and understandable will help ensure the message is not misinterpreted or misleading.

4. Verify

Cite sources whenever possible. For example, when talking about climate data, cite the source, as there are different methodologies for calculating the data. This demonstrates transparency to investors and gives them the tools to verify the information and avoid confusion.

5. Be consistent

To promote industry progress and best practices, teams should be made aware of how to describe investment outcomes. It keeps all communications consistent across the organization and avoids confusion. This training may include the following directions:

– Document outcomes when they can be supported by evidence.
– Avoid attributing outcomes to individual investors.
– Use the term ‘impact,’ in line with industry methodological best practice.

The feedback we received confirmed the need to equip teams with ESG communication tools. We continue to educate employees and our partner advertising agencies so they are better equipped to prevent situations of perceived greenwashing. Ongoing internal dialogue also helps keep everyone up to date about best practices and any new risks or developments.

Firms that are innovative and proactive about ESG-related communications and those target teams not usually involved in RI training can ensure their investors are confident about participating in RI. This is essential for the continued growth of an industry with significant potential for positive outcomes on the planet and society.

---

Contributor Disclaimer
Desjardins®, all trademarks containing the word Desjardins, as well as related logos are trademarks of the Fédération des caisses Desjardins du Québec, used under licence.

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.

Investors with net zero commitments share a challenge regarding the carbon-intensive companies in their portfolios. For now, most Canadian investors choose – at least publicly – engagement over divestment as the way to decarbonize their portfolios. But this is an unhelpful dichotomy and escalation is necessary for soft engagements that are not working. To decarbonize (and de-risk) their portfolios, Canadian investors need to flesh out their climate engagement strategies. This means a willingness to escalate to stronger engagement tactics, and, where there is no meaningful progress, divest.

At present, the state of investor climate engagement in Canada – as we have come to understand it in our climate shareholder advocacy work over the past two years – is characterized by:

– Confidential meetings between investors and publicly traded companies;

– Some investor-led initiatives like Climate Engagement Canada and CA100+;

– Some voting support for climate-themed shareholder resolutions, although a reluctance by investors to pre-declare their support and file resolutions (especially larger investors);

– Little attention paid to holding directors accountable for climate inaction; and

– A reluctance to extend engagement to fixed income instruments and private equity investments.

In the UK, engagement without escalation is somewhat cheekily called “tea and biscuits” – the practice of having a nice chat with the company and calling it a day. Unsurprisingly, there is little expectation that this will result in much change. Indeed, when we look at the plans of major oil companies, including Canadian ones, despite investor engagement they are doubling down on oil and gas expansion, thereby making investor portfolios even less aligned with net zero.

The Columbia Center on Sustainable Finance recently published a great overview of net zero finance best practices. It states that for any engagement policy to be effective it should “set clear targets, disclose engagement strategies and outcomes, communicate and execute escalation strategies, and have clear consequences for poor performance.” Engagement tactics require teeth to drive change. The Columbia Centre lists the following as best practices for escalating engagement:

– For public equity, lobbying for more stringent public policies and regulatory enforcement to make client engagement more effective. In addition, escalating from shareholder resolutions to voting against financial statements, executive remuneration, and/or directors where no meaningful action is taken on climate-related shareholder resolutions (e.g. BCI is one of the first Canadian investors to publicly do so with Imperial this season).

– For debt holders, “there is an opportunity, particularly during critical moments of refinancing, to require debt issuers to include climate strategies and transition plans as part of debt obligations.”

– For private equity investments, there is an opportunity to buy and restructure “non-1.5ºC-aligned companies to ensure credible and meaningful transition planning for 1.5ºC. Their longer time horizon as compared to public markets as well as their full ownership governance models grant them a strong lever.”

– Asset owners have the potential to “select (or terminate) asset managers on the basis of their climate or other sustainability engagement strategies (which may be laid out in the asset manager’s fund prospectus); the more publicly they do so, the more influential their efforts.”

– Banks have the ability to implement financial incentives and penalties that encourage companies to decarbonize.

Climate engagement is an important tool for decarbonizing financed emissions, but must be associated with these types of escalation tactics to influence management.

This brings us back to the unhelpful engagement vs. divestment dichotomy. In fact, when engagement has failed, and it is clear that a company has no real intention or ability to transition to net zero, financial institutions must be willing to walk away to avoid the transition risk associated with these assets. Rathbones, a UK-based investment firm with over 60 billion GBP under management, is a prime example of an investor willing to commit to divest when engagement escalation fails. This is essential for accountability and will help reduce the liquidity available for bad actors.

This coming year, we expect to see Canadian financial institutions improve their climate engagement practices by adding escalation tactics – per trends in Europe and from some of North America’s most progressive investors – as their clients and the public expect them to follow through on their climate pledges. To support this shift, investors would benefit from more quality, independent assessments of the net zero plans of major emitters, especially financial institutions and the oil and gas sector. In particular, we have noticed an appetite for more information on climate engagement best practices relating to private equity and corporate bond investments. Additionally, daylighting the climate-related proxy voting practices of major Canadian investors will help hold investors accountable to their stated commitments to climate engagement. Voting in support of climate-related shareholder resolutions is a relatively soft engagement tactic, but it is a critical first step in the escalation process and is an effective means of communicating shareholder priorities.

---

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.

With the recent launch of the Government of Canada’s groundbreaking Social Finance Fund (SFF), the social finance sector in Canada is set for significant  growth. One of the SFF wholesalers sets out what you need to know about this important new initiative.

What is the Social Finance Fund all about?

In brief, it is about creating a much stronger social finance market in Canada that is better able to deliver positive social and environmental outcomes. The Social Finance Fund is a Government of Canada $755 million initiative. It is part of its Social Innovation and Social Finance Strategy, launched publicly in 2018. In May 2023, the Government announced three fund-of-funds managers (wholesalers) to manage portions of the fund: Realize Capital Partners, Boann Social Impact and Fonds de finance sociale – CAP Finance.

What is the structure of the Social Finance Fund?

Fund-of-fund managers have been allocated money to use as investable capital as well as funding to build the market. Each fund-of-fund manager has its own strategy and structure for deploying capital and for market building. Broadly speaking, capital flows from the fund-of-funds managers to social finance intermediaries (fund managers and structured products) and then through to social purpose organizations (ventures, companies).

At Realize Capital Partners, we’ve structured our fund (targeted raise: $405 million) as a conventional limited partnership and will be investing across private market asset classes. Through this approach, we can aggregate investment needs across smaller emerging and established impact-focused fund managers, while operating at an investable scale for even large institutional investors. The Government of Canada has provided conditionally repayable contribution funding  to meaningfully de-risk private investment in this structure. It is participating on a “first in, last out” basis with its capital being deployed prior to private investors and only being repaid after private capital has been repaid with a minimum return.

How significant is this for the Government of Canada, and for the responsible investing sector in Canada?

This is a significant development. We believe it is a clear demonstration by the government of its interest in enabling markets to drive better social and environmental outcomes in tandem with public policy. It is a clear recognition of the need for private capital to be engaged at a meaningful scale to enable the growth of existing and new solutions. 

It is also meaningful for the responsible investing sector in Canada because it supports the mainstreaming of what has been a relatively niche part of the broader capital markets led by foundations, some family offices, and pioneering asset managers. Impact investments demand a stronger accountability for impact measurement and tangible outcomes, and the industry is already looking to progress in this area with themes such as climate and diversity, equity and inclusion.

This initiative is significant because it will support the maturity of more existing private market fund managers and product issuers, building both the scale and the track records necessary for more meaningful engagement from established actors in the capital markets.

Accredited and institutional investors will be investing alongside fund-of-funds managers, either into the funds or the underlying holdings directly. This provides a turn-key mechanism to invest in a larger, widely diversified strategy that will invest in a variety of impactful private market strategies. It will produce positive outcomes in communities across the country.

We expect that asset managers who may have been thinking of developing more impactful private market products but have been unsure of potential demand, will now consider bringing these opportunities forward.

Why is social equity such a focus for this initiative?

We believe the Government of Canada is trying to create a more equitable society through this initiative. All fund-of-funds managers are focused on this goal. Social equity is a strong focus of Realize Fund I because we believe this lens is both necessary to drive more impactful investments in communities across the country, and because we believe there are opportunities for a social equity lens to drive real financial alpha.

A social equity lens contributes to the selection of more impactful investments because it reflects the fact that social and environmental issues are rarely felt equally. Too often, communities facing greater socio-economic marginalization will  face other issues more acutely. For example, those in  economically precarious situations may be disproportionately impacted by the lack of affordable housing and access to care. By using  a social equity lens, investments will directly or indirectly affect equity-deserving communities, and opportunities that deliver positive social or environmental outcomes should be prioritized. We’re clear that we consider this the responsible, just thing to do.

We also believe that this lens can correct for biases in our own investment process and allow us to invest in opportunities that may drive better financial outcomes. In some underserved markets our partners will often be first or second movers and have the advantage of being able to work with remarkable, undiscovered businesses that just lacked better access to capital to thrive. A social equity lens can enable us to look at opportunities from multiple perspectives, informing a better understanding of if there’s a difference between real and perceived risk.  By creating a focus on underserved markets with untapped opportunities and informing a more complete view on risks, a social equity lens can also support financial outperformance.

How will the Social Finance Fund combat “greenwashing” and “impact washing”?

The Social Finance Fund requires active impact measurement and management across all investments. This creates a good opportunity to create a greater level of standardization around common requirements for impact measurement. This also means there will be more accountability for delivering positive outcomes across a range of dimensions. By acting transparently in our investments, holding fast to our requirements to monitor investments over time, we’ll avoid “impact washing”, and demonstrate authentic benefits to communities in Canada.

The steady progression of responsible investment (RI) in Canada over the last decade has given way to a flood of new developments. Fund companies have expanded their ESG teams and investment products. Regulators are advancing standards around disclosures, risk reporting, and terminology. And companies and investors alike are trying to map their climate ambitions to reality with net zero emissions targets at the forefront.

Topics that were until recently the domain of ESG specialists are becoming central to long term investment strategies, with leading organizations integrating ESG from the top down and throughout. There is also higher demand than ever for more standardized reporting as investors grapple with concerns about greenwashing, RI terminology and changing disclosure requirements, signaling a maturing industry.

Responsible investment is at a turning point where theory must turn into practice in order to reshape the Canadian economy It is in this unique context that we organized the first in-person RIA Conference since 2019, covering leading-edge and emerging topics in ESG and sustainable finance with national and international experts.

From Tuesday, June 6th to Wednesday, June 7th, we hosted the largest gathering of RI professionals in Canada for 25 expert-led sessions featuring 90+ speakers on the most important topics in the industry.

Big Picture Trends in RI

RI is evolving at every level, including global and regional standards and regulations. With Canada uniquely positioned to lead in key industries necessary for the transition to net zero, such as critical minerals, batteries and renewable energy, it is important that we forge this path instead of waiting to be told how to proceed. Large-scale investment is needed to transition our economy, but capital requires clarity and consistency. Disclosure and sustainability standards are key to mobilizing positive investor influence on the environment and society.

The 2023 Conference featured several panels focused on “big picture” challenges, as well as the establishment of better definitions, scoring, and reporting, which could define the future of responsible investment, including:

• Advancing Sustainability Reporting Standards: An Update from the ISSB
• Harmonizing RI Terminology: Progress Report on the CARET Project
• Regulators Roundtable: ESG in Focus
• Achieving Net Zero By 2050: Developments from SFAC & NZAB

The Investable Future, Now

The future of responsible investment is intertwined with our need to transition to a sustainable and inclusive economy. Embracing sustainability and inclusivity is imperative, not only to mitigate risk but also to identify new investment opportunities for a prosperous and equitable society. Several sessions explored specific sustainable investment opportunities and their related challenges, including:

• Investing in a Circular Economy: Tackling Global Challenges and Capturing Opportunities
• Innovations in Agriculture: Towards More Sustainable Food Systems
• Plugging into Electrification: Why and How to Expand and Decarbonize Canada’s Grid
• The Future of Energy: Deploying Capital for a Sustainable Future
• Critical Minerals: An Essential Input in the Energy Transition

Societal Shifts and Progress

Disruptive trends and societal shifts are bearing a variety of impacts on our way of life, from the prevalence of artificial intelligence, to our aging population and loss of biodiversity. By monitoring, mitigating, and/or adapting to these shifts, investors can position themselves to seize opportunities, reduce risks, and contribute to a more sustainable and equitable future. We convened experts on the following topics:

• AI is Transforming the World: What Does it Mean for Your Portfolio?
• Demographic Disruptions: Implications for the Financial Markets
• Real Assets & Responsible Investing: Sustainable and Long-Term Opportunities
• The Next Imperative: The Urgent Need for Investor Action on Biodiversity

Practical Knowledge for RI Advisors

Responsible investment represents an opportunity for advisors to grow their businesses. Research shows that ESG issues are becoming increasingly important to retail investors, and financial advisors need the knowledge and tools to help clients incorporate these factors into their investment decisions. Attendees developed their knowledge and shared peer-to-peer insights in sessions such as:

• Advisor Conversations: Engaging with Clients About RI
• Empowering RI Advisors: Unleashing Insights and Overcoming Challenges

Investing with an Impact

By strategically deploying capital into businesses, organizations, and projects that generate positive social and environmental outcomes, impact investors can drive meaningful change, foster innovation, and contribute to the sustainable development of communities and the planet. The 2023 RIA Conference shed light on key impact initiatives and frameworks in the following sessions:

• Halfway to 2030: Investor Action on Achieving the SDGs
• Accelerating Social Finance in Canada

Connecting with the Responsible Investment Community and Thought Leaders

In addition to the plenary sessions, attendees enjoyed a variety of opportunities to network, collaborate, and engage with industry colleagues. The 2023 RIA Conference offered an unparalleled opportunity for RI professionals to gain cutting-edge information from top thought leaders, share knowledge, exchange ideas, and collaborate.

Mark your calendars for the 2024 RIA Conference in Vancouver, BC on May 28th and 29^th!

Food prices are rising everywhere. While food insecurity is a global trend stemming from several strong macro-economic forces at play, certain unique market characteristics could be exacerbating the problem within Canada. If incomes fail to keep up with inflation, Canadian food insecurity is expected to worsen further. We outline the situation and suggest 7 actions investors can undertake to tackle the issue.

Why food insecurity should matter to investors

The World Food Programme estimates 345.2 million people around the globe will be food insecure in 2023, more than double the number estimated in 2020. Statistics Canada data showed that in 2021, 5.8 million Canadians (1.4 million of which were children) across ten provinces were living in food-insecure households. Use of food banks rose 35% between 2019 and 2022 and it is estimated that food banks and other non-profits dispensing free food will see another 60% increase in demand in 2023. Experts believe the problem of food insecurity is expected to get worse if incomes fail to keep up with inflation. Without significant change, food insecurity will become a larger issue in Canada and globally.

Addressing food security and hunger, in addition to being a moral imperative, is an investor issue. The 2023 World Economic Forum Global Risks Report lists the cost-of-living crisis as the number 1 risk in the next two years to the global economy. At a global scale, food shortages and rising food prices are linked to social unrest, which can lead to destabilization of markets. A prime example of this were the “food riots”: in 2011 when the UN’s Food and Agriculture Organization (FAO) Food Price Index peaked, and riots erupted in 48 countries. For reference, the FAO Food Price Index has never been higher than in May 2022, even when compared to the 2011 peak. 

While it is unlikely that food insecurity in Canada will lead to social unrest at home, it does have negative knock-on effects. High food prices and inflation for many reduces the ability to save money. When grocery prices dramatically increase, Canadians’ ability to save money for retirement, school or for emergencies, is also reduced. Retail investors under financial strain might prioritize household spending over mutual fund investing. A reduction in discretionary spending by Canadian consumers can also negatively affect revenue of corporate issuers investors hold.

The price of food in Canada

As of January 2023, grocery prices in Canada had risen 11.4% compared to the previous year – almost double the overall inflation rate of 5.9%.  There are many contributing factors.  Covid-19 and geopolitical conflict have disrupted supply chains while climate events are challenging status quo means of agriculture and quantity of food produced.  Escalating energy and fertilizer costs are also contributing factors.

In 2021 and 2022, grocery chain profits in Canada increased significantly amidst rising global inflation. Research examining the trend highlights how some of the Canadian grocers posted higher profits in the first half of 2022 relative to average past performance over the last five years.

Grocery Inflation

Statistics Canada reports that while year-over-year inflation is 7.7 per cent for all products, groceries have gone up 9.7 per cent.
Source: StatCan CPI food purchased from stores.
Toronto Star Graphic

There are calls for greater transparency from the grocers on the link between rising food prices, supply chain costs and where the rising profits come from.  The major grocers themselves note that excess profits can be attributed to sales in non-food segments such as makeup and pharmacy products, not to only from increases in food prices, and that they are in fact taking on more costs than they are passing on to the consumer. Enhanced disclosure by operating segment to give better insights into whether profits are coming from the pharmaceutical business, grocery business or elsewhere, could give away competitively sensitive information. However, seeing the numbers to verify the source of profits would help dispel concerns.

Under current practices, Canada’s major grocers do not disaggregate disclosures by operating segment (i.e. food versus non-food items) despite International Financial Reporting Standards (IFRS) requirement that disclosures be disaggregated if the nature of the products and services, and the means by which they are produced, are dissimilar. Investors can use their position of influence to encourage grocery retailers to enhance disclosure, mitigate food price-related risks and contribute to tackling food insecurity.

Canadian market dynamics and the Grocery Code of Conduct

Five large retailers control approximately 80% of Canada’s grocery retail market. The Canadian Competition Bureau is currently investigating whether competition in the sector is playing a role in the increase of grocery prices, with their report expected in June 2023. Some expect the bureau to recommend that the federal government create changes in the law to give it more power to address competition concerns.

Food supply chain complexities within Canada, including provincial border tariffs, also keep certain food prices artificially high or in some cases leads to forced food loss (see the Spotlight section).

Spotlight  The Canadian dairy, poultry and egg industry is a prominent example which showcases the difficulties of working in Canada’s food supply chain. Canada has a highly controversial supply-management system which regulates supply and imposes high border tariffs on taxes for these three food groups. This system, while in theory protects Canadian farmers, has been shown to have flaws, and is not holding up to the socio-economic pressures arising from high inflation. Dairy farmers, for example, are forced to dump milk in order to keep market supply levels within set quotas. Recently, these dairy farmers have been speaking out against the ‘milk-dumping’ policies, saying that more supply could lower prices. Additional supply could also potentially alleviate pressure on food banks.

Furthermore, an estimated 12% of Canada’s avoidable food loss and waste occurs during the retail phase of the supply chain. Grocery retailers can play a key role in reducing food loss and waste including through influencing their supply chains, for example through procurement practices. 

Concern that uneven power dynamics between grocery retailers and suppliers undermines the resiliency of Canada’s food supply chains has also led to efforts to develop a Grocery Code of Conduct to enhance transparency, predictability, and fair dealing within the sector.  The voluntary Code’s anticipated release is by the end of 2023.  One of the code’s intentions is to establish more equitable administration of retail fees that suppliers pay retailers to sell their goods.  Current practices have been characterized as retroactive, unpredictable, and unilateral (the latter of which places smaller suppliers at a significant disadvantage) undermining conditions to support greater product variety, innovation, and supply chain resiliency in Canada.  

While a Grocery Code of Conduct will not directly regulate prices nor fees that retailers set for food processors, it will establish contractual obligations for greater risk sharing including requiring more collaborative forecasting of supply orders.  

The Code will also include a dispute resolution mechanism, adjudication process, mediation and arbitration models, and enforcement mechanisms, all of which will help promote fair and ethical trading between Canada’s grocery retailers and suppliers that ultimately help support greater domestic supply chain resiliency.  A Grocery Code of Conduct can also help promote better worker conditions within Canada’s food supply chains by creating greater stability to support, for example, provision of a living wage and safe working conditions.

What can investors do?

Investors benefiting from higher grocery retail profits have their own obligation to conduct due diligence with investee grocery retailers accordingly to ensure that short term gains are not being prioritized over the longer-term implications that acute food inflation could have on returns across all portfolio investments.

Investors can encourage 7 best practices with companies both up- and downstream the food value chain and with policymakers:

1) Engage with Canadian grocers and food distributors to encourage more transparent disclosures aligned with the IFRS standards, which would create more transparency on profits by segment.

2) Encourage investee grocery retailers in Canada to proactively contribute and adhere to the principles within the upcoming Grocery Code of Conduct.

3) Given that food insecurity is expected to get worse if incomes fail to keep up with inflation, engage companies across portfolios on committing to providing Living Wages. Also consider support for initiatives such as the Workforce Disclosure Initiative, which creates reporting standards for companies on workforce matters including wage levels and benefits.

4) Encourage investee grocery retailers to implement effective human rights due diligence practices (HRDD) to prevent and mitigate actual or potential adverse human rights impacts from business activities. Under an HRDD approach, companies would need to investigate what adverse impacts operations have across the value chain. Access to food as a fundamental human right would be a key salient topic for companies in the food retail sector.

5) Keep an eye out for the Canadian Competition Bureau’s report in June to identify whether there are policy engagement opportunities based on its recommendations and advocate for human rights-based food policy with governments.

6) Encourage companies to advocate within their industry for more favourable market dynamics in Canada, which could help to lower food prices (such as in the example of the dairy, poultry and egg industry).

7) Encourage food retailer practices to reduce food waste and to donate excess food to food banks in line with the Canadian government’s recommendation for reducing food waste between food retailers in Canada.

Access to food is a fundamental human right and is embedded in the Universal Declaration of Human Rights. As responsible investors whose approach includes investing or engaging for sustainable outcomes, we can take actions such as the ones above to contribute to the second UN Sustainable Development Goal to reach ‘Zero Hunger’ by 2030, both abroad and at home.

---

Contributor Disclaimer
Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent prospectus.

This article is for information purposes. The information contained herein is not, and should not be construed as, investment or legal advice to any party.

BMO Global Asset Management is a brand name under which BMO Asset Management Inc. and BMO Investments Inc. operate.

®/™Registered trademarks/trademark of Bank of Montreal, used under licence.

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.

The gradual increase of green bond issuance through the 2010s accelerated into a tidal wave of ESG-labelled debt issuance in the early 2020s (Figure 1). The original green bond concept has developed into a use of proceeds category that includes green, social, and sustainability bonds. This category works well for government and corporate issuers that have specific green projects that qualify under green bond frameworks and can be verified by second party opinion providers. Sustainability-Linked Debt is one of the best ways to ensure that companies achieve their ESG targets and their sustainability goals.

Figure 1. Global GSSSB issuance forecast to reach $900 billion to $1 trillion in 2023 (Annual GSSSB issuance by instrument type)

Note: Excludes structured finance issuance. f–S&P Global Ratings forecast. GSSSB-Green, social, sustainability, sustainability-linked bonds.
Sources: Environmental Finance Bond Database, S&P Global Ratings.
Copyright © 2023 by Standard and Poor’s Financial Services LLC. All rights reserved.

The newer concept of Sustainability-Linked Debt has a coupon structure that is linked to corporate ESG targets and specific ESG Key Performance Indicators (KPIs) that are defined at issuance and go by the labels Sustainability-Linked Bonds (SLBs) and Sustainability-Linked Loans (SLLs). This category is open to any issuer that has relevant corporate ESG targets and consistent reporting for ESG KPIs (Figure 2).

Figure 2. Industry Classification: Sustainability-Linked Structures

Source: Bloomberg, Environmental Finance Data, Mackenzie Research
Historical Data 2019-2022 – 308 SLB assessed

Companies are generally motivated to issue SLBs to align their financing strategy with their sustainability strategy. Some critics think it is not sufficient for companies to define and report on their own targets, but this does not necessarily lead to lacklustre results. Companies with ambitious targets, who understand the risk and opportunity in their approach to ESG, can get it right. While not all ESG targets and SLB KPIs are relevant and ambitious enough, credit and ESG analysts can indeed sort out the ‘good’ SLBs from ‘bad’ SLBs.

In general, what gets measured gets managed. Mechanisms such as sustainability-linked debt ensure that words turn into action and that failures to achieve ESG targets will be high profile and will result in significant reputational damage for both executives and the company – as well as a modest interest rate penalty. The benefit to the issuer is primarily to boost their reputation and their sustainability credentials. In recent years, companies have set targets in their SLB frameworks ranging from the reduction of greenhouse gas emissions to the increased use of renewable energy to specific targets related to gender equality and to racial and ethnic diversity (Figure 3).

Figure 3. KPI – Key Performance Indicator (SLB – ~96% Data Coverage)

Source: Bloomberg, Environmental Finance Data, Mackenzie Research
Historical data 2019-2022 – 308 SLB assessed that include 394 KPIs
Figure 3 shows % of the 394 for each type of KPI

An available universe of over 300 SLBs shows that half of issuers use one KPI and half use more than one KPI (Figure 4). We provide an example of how the most frequently used ESG KPI can be used below.

Figure 4. Number of targets – KPI (SLB Universe)

Source: Bloomberg, Environmental Finance Data, Mackenzie Research
Historical data 2019-2022 – 308 SLB assessed
Figure 4 shows % of the 308 that have 1, 2, 3, 4, or 5 KPIs

ESG KPI – Greenhouse Gas (GHG) Emissions Reductions Targets by 2025 and 2030

Corporates can follow government GHG emission reduction targets or select their own targets by 2030 as a key milestone towards their Net Zero by 2050 commitments. GHG emission reduction targets are the most popular, with over 50% (Figure 3) of SLBs having at least one target related to GHG emission reduction. Corporates are focused on Scope 1 and 2 emissions for their targets although some have started to include Scope 3 emissions that better reflects their total carbon footprint (Figure 5). Scope 3 is more difficult to estimate and generally outside of the companies’ direct control because they represent the upstream emissions of their supply chains and downstream emissions of their customers.

Figure 5. GHG emission reduction targets – Type

Source: Environmental Finance Data, Mackenzie Research
Historical data 2019-2022 – 308 SLB assessed

Examples of ESG KPIs include the few SLBs issued to date in Canada. These three SLB issuers below represent the full set of SLB issuers in Canada, but many more are expected in the coming years to join the growing list of SLB issuers from the United States, Europe, Latin America, and Asia Pacific. 

Conclusions and Recommendations

The Mackenzie Fixed Income Team believes that corporate debt issuers should focus on 2 or 3 ESG KPIs to be included in their SLB frameworks, issuance and reporting.  In our view, issuers should select their most important environmental KPI, their most important social KPI, and any other KPI that is specific and material to their business. A certain number of company projects can be financed with green, social, and sustainability bonds. The rest of their debt financing and refinancing needs can be met with sustainability-linked bonds and loans. We are starting to see companies who are driving towards or who have already achieved 50% ESG-labelled debt or even 100% ESG-labelled debt by using a combination of green, social, and sustainability use of proceeds debt and sustainability-linked debt. 

Companies should select the metrics that are most material to their company and to their sector. This process should start at the top of the company with the development of corporate ESG strategy by the executive team and the board of directors. The corporate ESG strategy and any related targets should be important to and driven by the CEO as well as the CFO and communicated as such to all stakeholders, demonstrating to potential investors the company’s commitment to sustainability.

---

Contributor Disclaimer
The content of this article (including facts, views, opinions, recommendations, descriptions of or references to, products or securities) is not to be used or construed as investment advice, as an offer to sell or the solicitation of an offer to buy, or an endorsement, recommendation or sponsorship of any entity or security cited. Although we endeavour to ensure its accuracy and completeness, we assume no responsibility for any reliance upon it.

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.

While integrating Environmental, Social and Governance (ESG) considerations into real estate investment decisions has become mainstream over the past decade, the role of lenders in this evolution has often been overlooked. Real estate lenders are increasingly integrating ESG considerations into origination, underwriting and due diligence processes — as well as engaging with borrowers on sustainability considerations throughout the life of the loan. Identifying and incorporating into the lending process ESG factors which are material – meaning, omitting, obscuring or misstating these factors could be reasonably expected to influence investor decisions – may help mitigate risks at the underwriting stage and ultimately de-risk assets through the holding period to loan maturity.

ESG-Focused Lending and Risk Profile Enhancement

Lenders who rely solely on comparable market transactions for underwriting, without incorporating material ESG risk factors and important non-financial information, may fail to address issues that transform into tangible financial risks. As a result, investors ignoring material ESG considerations may misprice investment opportunities and potentially suffer higher loan impairments or losses. 

Further, by engaging borrowers on material ESG issues throughout the holding period, lenders may gain an opportunity to improve income security and predictability and may nudge borrowers toward mutually beneficial ESG performance improvements that help drive positive property-based outcomes, such as better tenant attraction and retention. 

ESG Integration in Real Estate Debt: A Practitioner’s Guide

Many of the ESG integration approaches from real estate equity investing are transferable to commercial mortgages. The key to adapting equity-focused practices for debt investing is determining how to right-size ESG information requests and streamline the integration approach. ESG integration should be considered across three stages in the commercial mortgage debt issuance process:

1) Origination/Underwriting: Collecting and assessing ESG information during this stage is crucial for contextualizing a commercial mortgage opportunity. Sophisticated lenders are increasingly using ESG checklists during underwriting to obtain enhanced visibility on material ESG issues, which significantly impacts mortgage attractiveness and the negotiated terms. Factors to consider include (but are not limited to):

a) Sustainability-focused building certifications: These can offer third-party validation of a property’s environmental and/or social attributes — and position it to be more competitive from a tenant attraction/retention and operating perspective (e.g., indoor air quality enhancements).

b) Operational performance of the underlying asset: Objective measures of operating efficiency, such as the ENERGY STAR Portfolio Manager score (the industry benchmark for commercial buildings) as well as energy use intensity and operating costs, can influence the borrower’s debt servicing abilities.

c) Reputation: The borrower’s operating reputation, existing community/stakeholder relationships and potential controversies (e.g., a history of “renovictions” for multi-family building owners) can impact a lender’s outlook on the property’s income and value creation potential.

d) Proximity to key amenities and transit: Objective measures such as a property’s walk, bike and transit scores can influence its ability to attract and retain strong covenant tenants.

2) Due Diligence: At this stage, select ESG metrics are measured, assessed and folded into the investment thesis. Red flags at this point will often change the trajectory of the investment, at a minimum requiring a revisit to the underwriting. For example, lenders can issue an ESG survey or checklist that builds on information gathered during the underwriting phase, such as:

a) The governance capabilities of the borrowing group, including assessing their policies and governance structures through borrower group interviews.

b) Property condition and climate resilience considerations through a review of third-party Building Condition Assessment reports and assessments of exposure to natural hazards (e.g., seismic) and physical climate risks (e.g., flood, wildfire, sea level rise), while also ensuring adequate insurance coverage is in place.

c) Environmental contamination or pollution risk assessment, ensuring an Environmental Site Assessment report and detailed findings are considered.

d) Compliance with regulatory reporting requirements for energy use, water consumption and/or greenhouse gas emissions, which could result in fines or penalties to the owner if not in compliance.

3) Post-Underwriting (Holding Period): Sustainability considerations can be integrated into portfolio management processes primarily through engagement with the borrower. For example:

a) Alongside annual financial statement requests, lenders can request property-specific sustainability information (e.g., planned sustainability retrofit projects and ongoing initiatives) to facilitate constructive dialogue on sustainability-focused opportunities for the property.

b) Lenders can discuss sustainability-focused operational enhancements or retrofit financing opportunities (e.g., “green loans”).

By proactively engaging borrowers on ESG considerations throughout the life of the loan, lenders not only position themselves for success during the holding period, but also for potential mortgage renewal and follow-on financing opportunities. 

Case Study: ESG Integration in Underwriting May Lead to Improved Financing Terms 

Property: New build, downtown Toronto office

Notable Features: Platinum certification from Leadership in Energy and Environmental Design (LEED), the most widely used green building system, with on-site renewables

The property was built in 2016 to far exceed building code requirements with energy and water efficiency-focused features. As a result, it achieves operating costs (excluding realty taxes) approximately 25% below competing properties. This reduction has allowed the borrower to remain competitive while charging a higher net rent. In the event of market turmoil and falling rental rates, the borrower’s cash flow stream will likely remain more resilient than its competitors’. The lender also considered the LEED Platinum certification, LEED’s highest rating level, to further protect itself from downside risks as it meets tenants’ ever increasing sustainability requirements. 

As a result of the sustainability attributes of the property, the borrower was able to increase the financing proceeds by about 10% while maintaining loan fundamentals consistent with market-leading pricing. Consequently, the lender’s broad understanding of ESG impacts allowed it to be more competitive than peers, whose underwriting was based solely on market standards.

Conclusion

As outlined, there are good reasons for lenders to expand their influence with respect to ESG engagement in commercial mortgage lending. Those include creating a more resilient loan portfolio, benefiting from broader market trends due to valuation premiums or discounts based on a property’s ESG profile, and a recognition that tenants have increasing leverage in some property types to force concessions. Integrating ESG considerations can help provide downside protection as well as the potential to strengthen relationships with borrowers through constructive dialogue.

---

Contributor Disclaimer
The information contained is for information purposes only. The information has been drawn from sources believed to be reliable. The information does not provide financial, legal, tax or investment advice. Particular investment, tax, or trading strategies should be evaluated relative to each individual’s objectives and risk tolerance.

This material is not an offer to any person in any jurisdiction where unlawful or unauthorized. These materials have not been reviewed by and are not registered with any securities or other regulatory authority in jurisdictions where we operate. 

This document may contain forward-looking statements (“FLS”). FLS reflect current expectations and projections about future events and/or outcomes based on data currently available. Such expectations and projections may be incorrect in the future as events which were not anticipated or considered in their formulation may occur and lead to results that differ materially from those expressed or implied. FLS are not guarantees of future performance and reliance on FLS should be avoided. 

TD Global Investment Solutions represents TD Asset Management Inc. (“TDAM”) and Epoch Investment Partners, Inc. (“TD Epoch”). TDAM and TD Epoch are affiliates and wholly-owned subsidiaries of The Toronto-Dominion Bank. 

®The TD logo and other TD trademarks are the property of The Toronto-Dominion Bank or its subsidiaries.

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.