Sustainable finance: three things advisors need to know

The panel defined sustainable finance as “capital flows (as reflected in lending and investment), risk management activities (such as insurance and risk assessment), and financial processes (including disclosures, valuations, and oversight) that assimilate environmental and social factors as a means of promoting sustainable economic growth and the long-term stability of the financial system. The conditions for sustainable economic growth are to meet the needs of the present without compromising the future.”

Responsible investments that rigorously incorporate environmental, social and governance (ESG) factors would be a subset within the broader realm of sustainable finance.

Major institutional investors immediately welcomed the panel’s recommendations and declared their support for sustainable finance more broadly. Finance Minister Bill Morneau also welcomed the recommendations and asserted the government’s intention to implement them, although he cautioned that it will take some time.

Three potential policies advisors should know about

Among the many recommendations and policy proposals included in the report, three stand out as being particularly relevant to investment advisors.

1. Knowing your client’s sustainability preferences

During its consultations, the panel heard that although Canadians are often confronted with the impending threat and costs of climate change, they are rarely informed about climate-smart investment opportunities. As a result, the panel recommended that investors should be provided with opportunities and incentives to connect their savings to climate objectives.

Notably, the panel stated, “provinces should assess the formal responsibilities of Canadian investment advisors and agents in engaging clients on their sustainability preferences and communicating the merits of related investment options.” This is a call for provincial securities regulators to revisit the know-your-client rules, which are currently silent on assessing a client’s preferences regarding climate change and other ESG matters.

Although it remains uncertain whether regulators will take this action, Morneau’s public statement in favour of the recommendations suggests that such a regulatory change may, in fact, be on the horizon. Advisors who are already positioned as responsible investing (RI) experts would have a clear competitive advantage in this scenario.

2. More RRSP room and tax deductions for climate-conscious investments

The panel also proposed a financial incentive for retail clients to choose climate-friendly investments through their registered savings plans. For example, the panel recommended the federal government offer increased contribution space and a “super tax deduction” for contributions to registered retail savings plans earmarked for climate-conscious products. A similar program could also be rolled out for defined contribution pension plans.

Specifically, the panel proposed taxable income deductions greater than 100% on eligible contributions, combined with an increased contribution limit available only for eligible climate-smart investments. Such a program would surely spark a wave of retail assets moving into responsible investment vehicles.

3. Clarification of fiduciary duty in the context of climate change

The panel found during its consultations that some market participants continue to hold a narrow interpretation of fiduciary duty and materiality, making them believe that climate change and other ESG factors are beyond the scope of fiduciary obligations.

However, the panel heard from legal experts that such narrow interpretations are risky, since fiduciaries that fail to consider material ESG risks such as climate change may expose themselves or their firms to legal liability for various claims. For example, the panel noted that more than 1,200 climate change actions have been filed against governments and corporations in over 30 jurisdictions.

As a result, the panel urged policy-makers to clarify that incorporating climate change and other relevant ESG factors into investment decisions is indeed compatible with a fiduciary duty – and may even be required. Such a clarification would surely be another boon to responsible investing, and investment professionals who are knowledgeable about RI would be positioned to reap the rewards.

The road ahead

The investment industry seems to be in a constant state of disruption, and climate change has now emerged as one of those disruptive forces – not only for securities selection, but also for advisor practice management.

As Morneau noted, it will take some time for these recommendations to be implemented. Nonetheless, the markets are moving to achieve long-term, sustainable growth – regardless of which political party is in power. In this market environment, advisors can gain a competitive advantage by understanding the financial risks and opportunities associated with climate change and other societal challenges.