As Australia finances its transition towards a low carbon economy, it can draw lessons and parallels from Canada’s experience, according to RBC Capital Markets’ Sarah Thompson. That’s because both countries are likely to face similar challenges and opt for similar solutions to overcome them.
“The Canadian economy, just like Australia’s, is highly dependent on natural resources and heavy industry,” Thompson told the audience at a recent KangaNews discussion entitled ‘Funding transition: instruments, delivery and demonstrating good faith’.
As the world’s financial sector develops the tools needed to aid the transition, Thompson noted that: “there is a risk they will exclude some of our most important economic sectors from participating in the green or transition finance market or cause our issuers to be excluded from various investment mandates and funds”.
Green financing on the march around the world
As session host, NAB’s David Jenkins, observed, the number of financing instruments that will fund climate transition is growing rapidly. These range from specifically-labelled “transition bonds” - such as those used by the UK’s Cadent Gas and Europe's SNAM - to sustainability-linked loans that bind borrowers to enforceable climate change targets.
As these become more mainstream, the importance of risk assessment will grow too, said panelist Moody’s Brian Cahill. “There is a significant issue here that needs to be understood, captured, assessed and priced,” he observed.
“What you’re going to be seeing relatively soon is that this transition risk concept is going to impact access to and the cost of capital in a very broad way.”
A local challenge to global development
This is where both Australia and Canada, with their resources-dependent economies, could struggle, Thompson argued. However, she noted that the Canadian financial sector has been working with the country’s standards association to help overcome the challenges.
Together, they are in the process of developing a framework for transition finance that, while in line with international standards, also reflects the reality of Canada's economy.
“As international efforts get underway to develop green and transition finance standards and taxonomies, there was a risk those tools would not reflect the opportunities that were most meaningful in the Canadian economy,” Thompson said.
“We wanted to make sure we identified the principles that would underpin transition finance in Canada, that would align with principles internationally but that would also focus on the sector-specific activities that would drive the most meaningful reduction in Canada's greenhouse gas emissions.”
Just a day before Thompson spoke, the Australian Sustainable Finance Initiative (ASFI) released its own roadmap for aligning Australia’s financial services sector with its sustainability targets. Any standards or taxonomies coming out of Canada will be useful for Australia when it comes to putting that road map into action.
The problem with perverse incentives
One particular challenge both Canada and Australia face when it comes to transition financing is that under most arrangements to date, an issuer or investor receives a benefit when a company falls short of their sustainability objectives - something Thompson refers to as a “perverse incentive”.
“We’ve seen some interesting solutions to this problem,” Thompson told the panel. “For instance, instead of paying the penalty back to the lender through a margin increase or coupon step up, in some cases that money has been directed to a charity that aligns with the sustainability objectives and goals.”
This is something Jenkins noted has also happened elsewhere previously, where a company pledged to reinvest any margin incentives received in measures to improve social outcomes, particularly when it came to creating a minimum number of Living Wage Contracts within its business.
However, Thompson argued that the ‘carrot or stick’ question of financing should ultimately fall in favor of the former and that financing should have an important role to play in delivering carbon neutrality. Ultimately, whether it is in the context of Australia or Canada, she believes it will be the positive effects that come from meeting sustainability goals and not the threat of penalties that will lead to the take-up of sustainable financing.
“What we’re mostly hearing is less of a focus on [penalties] and more excitement around behavior changing incentives,” she explained.
