Investing according to environmental, social, and governance (ESG) criteria has never been more popular. Sustainable finance, and the related concept of ESG investing, refer to investments that consider environmental, social, and governance risks and performance as relevant (i.e. ‘material’) factors for investment decision-making. There is a spectrum of sustainable finance activities, ranging from exclusionary or negatively-screened investments, to ESG integration and engagement (with the goal of investing in best-in-class companies, or using shareholder voice to influence decisions at investee companies), all the way to thematic investing, impact investing, and venture philanthropy. 

According to the Global Sustainable Investment Alliance, the total amount of money invested in sustainable investment funds reached $35.3 trillion in 2020, representing 36% of all managed assets.  According to data from Deloitte, the share of investors applying ESG criteria to at least a quarter of their total investments has jumped from 48% in 2017 to 75% in 2019, and the COVID-19 economic crisis only worked to accelerate this trend. Most significantly, the total amount of funds committed to divestment from fossil fuels reached $39 trillion in 2021, nearly doubling over the previous year. Over 1,485 institutions have committed to fossil fuel divestment, representing 71 different countries. 

Canada has seen 48% in sustainable investment over the past two years, the largest growth rate of any single country. According to the Responsible Investment Association, responsible investments represented 61.8% of professionally managed assets in Canada, up from 50.6% in 2018. This increased popularity is largely attributable to the fact that ESG products tend to outperform the market. In the Canadian context, 80% of responsible investment funds outperformed their average asset class over the one-year period ending March 31st, 2020.

The smaller market for green, social, and sustainability (GSS) bonds and loans, defined as bonds that are designed to specifically support positive environmental or social projects, has also been growing significantly. At the end of the first quarter 2021, the North American GSS debt market reached $311 billion. Green debt is the dominant theme, representing 87% of the volume, followed by smaller but growing shares of sustainability and social themed bonds. Cumulatively, Canadian GSS bonds and loans amounted to $42.1 billion at the end of the first quarter of 2021, putting Canada in 11th place globally. 

For information about impact investing, see our impact investing guide.

The sustainability landscape features an ‘alphabet soup’ of acronyms and other jargon that can be difficult to absorb at first glance. The recent rise of ESG investing has added a diversity of new terms to the older language of corporate sustainability and CSR, and there remains some contention around which ESG strategies can be truly seen as ‘sustainable’. See the following definitions for additional clarity. 

ESG: The acronym ESG refers to business or investing strategies which consider environmental, social, and governance factors to be material considerations for decision-making processes. ESG strategies focus on reducing risks presented by environmental, social, or governance factors, such as property damages driven by extreme weather events or reputational damage resulting from complicity in human rights abuses. Although they are related concepts, ESG should not be conflated with sustainability: ESG tends to focus on the material risks to a company’s operations presented by environmental, social, and governance issues, whereas the concept of sustainability aims to assess a company’s positive or negative impacts on society and the environment. ESG is ‘outside-in’, while sustainability is ‘inside-out’, although there are hopes that this difference will disappear over time with the adoption of a double materiality lens. 

Socially Responsible Investing: Socially responsible investment (SRI), according to the International Capital Markets Association (ICMA), refers to investing with the aim of achieving financial returns while respecting specific ethical, environmental and social criteria. 

Taxonomy: A sustainable finance taxonomy is a mandatory or voluntary set of standards around what investment products or economic activities can or cannot be considered ‘sustainable’, for the purposes of improving transparency and reducing greenwashing. Many countries are in the process of developing their own mandatory sustainable finance taxonomies, with the most comprehensive taxonomies coming from the EU and China. 

Green Bonds: Green bonds, as defined by the ICMA’s Green Bond Principles, are any type of bond instrument where the proceeds or an equivalent amount will be exclusively applied to finance or refinance, in part or in full, new and/or existing eligible green projects. Such eligible projects include, but are not limited to, renewable energy, energy efficiency, pollution control, sustainable management of land and natural resources, biodiversity, clean transportation, water management, climate change adaptation, circular economy, and green buildings. The four core components for alignment with the green bond principles are: use of proceeds, process for project evaluation and selection, management of proceeds, and reporting. 

Sustainability Bonds: Sustainability bonds, as defined by the ICMA, are any type of bond instrument where the proceeds or an equivalent amount will be exclusively applied to finance or refinance a combination of both green and social projects (corresponding to the Green Bond Principles and the Social Bond Principles). It is understood that certain Social Projects may also have environmental co-benefits, and that certain Green Projects may have social co-benefits.

Sustainability-Linked Bonds: According to the ICMA, sustainability-linked bonds are any type of bond instrument for which the characteristics of the bond (such as the interest rate) can vary depending on whether the issuer achieves predefined sustainability objectives. In sustainability-linked bonds, issuers are committing explicitly (including in the bond documentation) to future improvements in sustainability outcomes within a predefined timeline. Those objectives are measured through predefined Key Performance Indicators (KPIs) and assessed against predefined Sustainability Performance Targets (SPTs). 

Social Finance and Social Bonds: Social finance is financing that supports actions mitigating or addressing a specific social issue and/or seeking to achieve positive social outcomes. According to the ICMA, social bonds are any type of bond instrument where the proceeds, or an equivalent amount, will be exclusively applied to finance or refinance in part or in full new and/or existing eligible social projects, which include affordable basic infrastructure, access to essential services, affordable housing, employment generation, food security and equity, and socioeconomic advancement. 

Transition Finance: Transition finance refers to financial instruments designed to assist an organization or firm reduce its emissions and implement a low-carbon transition strategy. The ICMA requires that transition bonds must be allocated to transition plans which are science-based, quantitatively measurable, publicly disclosed with interim milestones, and supported by independent assurance and verification. 

Sustainability Standards: There are a variety of global sustainability standards which organizations use as frameworks to disclose their performance on sustainability issues. Many global sustainability standard setting organizations are currently in the process of being consolidated into the International Sustainability Standards Board (ISSB), an initiative of the International Financial Reporting Standards Foundation. The other major international sustainability standards setter is the Global Reporting Initiative (GRI), which develops both the oldest and most widely used set of standards unique in its focus on both stakeholder and shareholder value creation. For more information about sustainability standards and ratings, see this article from the GRI. For a full list of sustainability standards and frameworks organized by issue area, see our company transition toolkit. 

Simple vs. Double Materiality: In financial accounting, the concept of ‘materiality’ refers to whether or not a piece of information is deemed relevant for decision-making purposes, on the basis of whether its exclusion would change the result of a particular decision. Traditional notions of materiality (i.e. simple materiality) focus exclusively on financial materiality, or whether or not the information in question will affect shareholder value. The concept of double materiality represents a paradigm shift in thinking about corporate reporting: simply put, it means that both financial and non-financial forms of value are considered material, and it implies that a corporation’s impacts on the world are as decision-relevant as the world’s impacts on the corporation. While the newly created ISSB currently adopts a simple materiality approach, interpreting social and environmental risks through the narrower language of financial value creation, the GRI advocates for a double materiality lens with a focus on stakeholder value creation as the basis of sustainability reporting. The European Union has officially adopted the double materiality lens as its required approach in its updated Corporate Sustainability Reporting Directive, and the European Financial Reporting Advisory Group has signed a statement of cooperation with the GRI. More recently, the ISSB and GRI have announced their intentions to align their respective standards. 

Climate-Related Risk: Climate-related risks are those risks posed to a business by the effects of climate change, which include either physical risks (i.e. property damage) or transition risks (i.e. stranded assets due to carbon pricing regimes and low demand). The Task Force on Climate-Related Financial Disclosure has taken the lead in developing standards for the disclosure and management of climate-related risks. For more information, see the TCFD recommendations report, and the TCFD Knowledge Hub. 

Scope 1, 2, and 3 Emissions: Companies reporting on their annual greenhouse gas emissions are required to differentiate between three scopes of emissions. Scope 1 emissions cover emissions that are under direct operational control, Scope 2 emissions refer to emissions from purchased electricity or energy, and Scope 3 emissions refer to all emissions that an organization is indirectly responsible for throughout its supply chain. For more information, see the GHG Protocol. 

Net-Zero and Science-Based Targets: Many corporations have made pledges to reach net-zero carbon emissions by the year 2050, but not all of these pledges are credible. The Science-Based Targets Initiative is a third-party verifier which aims to assess whether a corporation’s net-zero targets are legitimate and based in science. For more information about net-zero leaders in Canada, see Destination Net-Zero. 

Carbon Offsets and Sequestration: Carbon offsets are a way to use carbon removal or negative emissions technologies to remove greenhouse gases from the atmosphere to create credits which can then be sold to corporations that cannot otherwise reduce their GHG emissions. Carbon offsets have been heavily criticized by many actors, with the Intergovernmental Panel on Climate Change warning that they face “multiple feasibility and sustainability concerns.” Science-based targets cannot make use of carbon offsets in lieu of genuine low-carbon transition plans, or can only use independently verified carbon offsets when no technological alternative is readily available. Credible carbon offsets must be additional, in that they account for emissions reductions which would not have otherwise occurred without the offset purchase. For more information about credible carbon offsets, see the Oxford Principles for Net-Zero Aligned Carbon Offsetting. 

Nature-Related Risk and Nature-Based Solutions: Many corporations are now considering nature-related risks in addition to climate-related risks, which include risks related to the collapse of vital ecosystem services that are necessary for normal economic functioning. For more information about nature-related risk, see the Task Force on Nature-Related Financial Disclosures. The International Union for the Conservation of Nature has developed the concept of nature-based solutions to refer to projects that restore ecosystems and steward biodiversity. 

Impact Assessment: Impact assessment is an umbrella term used to refer to the assessment of the impacts of an organization’s behaviour on society and the environment. At the project-level, impact assessments are meant to assess potential harms while there is still opportunity to modify or abandon the project plans. Companies looking to improve reporting on their social and environmental impacts should utilize the framework developed by the Future Fit Benchmark. 

Sustainable Development Goals: The Sustainable Development Goals (SDGs) are a list of 17 high-level goals related to human flourishing and ecosystem well-being developed by the United Nations. Many corporations reference SDGs in their sustainability reports, but few integrate them into their overall strategies or actually measure their contribution to the SDGs. For more information about corporate action on SDGs, see the SDG Action Manager.

There is currently extremely strong momentum to shift international capital markets in the direction of a more sustainable world. In 2021, the International Energy Agency released a bombshell report calling for no new investment in fossil fuel infrastructure, outlining the need for capital markets to rapidly redirect funds towards clean energy.  The Climate Action 100 initiative currently includes 575 investors, collectively managing $54 trillion, who are demanding their 167 portfolio companies (representing 80% of global industrial climate pollution) to adopt low-carbon transition plans. New expectations around the fiduciary responsibility of corporate directors to mitigate climate-related risks to their businesses, driven by the widespread adoption of disclosure standards developed by the Task Force on Climate-Related Financial Disclosures, have created increased attention around the importance of emissions reductions and low-carbon business models. The number of organizations supporting the TCFD grew by a third in the past year, bringing the global total to 2,600 firms (including 83 of the largest 100 companies). 

There has also been significant progress in addressing a significant challenge for sustainable finance, which is the fragmentation of sustainability standards and the unreliability or inconsistency of sustainability data. An increasing number of large firms have begun publishing annual sustainability reports, with the number of S&P 500 companies that produce sustainability reports having grown from 20% in 2011 to over 90% today. There is now wide recognition of the need for greater rigour and reliability in sustainability reports, and new initiatives are emerging for mandatory disclosure standards, third-party verification and quality assurance, science-based targets, global harmonization of sustainability standards. The creation of the International Sustainability Standards Board, as a merger between the major standards setters including the Value Reporting Foundation and the Climate Disclosure Standards Board, has been a step forward in this evolution to harmonize standards and improve the rigour and granularity of data. 

Most importantly, there has been major progress in regulatory initiatives to eliminate greenwashing in the ESG investing landscape by adopting mandatory rules around climate-related risk disclosure and labeling rules related to what does or does not qualify as a ‘sustainable’ investment. The EU has led the charge with its extremely comprehensive sustainable finance strategy, which includes a taxonomy listing all eligible green investments, a Corporate Sustainability Reporting Directive (CSRD) to mandate sustainability reporting and quality assurance for major corporations, as well as a Sustainable Finance Disclosure Regulation (SFDR) applying to investment funds and banks that offer labeled as green or sustainable. The CSRD requires firms to disclose what percentage of their operating and capital expenditures align with the EU taxonomy, while the SFDR does the same for investment products. The US Securities and Exchange Commission has also published new rules related to mandatory climate-risk disclosure for American corporations, and the Canadian Securities Administrator is also in the process of defining a national instrument on climate-related disclosure. Most recently, independent Senator Rosa Galvez has proposed a Climate-Aligned Finance Act which would, if passed, align Canada’s financial system with its climate commitments.

Despite a flurry of net-zero pledges, the financial sector continues to play a significant role in fueling climate disruption and ecological destruction. The Rainforest Action Network has determined that the world’s 60 largest commercial and investment banks have provided over $3.8 trillion in funding to the fossil fuel sector from 2016 to 2020. Global banks continue to finance new oil and gas projects in spite of their public net-zero pledges. The Bank of England has determined that the global financial system currently supports high carbon projects that will cause a global temperature rise of more than 4°C. Additionally, one study demonstrated that in 2019 alone banks around the world lent $2.6 trillion that was directly linked to ecosystem and wildlife destruction. Since the Paris Agreement, banks and asset managers from the EU, UK, US, and China have made over $157 billion in deals with firms directly responsible for destroying tropical forests in Brazil, Southeast Asia, and Africa. 

ESG investing has failed to put a dent in global carbon emissions. Research by the OECD has shown that many ESG indices are not actually less emissions-intensive than their parent indices, and that in many instances “high E scores positively correlate with high carbon emissions.” Another study by the EDHEC-Risk Institute found that institutional shareholders do not reduce their investees’ carbon footprint in any meaningful way. Given these findings, it is clear that many ESG labels contribute to greenwashing. A lack of stringent or truly meaningful standards around what counts as ‘ESG’ has led to a situation in which 90% of the stocks in the S&P 500 have wound up in ESG funds built with ratings provided by MSCI. As such, many ESG funds are not appreciably different from a standard index fund. 

Particularly worrisome is the fact that many firms tend only to focus on those social or environmental issues that are deemed material to the company’s bottom line. This narrow focus on simple materiality has the tendency to reinforce the underlying problem of shareholder primacy by exclusively interpreting environmental and social risks through the language of financial accounting. If sustainability reporting is supposed to be about a firm’s effect on society and the environment, then the focus on enterprise materiality reverses this principle by focusing exclusively on how social and environmental problems affect the balance sheet. This causes firms to have less interest in reducing their social and environmental impacts than on finding ways to limit how social and environmental problems will harm their overall financial position. It also has the consequence of causing firms to become blind to long-term social and environmental problems that are of grave concern to society but are not yet considered relevant business risks. As recent Bloomberg analysis has demonstrated, ESG ratings often have less to do with reducing negative impacts than with ensuring a company’s continued profitability. Their analysis of MSCI’s ESG metrics showed that a company’s “water stress” score had nothing to do with measuring a company’s impact on local water supplies, but rather whether local supplies contained enough water to sustain their factories. Without a double materiality lens, it is unlikely that this problem will be overcome. 

There is also a risk that an excessive reliance on ESG investing and improved disclosure to drive a shift in private capital markets risks displacing public sector action (and more specifically, public spending) that would otherwise help accelerate the clean transition. Critics of ESG strategies often claim that the language of ‘risk management’ necessarily depoliticizes what are inherently political questions, helping to cloak issues of power and injustice in the politically neutral, technocratic of risk. As Daniela Gabor argues, this provides an avenue to help drive the creation of new private-public partnerships aimed at ‘de-risking’ infrastructure and energy projects, which could be a veil for the privatization of the green transition (and a way to obstruct more ambitious public spending programs, such as a Green New Deal, as the CEO of MSCI recently implied). To avoid this situation, it is of vital importance that private sector capital complements and does not displace public spending. 

When it comes to equity, pricing in climate risk could also be risk of its own. When investors confront risk, they either decline to make an investment or demand a higher return as compensation. Areas with greater exposure to climate-related damages would be charged more when trying to get financing. As climate change disproportionately affects poorer countries and low-income communities, which are often composed of Black, Indigenous and People of Colour, pricing climate risk is likely to intensify inequality and leave affected areas without support. In the absence of control measures, pricing in physical climate risks could result in an asymmetric cost of capital. Fortunately, there are smart policy measures that can ensure equal access to insurance and adaptation finance. Investors, insurers, and accountants have a responsibility to push the conversation on these policies.

Even within the paradigm of enterprise materiality, corporate sustainability reporting is still falling short. Few firms are fully complying with the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD), one of the most prominent international standards-setters on the risks of climate destabilization to business. Only 3 in 10 companies fully disclose their environmental and climate-related aspects of their business model. Very few companies complete scenario analyses against a 2˚C or lower scenario, and only 6% of companies identify the short, medium, and long-term time horizons over which identified risks would impact the organization. According to GreenBiz, few companies overall implement climate resilience strategies, use different climate-related scenarios, or disclose processes for identifying, assessing and managing climate risk or integrating it into overall risk management. Firms aiming to improve their risk disclosures should see these guidelines from the TCFD on metrics, targets, and transition plans, as well as this guide to scenario analysis from the Institutional Investors Group on Climate Change.

The Canadian government established an Expert Panel on Sustainable Finance whose final recommendations included increased regulations on the ESG space. To learn more about sustainable finance in Canada, see the Institute for Sustainable Finance at Queen’s University. 

For more information about sustainable finance in general, see the following resource hubs:

• Toronto Finance International – Resource Centre
• International Institute for Sustainable Development – Sustainable Finance
• TCFD Knowledge Hub
• Net-Zero Knowledge Hub 
• Accounting for Sustainability 

To keep updated with sustainability news and sustainable finance developments, see the following media sources: 

• Corporate Knights
• Responsible Investor
• ESG Investor
• ESG Today
• Green Finance Platform 
• ImpactAlpha
• GreenBiz
• Future of Good

For more information about investing for net-zero, see Section 1.1 of our company transition toolkit on Emissions. Here are some additional resources about climate-risk assessment and disclosure: 

• Guidelines from the TCFD on metrics, targets, and transition plans;
• Guide to scenario analysis from the Institutional Investors Group on Climate Change;
• Technical guidelines for assessing portfolio alignment, and guidelines developed by the Portfolio Alignment Team;
• Paris Agreement Capital Transition Assessment (PACTA) tool provided by 2 Degrees Investing;
• Guide from the Net-Zero Hub on climate-related regulations for the financial sector.

To see more about investing for biodiversity and ecosystem protection, see Section 1.2 of our company transition toolkit on biodiversity, ecosystem services, and land use. Here are some additional resources about biodiversity disclosures: 

• Convention on Biological Diversity quick reference guide for the finance sector;
• UNPRI guide for investors;
• Dasgupta Review pathways for the financial sector;
• Investor agenda on biodiversity action and recommendations for developing financial market strategies from Preventable Surprises, a UK-based think tank.

To see more about protecting human rights in the financial system, see Section 2.1 of our company transition toolkit. Firms should participate in the Investor Alliance for Human Rights, as well as the Thun Group of Banks which has released a series of discussion papers related to the implementation of the UN Guiding Principles. All financial firms should also abide by the Equator Principles and the Wolfsberg Principles. 

For watchdog organizations specific to the financial sector, see the following organizations:

• FinanceWatch
• Fair Finance Watch 
• Fair Finance International
• Americans for Financial Reform
• Reclaim Finance
• Facing Finance
• BankTrack
• Global Financial Integrity
• Hedge Clippers
• Private Equity Stakeholder Project