ESG and Capital Raising: An Overview of the Unique Sustainable Finance Tools Available to Canadian Businesses

Background

In recent years, environmental, social and governance (“ESG”) considerations have earned a top position among factors that influence investment decisions. As attention intensifies on the world’s climate, some market participants and regulators have called for more widespread and concerted efforts across various segments of society. As a result, the topic of sustainability is rapidly gaining traction as an important area of focus not just for governments and activists, but also in the business and financial sectors.

Sustainable finance offers investors an opportunity to support businesses that adopt ethical and sustainable practices, without having to sacrifice profit. Sustainable finance is a subset of traditional finance and refers to all financial activities which take into consideration ESG factors in order to promote sustainable economic growth and a stable financial system. Environmental factors may include the use of sustainable resources and other measures targeted against climate change. Social factors may include those related to human rights, labour practices as well as diversity and inclusion. Governance factors include board structure, management, executive compensation and shareholder rights.

Data surrounding the exponential growth of the sustainable finance market makes it increasingly evident that the private sector is recognizing the immense opportunity that sustainable finance presents. According to a 2022 report, ESG-focused institutional investment is expected to soar 84% to US$33.9 trillion in 2026, representing an impressive 21.5% of assets under management globally.^[1]

This data demonstrates an unprecedented and continuing shift in the asset management and wealth industry. An increasingly broad set of stakeholders, including both institutional and retail investors, are recognizing the importance of ESG and its ability to act as a powerful driver of sustainable growth. Indeed, investor demand for ESG products currently exceeds supply.^[2] 

As businesses look to support their operations, foster growth and capitalize on the opportunities presented by investor demand around ESG, there are a number of sustainable financing options they can pursue. This article seeks to provide a high-level overview of the key sustainable finance options that are available for both public and private businesses in Canada. Choosing the right option will depend on the particular needs, the maturity of the entity’s ESG operations, strategy and integration, and ESG goals of the company.

Sustainable Finance Options for Canadian Businesses

Green Bonds

Green bonds are debt securities issued by companies to fund sustainable projects or investments. Green bonds have attracted interest from domestic and international investors seeking socially responsible and environmentally sustainable investment opportunities. The proceeds from these bonds must be used for projects with a positive environmental impact, such as renewable energy, energy efficiency or sustainable agriculture. Green bonds can be differentiated from the narrower category of climate bonds, which are used to finance projects that reduce the impacts of climate change specifically, such as by reducing carbon emissions. In this way, green bonds have the potential to address a broader range of issues, such as biodiversity, which are becoming a greater focus in ESG discourse.

Canada is considered a global leader in green bond issuance. The country's strong commitment to sustainable development and environmental stewardship has driven the growth of the green bond market. Green bonds in Canada have been issued by a diverse range of entities, including government agencies, municipalities, provinces, corporations and financial institutions. As of September 2021, Canada had witnessed significant growth in green bond issuance and, since 2014, the cumulative issuance of Canadian green bonds had surpassed approximately US$39 billion across various sectors.^[3]

Transparency and accountability are crucial in green bond markets. Issuers typically provide regular reports on the use of proceeds, impact assessment and adherence to environmental standards. Verification by third-party organizations may also be conducted to ensure compliance with green bond principles.

Green Loans

Green loans, also known as sustainable loans or eco-friendly loans, are similar to green bonds in that the funds are tied to sustainable projects or investments. However, the structure is that of a loan and may be offered by a bank or other financial institution. This differs from green bonds, which are available for public offerings or private placement. Given these differences, green loans are typically for smaller monetary amounts. This may be offset, however, by the lower transaction costs typically associated with green loans.

The Canadian government has been actively supporting green finance and sustainability through various programs and initiatives. For instance, the Canada Infrastructure Bank offers low-cost financing options for projects that support green infrastructure development. Many Canadian companies have been accessing green loans to fund sustainable projects. These loans are often used to finance renewable energy projects, energy efficiency initiatives, green building construction, sustainable transportation and other environmentally friendly ventures. Canadian banks and financial institutions have been playing a significant role in promoting green loans. Several major banks in Canada have developed specific green loan products and frameworks to support sustainable initiatives.

To ensure credibility and transparency, lenders and borrowers often follow established frameworks and guidelines for green loans. Internationally recognized frameworks like the Green Loan Principles and the Green Bond Principles are used to guide the issuance and reporting of green loans.

Sustainability-Linked Bonds

Sustainability-linked bonds are a relatively new type of bond that ties the financial terms and structural characteristics of the bond to the sustainability performance or ESG metrics of the company. For example, the interest rate or repayment terms may be adjusted based on the company’s ability to meet certain sustainability targets. 

One of the benefits of this type of bond is that the funds are not reserved for specific projects or purposes in the way that green or climate bonds are. Instead, sustainability-linked bonds can be used to finance general corporate activities, making them an attractive option for companies who, while not directly involved in activities like renewable energy, are seeking to improve their sustainability performance and take advantage of investor demand for ESG products. However, the flexibility of sustainability-linked bonds also presents a greater risk of actual or perceived greenwashing. Companies should therefore be careful to develop clear, credible ESG metrics and transparent reporting and disclosure practices when pursuing financing through sustainability-linked bonds.

Sustainability-Linked Loans

Sustainability-linked loans are similar to sustainability-linked bonds, but with a loan structure. As a result, sustainability-linked loans share the same differentiating factors as green loans, discussed above. Unlike green loans or green bonds that specifically finance environmentally friendly projects, sustainability-linked loans provide borrowers with more flexibility in the use of funds. The focus is on improving overall sustainability performance rather than funding specific green projects. Sustainability-linked loans are designed to incentivize borrowers to achieve predetermined sustainability performance targets, commonly known as key performance indicators (“KPIs”). These targets are related to ESG objectives and are linked to the terms and conditions of the loan.

The key feature of sustainability-linked loans is the link between the loan’s pricing and the borrower’s performance against the predefined KPIs. If the borrower achieves the agreed-upon targets, they can benefit from a lower interest rate or other financial incentives. Conversely, failure to meet the targets may result in higher costs.

Sustainability-linked loans are not limited to specific industries or sectors. They are available across a wide range of sectors, including but not limited to energy, manufacturing, transportation, real estate, retail and financial services. This allows businesses from various industries to integrate sustainability into their operations and financing strategies. To enhance transparency and comparability, market participants, including financial institutions and organizations like the Loan Market Association (“LMA”) and the International Capital Market Association (“ICMA”), have developed frameworks and guidelines for sustainability-linked loans. These initiatives aim to standardize key principles and definitions in the market. Sustainability-linked loans often require third-party verification of the borrower’s performance against the agreed-upon KPIs. Independent auditors or sustainability consultants assess the borrower’s progress and provide assurance to lenders and other stakeholders.

Green Crowdfunding

Crowdfunding is a way for companies to raise funds through small amounts of capital from a large number of individuals or organizations, typically via online crowdfunding platforms. There are several crowdfunding platforms that have been specifically designed for sustainable projects. These platforms can help companies, particularly sustainability-related startups, reach a wider audience of socially and environmentally conscious investors, who often become customers once the product or service offering becomes available.  

Social Impact Bonds

Social impact bonds are a type of pay-for-performance contract by which the government pays investors based on the achievement of agreed-upon social outcomes. This allows the financial risk associated with social programs and services to be transferred from service providers and governments to investors. While there have been some pilot projects for social bonds in Canada, such as the City of Toronto’s Social Debenture Program, social impact bonds have not yet gained much traction in the Canadian context. Nonetheless, social impact bonds remain an option for companies involved in the provision of social services.

The Move to Standardize ESG Reporting

In an effort to unlock the full potential of sustainable finance, investors and asset managers alike are pushing for standardized ESG reporting standards. Currently, there are a number of different reporting standards, frameworks and ESG rating agencies. This often leads to conflicting concepts and fragmented requirements which can be difficult for companies and investors to navigate. However, organizations like the International Sustainability Standards Board (“ISSB”) and the Canadian Sustainability Standards Board (“CSSB”) are making strides to change this. The ISSB is working to develop a global baseline for sustainability disclosure standards and is working with the CSSB to support the adoption of ISSB standards in Canada and ensure that any future CSSB standards work in tandem with ISSB standards.

Standardizing ESG reporting globally will be an important improvement for the sustainable finance sector. Greater uniformity in ESG reporting standards will create a more level playing field for companies wishing to utilize sustainable finance tools, as it will be easier to determine what must be reported in order to access global investors and markets. Similarly, investors will be better positioned to assess and compare potential investment opportunities. Standardized ESG reporting can also enhance trust and credibility in a way that decreases the risk of both greenwashing and greenhushing (i.e., not disclosing ESG matters due to a fear of greenwashing allegations).

Conclusion

Companies looking to capitalize on the opportunities surrounding ESG have a range of financial tools. Choosing the right option will always depend on the particular context, but understanding the nature of each is a crucial first step. Companies must then take steps to ensure that ESG and sustainability are sufficiently integrated across the business and can be marketed effectively to potential investors. As sustainable finance continues to gain traction, investors are expected to take a broader view of ESG and sustainable investing, supporting not only companies and assets that are already fully sustainable, but also those that are undergoing green transitions. Bolstering your organization’s approach to ESG and sustainability is therefore important not only for positioning your company to leverage the sustainable finance tools discussed above, but for ensuring that your company is ready to benefit from future financing opportunities as they arise.