Where Capital Flows Next: Canada’s Evolving Sustainable Finance Market

Speaker A: The following episode of Sustainability Leaders is based on a panel discussion that took place on May 6th at the BMO Government Reserve and Asset Managers Conference. John U? Ren, Global Head, Sustainable Finance at AH BMO Capital Markets, moderated a panel discussion on the trends that will drive the future of sustainable finance in Canada. Let's listen in.

Speaker B: Welcome to Sustainability Leaders. Michael I'm Michael Torrence, Chief Sustainability Officer at bmo. On this show we will talk with leading sustainability practitioners from the corporate investor, academic and NGO communities to explore how this rapidly evolving field of sustainability is impacting global investment, business practices and our world.

Speaker C: The views expressed here are those of the participants and not those of bank of Montreal, its affiliates or subsidiaries.

Speaker B: Before I bring the panelists into the conversation, I just want to level set a little bit around the state of the sustainable finance market, both globally as well as here in Canada. So globally we have labeled green bonds are down 11%, sustainable bonds year to date are down 58% and the volume drop is much more significant in the U.S. but interestingly, the story globally isn't quite that dire. Right when we look at Europe, they're investing record amounts into scaling renewables. In China, they're leaders in solar as well as storage. And even here in Canada we are in the process of creating the Sustainable Investment Guidelines, which is the Green and Transition taxonomy that will create a made in Canada solution for labeled transition debt. And we expect to see issuances of transition debt as soon as 2027. It's estimated that there's about 125 billion annually needed to fund the transition to a low cost economy in Canada alone. And with that comes a requirement that all actors are really playing their part in playing a role in the ecosystem. So we have the public sector represented here today with the private sector that needs to do its part as well as investors. But we also need to think about the way that Indigenous peoples as rights holders are included in a number of these assets because increasingly we're seeing indigenous groups becoming equity partners in a lot of the major projects, either at the nation building level or down at the local level. So today we have a great panel of folks from government, from financial institution, as well as a leading investor in the space to talk about the role that they play in the future of sustainable finance in Canada. James, I want to start with you. Can you give the audience a bit of an overview of FNFA's borrowing program?

Speaker A: Sure. I'll start with a little overview of FNFA just to make sure everybody knows what it is and what we Do. Historically, first nations had a difficult time accessing capital. Reasons for that were all the First Nation governments were put onto their reserves. The reserves were not technically owned by the First Nations. It made it so that banks couldn't secure any assets that are on reserve. So if a First Nation wants to build a building on reserve, a bank couldn't secure that building. Therefore they'd give them high interest rates. So, so FNFA was established in order to give better rates to First Nations. So it's to give access to rates that are comparable to other levels of government. FNFA is, uh, a not for profit organization and we do loans to the First Nation governments all across Canada. So these loans might be for infrastructure, it can be economic development, can be almost anything. And the way we get around it, the securing assets, is we secure the revenue streams instead, which a lot of the banks do that now as well, which makes it so that first nations can access capital now in a much more meaningful way. We have 900 million of commercial paper that we issue and how our program works. We loan out of our commercial paper program in the interim, build up a pool of loans to first nations in there and then we go and issue it in a, uh, bond, term it out into a bond and then we repeat that process. So we've done almost 5 billion in loans to date. We've done 15 bond issuances and we're going to do our 16th probably in a month or so. We've done various terms now. We used to just do 10 year terms, but now we've done five years, 10 years and a uh, 30 year,

Speaker B: which we first off, congratulations. FNFA won the Environmental Finance Sustainable Bond of the Year for the bond we're about to talk about. So congratulations, James. But it was last year. The issuance was a $350 million bond to the Haisla Nation to really fund its equity ownership in the Cedar LNG Project. So can you talk a little bit about that BO bond, that issuance and then the impact that it has for the Haisla Nation?

Speaker A: Yeah, so the Haisla First Nation FNFA is going to be loaning for their 50.1% equity ownership in the Cedar LNG project. So they're partnered with Hemina Pipelines. The borrowing amount is going to be up to 1.4 billion from FNFA. They're drawing on that now. So that first $350 million 30 year bond that we issued was actually at 31 years. So it was a 2056 at the time. But that one was the first issuance for it. They're going to be drawing until December 2028 because it's in a uh, construction phase. So they're going to continue to draw monthly on the third year was the first one. But with the size of this loan and we're starting to see this with a lot of our projects as we're starting to do projects in the hundreds of millions and it's really up to our members, we work with them on giving them advice on the terms to put their loans into. With Haisla, uh, they wanted to do a 30 year to try to get a fixed rate for a long period obviously just to have that interest rate risk avoided. But then they also want options to pay down earlier. And so we've put them into a five year as well. We've put them into a 10 year so they're putting into various terms so they have the options to pay down, realize a little bit of a lower interest rate on those shorter terms and also fix a portion of it. So they're likely going to put, we will do another 30 year and add some more to that 2056 eventually and they're likely to put about half of that into the 30 year and half into other terms is what the plan is for it with the sustainability award it was really because this project, it's going to be one of the lowest carbon producing LNG facilities in the world. Big reason for that is it's renewable energy that's going to be used to power it and it's brand new so it's just more efficient as well and

Speaker B: safe to assume the 30 year was well received by investors.

Speaker A: Yeah, 30 year, we had a lot of demand for that and we constantly have investors asking us to do another one. So sure we will eventually. Great.

Speaker B: Elizabeth M. Ontario is the largest issuer of Canadian dollar green bonds. So you're well versed, have a lot of experience in this space. We can talk about 30 years as well if we want. But let's just maybe focus first on what you're hearing from investors around where demand is deepening for your green bonds. Is it around the use of proceeds design? Is it reporting? Is it size? Is it novel projects being financed? Like what are you hearing from investors?

Speaker D: When we're, we speak a lot with investors, we're a very investor demand driven issuer in all of our programs and our green bond program is no different. The conversations we've been having of late aren't so much I would say on the impact reporting and that kind of thing. We actually recently had an investor book, a meeting with us and really they just wanted to say thank you for the impact reporting that we do because it makes their life and the analysis they're doing it their end much simpler. So I feel like we have a fairly strong base in that. But what investors are talking about more and more with us is the potential for issuance of a social bond. A lot of interest in that particular space and indigenous bonds, very specifically, uh, something that is very topical and a lot of investors very interested in what James is doing and looking more broadly what others can do in that space and then very specific green bond areas where they are looking at something that is particular to their mandate that they aren't seeing in the market. So we sort of a little bit more of a bespoke approach. So those are kind of the conversations in terms of what type of issuance they might be looking for. And then just very recently in the announcement I, uh, believe came out last week, Canada being named as the host for the Defence Security and Resilience Bank. So starting to hear the topic of resilience, but not in the terms we've been thinking about it previously. Not so much in terms of climate resilience, but more, I guess, economic resilience. Talk of what we are going to do in terms of defending, I guess, against some of the external forces in a way to make our economy stronger and more resilient. And it's very interesting. So lots of talk now maybe about defense bonds, but a bit of a mind flip, not defense being equated to armament, but defense more in terms of keeping your sovereignty intact, keeping your infrastructure strong, those kinds of conversations. So that's really very topical at this point. And when we talk to investors, that's going to be, I think, a conversation starter as we move through this year. But Ontario doesn't have too much that we are going to change in the fundamentals of the program. We are issuers of large liquid bonds and the feedback we get from investors is that they really like that, that they would like to see much more diversity in terms of the projects. And that's something we will continue to work on. I would love to get something in the social world into the market, but it's a collaborative effort across government. And for those of you from large organizations that may have some bureaucracy associated with them, you may understand the challenge that comes from having to reach out to different groups and different areas with different mandates and try and get them on board with your particular passion project. So that's an area where we're going to chase things down a little bit more heavily this year. The other comment I would make, and maybe James, this is something for uh, your expansion of your program is we did issue a, uh, Green FRN last year and that met with really good investor response. And when we were talking to investors and they're talking about gaps, there's gaps in terms of the types of projects they'd like to do, but there's also gaps in the types of bonds that are available to them. So previously we had done a 30 year green bond. This year we did, uh, green FRN. And so also looking to fill gaps in the market by doing things just a little bit differently.

Speaker B: Jonathan, we'd love to hear a little bit from you around AlphaFix's approach to sustainable investing and feel free to even respond to any of the questions that have been asked so far.

Speaker E: Thank you for the invitation. To answer your question. We see this just as sane Risk management. Alphafix, uh, has been integrating ESG factors since the beginning of the firm in 2008. We think that companies that are good in managing these risks tend to do better in managing financial risk as well. We only manage fixed income, so only one asset class. And with this narrow focus we tend to innovate a lot in that space. So we launched the first green bond fund in Canada in 2017, which now we manage. About a third of our AUM is impact bond strategies. So we're very proud of that. But as we all know, Canada has a tremendous opportunity to reorganize and develop its territory with major projects, mining, mineral defense, renewable energy. And it has to be done in collaboration with indigenous peoples. And this is where we focus now in accelerating, uh, reconciliation with indigenous peoples.

Speaker B: Let's double click on that point then because obviously there's, you know, you have an expanse of expertise in the green bond fund. You know, let's talk a little bit about your, the innovation piece that you said is critical to Alpha Fix, like around a new strategy for, for indigenous fixed income. Um, in particular, can we, can you elaborate on that a little bit and why it needed to be its own sort of standalone strategy versus rolled into green or a sustainable fund?

Speaker E: Yeah, sure. Well, first I'm non indigenous, working in a non indigenous firm. So every step towards a reconciliation we've done in collaboration with indigenous peoples. So that's a very important thing. And for the short story, so we, as I said, we launched the first green bond fund in 2017. We had a partner meeting. Uh, everybody's typing Ourselves in the back. It's a good story. We know that we are good at uh, knowing the impact we have in environment, carbon emissions, energy saving, water savings. And one of us asked, okay, that's very good. But most of these projects that we finance are on indigenous territory. So do we know the impact we have on these communities? And everybody went silent. So we couldn't keep this blind side. So we decided to like, educate ourselves, try to understand this risk more and more. And um, it became obvious that indigenous financing had to have its own framework for the simple reason that indigenous peoples need to be involved in building this framework. So it needs to be co created. If not, it just goes against the main idea of true reconciliation. So this is why we think it very important thing to have a distinct framework.

Speaker B: Congratulations. It sounds like there's a lot of great work happening and I know we'll hear more from Alpha Fix in this space in the coming months. Madeline, uh, I want to bring you in. Can you talk a little bit about the government of Canada's green bond program?

Speaker C: Yeah, definitely. So we have two main goals with our program. The first is obviously to mobilize private capital in order for us to be able to achieve our climate goals. But I think the main really crux of our program is that we're trying to develop and build capacity within the Canadian sustainable finance market. So since 2022, when we launched our inaugural framework and we had our inaugural bond, we've issued 17.5 billion dol the market. And we've since also had a uh, framework update in 2023 to include certain nuclear energy activities in our framework. And so in that way we try to spearhead different initiatives that may be a little bit more scary to take on as a private issuer. And we try to align uh, our priorities with the government of Canada's climate plans in order to build something for the market that the market can actually use as an example. So whether or not that's our framework or whether or not it's our benchmark bonds to use firstly as reference and also to build liquidity in the market. Very similar. Elizabeth. We are investor driven. So when it comes to issuing, we now issue twice per year. So we listen to the market on that one. We used to issue once annually and we figured that it was better for the market to be a little more responsive and offer more tenors at different points during the year. And so as of two years ago, we started issuing twice a year, fall and winter. And we tried to be a little bit more programmatic in our approach and also reach out to investors to determine what does the market need at the time, given that we are a market building capacity. So that's kind of a very broad overview of our program. But uh, welcome many questions.

Speaker B: I'm curious about the. So I mentioned the sustainable investment guidelines. The work's underway to publish agreement and transition taxonomy in Canada. First three sectors expected to be published before the end of the year, then three sectors following in the spring of next year. As, uh, you think about, you know, expanding your green program into transition, how are you going to kind of delineate for investors, you know, different eligible spend that may cross over both categories, green and transition? Like what's going to be the approach for really finding the transition assets, particularly if they have green components as well?

Speaker C: Yeah, definitely. So I'm going to go back a bit to 2024 where the government published a guidance, I guess you could say, on the way that we're thinking about developing a taxonomy. There were a lot of principles within there, but I think the two main principles that are very pertinent to this question was usability and credibility. And so in developing a taxonomy while it is arm's length, the hope of the government was that the taxonomy, right, would be extremely credible and science based. And so it incorporates science backed criteria, but that at the same time it's actually usable to investors, that there's actually expenditures within the market that can be used to allocate towards these transition bonds should they be issued. So in Canada we're taking an approach of arm's length and letting the market decide what they believe is credible and usable through the taxonomy process, the made in Canada investment guidelines and the government will essentially be takers of this. So like I said, we're very investor driven. And so it's very important to us that our program reflects what the market believes is credible and believes is usable. And we really believe in the people that are currently running the taxonomy process, the Taxonomy Council, it's a wonderful group of experts and we will take their expertise on that in determining what is green in transition, which should come through the taxonomy. Very broadly though, the way that we are kind of framing this in our mind right now is that you can't actually peg an entire sector as either green or transition. You really have to look at the specific activity and ask yourself very broadly, is this activity what we can foresee as being in our portfolio in 2050 and it ah, aligns with the 2050 goals or is it something that's going to take us to the 2050 goals, but at that point may need to be eventually phased out or not align as green at that point. So that's a very broad way to describe it and it's not very usable. And so that's what we're hoping the taxonomy will clarify. I think a good example for that would be like energy efficiency for example. That category currently in our framework actually includes things like CCUs. But as time has evolved we've noticed that could actually potentially be more aligned with transition. And so these are the kind of questions that we're hoping to answer through the taxonomy process. And as we explore the development of a sustainable bond framework that will include transition and green bonds, we hope to align it with the taxonomy so that it's fully usable and so that it's also aligned with uh, priorities of the government. So we'll have to have that balance as well.

Speaker B: James, I'll come back to you. Budget 2025 in Canada announced an intention to amend the First Nations Fiscal Management act to allow FNFA to lend to indigenous owned special purpose vehicles. Curious what the impact you see for FNFA on that potential amendment as well as the impact on your first nations members.

Speaker A: So that one's still in the works right now. But how our loans work right now is First Nation needs to become a member of FNFA and we can only lend to the First Nation government. And so it has to go to chief and counsel. If they want to partner uh, on a project, they have to re lend it into the, into the limited partnership or SPV to do that. So if you have a project, some might be aware of the Stone Lassic deal here, that was the 38 First nations bought 12.5% of Enbridge pipeline. All 38 of those first nations would have to become members of FNFA. We would have to do 38 individual loans and then um, they would have to do 38 loans into the limited partnership. So it would be impossible to do. And so this amendment to our act, the act lays out the rules that we're allowed to operate in. So the amendment is going to make it so that we can lend straight to that special purpose vehicle rather than doing every single individual one. So it makes it more efficient and just makes it possible. So it'll make it so that FNFA is an option for any of those larger projects that are happening with multiple first nations involved. And so it'll be just one more tool, one more option for first nations that we can give a, ah, lower interest cost on it and hopefully it'll add a few more loans to fnfa. We don't see it adding a substantial amount of loans, but it'll add 2, 3, 4 loans a year potentially. But there'll be large loans that Enbridge 1, the Stone Lassic 1, was 730 million or 40 million. So we could see it adding substantial size with a few large loans. So that's about it.

Speaker B: More to come on that, but that'll be an important and meaningful change for sure. Elizabeth, I want to talk about physical climate risk a little bit and the impact that it has on your borrowing program. So, you know, right now Ontario is allocating about 2% to sort of climate adaptation or, uh, resilience type projects. Do you see that as scaling and increasing over time as you see more physical risks associated with climate change?

Speaker D: Scalability in this category has not been easy for us. A lot of the projects that deal with flooding, fire, weather events actually get dealt with a lot more in the municipal space. And being provincial, we're kind of secondary sometimes supporting the municipality in the work they're doing. So it's a tricky space for us. The one project we did have that came into this category was the port lands in the east of Toronto. And that was three levels of government involved on that particular project. And that was a really good experience, I think, for all three of us that were involved. And so we'll look for projects like that as they evolve in terms of what the government is planning on doing. But at the provincial level, much of the work in this category are things like climate change policy legislation and programs, tracking climate change initiatives, because a lot of policy work, which is really important work to be done, and it's done through the Ministry of Environment, Conservation and Parks. But it's not the kind of work that has great impact metrics and the kind of thing like you're talking about a number of salaries generally as being the cost of putting those policies in place, that kind of thing. So we're struggling to kind of figure out how to work that space a little bit better so that investors who we know are very interested in this category, seeing more projects come from it, trying to get something that fits for us and fits for them. But like I said, a lot of the work is more on the policy side and that's a lot trickier to show out in a green bond kind of framework relative to some of the more tangible projects. We might be able to say, you know, like port lands, where we're doing all kinds of changes to like naturalization of the mouth of The Don river, creating all kinds of parkland, having all kinds of indigenous species return to what was an industrial, almost a wasteland. Like those kinds of things are much more measurable for investors. So it's a quandary we have. It's not off the table in terms of, you know, what we're trying to do. It's just trying to figure it out year in, year out with what comes up in the budget and what would fit.

Speaker B: And then, Madeline, I'm going to jump to you because Elizabeth made the point around KPIs and being able to measure impact and that obviously being very important to the allocation decisions and what makes its way into the Green Bond program versus a conventional bond. But I know Canada just released about a month ago its Green Bond impact and allocation report. 89 pages. It's a great read. It's long, but a great read. Madeleine, do you want to kind of walk us through what that report and some of the allocations indicated there say about how Canada is thinking about green allocation?

Speaker C: Yeah, definitely. So if you actually look at our reports through time, you'll notice a very big shift in the allocation to categories that we have. So our first report published in 2022, had, I believe, over 50% or nearly 50% to clean technology as time has shifted. Now in the latest report, we're down to 25%. And that's really a testament to the breadth of different investments that the government is doing. And so as the government is creating these new, well, not new, but really reiterating the same goals as before and having different strategies. So we have like this, the nature strategy, the climate competitive strategy. These different strategies address very different sectors. But all of these sectors are extremely important, important to the greening of our government and of Canada in general. And so our report, the way that we report essentially is on a pro rata basis. So we do not pick winners or losers. We essentially take the entire pool of Government of Canada expenditures that could be eligible for the Green Bond program, and then we allocate on a proportional basis of how much that expenditure equates within the entire pool. They get that percentage of the allocation. Our goal in doing that is to demonstrate this breadth. And so as you've seen through time, the government has focused its priorities towards very different categories. And so we've seen like a very dramatic increase actually in living natural resources as well as biodiversity. We've gone from 5% to 10%. And so as you track those categories, you can somewhat get a feel for the broadening of our policies of Our policy reach and also the broadening of projects that we're funding. And that can also be uh, shown just in the amount of projects and programs that we're funding. We've gone from 30 and now we're upwards of, I believe, 50. And so, yeah, so really for us it's really a demonstration of breadth that we're addressing multiple different sectors. We're not focused on one sector. And it's still in order for us to be able to demonstrate that we're putting our money where our mouth is on all of our strategies.

Speaker B: Jonathan, I want to come to you now around, you know, what do you think it would take for corporate Canada to become sort of more focused on the need for indigenous financing? Like, how can corporate Canada engage in more meaningful ways beyond statements of intent and etc. Like how can we actually mobilize capital in this space from a corporate perspective?

Speaker E: Willingness maybe. And also understand that having an indigenous equity partner is a good business decision. Access to capital is challenging. Even though there are great institutions like FNFA or uh, the bmo, uh, Indigenous Banking Unit that has been around for over 30 years, access to capital is challenging. When the projects are under construction, there are no cash flows that can be used as collateral. So we'd love to see corporate Canada playing a larger role during construction phase by financing directly, uh, indigenous equity partners and then pass financing through, uh, a bond issue where we would gladly buy it. It would be a game changer because when the project is built then there are existing cash flows. Indigenous partners can go refinance themselves through FNFA or a bank. And we've seen this model work.

Speaker B: And so that's corporate Canada. How about the public sector? Like how do you, how does off fix engage with the public sector, government agencies, agencies to try and create the right environment or uh, financing models, et cetera, to actually see change either financing through construction or taking a longer view around what this looks like. Like, are there ways you're engaging or ways you intend to engage with government agencies in particular to try and move the needle here?

Speaker E: Well, the past three years we have built a framework to evaluate every issuer in Canada under an Indigenous reconciliations core, either a corporate or government, provincial or federal. So the way we see it, and we've done it, uh, with the green bond funds in 2017, once Indigenous reconciliation become embedded in the quality score of an issuer for a manager, uh, then it means that it could affect eventually your cost of capital. And when we give these information to one of our clients and say, hey, look, the metric that you can find on Indigenous reconciliation for your portfolio. We raise awareness. It becomes important for them. Once it's important for them, they also ask their other manager to say, hey, we would love you to give us more reporting and transparency on that. And once lots of managers are asking for more information to the processes, now it starts to move the needle. And this is how we see our role. As I said, we had success in Green Bond. We're condensed. We do the same for Indigenous reconciliations as well.

Speaker B: And your voice has like, carries some weight, right? As one of the leading fixed income investors in Canada, when you're doing that engagement and you're giving an economic reconciliation score, Indigenous reconciliation score, like that has power.

Speaker E: So, yeah. And the reception has been very good so far. Uh, we, we've had discussion with yourself lately also. We are learning a lot through engagement. I think the key there is to understand who are the leaders, who are the laggers. And when we meet with the laggers, we can say, hey, by the way, your competitor is doing some stuff that, that you are telling me it's impossible to do.

Speaker B: James, maybe the final question to you. So we're talking about how Alpha Fix engages with public sector and private sector. But maybe like there are currently in market, There's a, uh, $10 billion Canadian Indigenous Loan Guarantee program. There's five provinces that have similar loan guarantee programs for Indigenous finance. There's the cib, Indigenous Equity Initiative as well. There's. So there's a few different mechanisms in market that government has set up to, you know, support some of these transactions. But there is still gaps and you know, Jonathan was alluding to it around construction and things like that. Like what are you seeing as you, your members around some of the financing gaps that exist right now and any ideas for how we can solve them?

Speaker A: It's one. Like you said, Jonathan was talking about it, the construction risk is still a bit of a gap there. If there's no cash flows or uh, contract in place that essentially says there's for sure going to be cash flow as soon as this is done and there's not cost overruns that are going to affect that cash flow, then it's still really hard to finance. The guarantee programs could help with that. But a lot of the guarantee programs don't want to take on construction risk as well. CIB takes on a little Canada Infrastructure bank seems to be more open to take a little bit of the construction risk on some, a lot of the projects. If we're doing the power projects, if there's transmission lines or wind farms. The Crown corporations are taking on a lot of that risk. So the first nations don't have to put the equity in until that project is at the operation date. And so that gets around that gap. But if a First Nation wants to go and build a wind farm on their own and take on that risk, there's nobody out there that can finance that right now. Or if they want to go and develop a project that whatever it is, building a hotel and you've got great projections and you expect it to be incredibly profitable, nobody will take that risk right now. And so there's still that gap on the construction projects where there's not a almost guaranteed cash flow counting as soon as that starts operating. Then there's FNFA has a hard time doing that as well. The area that FNFA can help with that is if a nation wants to build, I'll use the hotel as an example. If they want to build a hotel and they have other existing own source revenues, they could pledge that revenue to us to build that hotel. And we do that lots too. And that's how we do all of our infrastructure loans to first nations as well. If they have, whatever it may be, a revenue royalty agreement with BC Hydro or something like that, they can pledge that royalty to us to build an infrastructure project or to build any economic development project. But if you're trying to finance it with the project, that's where there's still a little bit of a gap out there.

Speaker B: The future of sustainable finance and investing is bright in Canada thanks to these leaders on the stage.

Speaker A: So thank you very much.

Speaker D: M.

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