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Canada’s forthcoming climate taxonomy, which puts forth standards for identifying green investments, does a good job of a delicate balancing act.Michael Dwyer/The Associated Press

Jonathan Arnold is research lead for clean growth at the Canadian Climate Institute. Jim Leech is the advisory board chair at the Institute for Sustainable Finance and is chancellor emeritus of Queen’s University.

The race to attract global capital to finance Canada’s net-zero transition is accelerating faster than anyone expected. To keep up with the global shift to clean energy sources in response to climate change, Canada’s transition requires more than $80-billion each year in new investments, most of which needs to come from the private sector. Yet financing this transition is now more challenging for Canada with the passage of the U.S. Inflation Reduction Act, which is poised to offer investors juicy returns south of the border.

A newly announced climate investment taxonomy – a system that will create standardized labels for different types of investment – will soon be released. Developed and supported by Canada’s 25 largest financial institutions through the federal Sustainable Finance Action Council, it is a major step toward shoring up Canada’s competitiveness. The framework would specify what investments are – and are not – aligned with global climate objectives. The initial taxonomy, developed with research support from the Canadian Climate Institute and the Institute for Sustainable Finance, not only defines “green” investments but also the more controversial “transition” investments.

Canada is among the last of the countries in the G7 and G20 to develop this type of taxonomy. However, it’s making up for lost time by providing a concrete framework to categorize transition activities: the parts of Canada’s emissions-intensive economy that can successfully be transitioned to align with a net-zero future.

The architects of Canada’s ‘green taxonomy’ rule book say it will unlock billions in new cleantech investments

Defining this transition category is admittedly harder than identifying green investments and requires a delicate balancing act, as identifying high-polluting activities that have viable, credible transition pathways is more complex. Yet the proposed taxonomy for Canada walks the line well.

Successfully landing a climate investment taxonomy in Canada will be crucial to securing the country’s energy transition and future prosperity. It will not only help mobilize private finance toward new, green growth, but it will help Canada decarbonize and transition its existing, emissions-intensive engines of growth to cleaner alternatives. If it’s done well, the Canadian framework could be adopted by countries around the world that will be watching closely.

Climate taxonomies act like a gigantic sorting hat for the financial system, offering a standardized and science-based way to determine whether specific projects align or don’t align with climate goals. In doing so, taxonomies can help clear up the avalanche of misinformation and greenwashing that currently plagues climate finance globally. At the same time, taxonomies ensure that investment dollars flow to the projects most urgently needed to drive the energy transition, such as renewables, batteries and storage, or clean hydrogen. Critically, taxonomies are an essential complement to other climate policies, such as regulations and carbon pricing (and not a substitute).

Fundamentally, the new taxonomy is designed to build and maintain the confidence of global capital markets seeking to align investments with net-zero pathways. This is why the whole framework is grounded in climate science and the Paris Agreement goal of keeping the rise in global temperature below 1.5 degrees relative to preindustrial levels. Anything less than this ambitious goal would undermine the taxonomy’s credibility.

Take, for example, how the framework treats oil and gas projects. It recognizes that reducing emissions from existing production is crucial in the short term, and transition-labelled investments could fund technologies that have value long into the future (for example, carbon sequestration infrastructure). New oil and gas projects, or expansions of existing projects, would be ineligible for taxonomy financing. And existing projects would only be eligible if the investment makes significant and transformational reductions in the emissions associated with producing oil and gas.

The framework could also unlock transition capital for other heavy-emitting sectors. Efforts to electrify Canada’s steel and auto manufacturing sectors, for example, could qualify as transition investments, as could other important projects, such as making low-carbon hydrogen from natural gas or low-carbon chemicals to fuel hard-to-decarbonize sectors.

Successfully defining transition activities in this way could have huge benefits for Canada’s entire economy. Decarbonizing Canada’s most energy-intensive and export-oriented sectors is fundamental to the country’s economic prosperity: They directly employ over 800,000 workers. The more these sectors can reduce emissions, the more competitive they will be in a global low-carbon economy.

Time is of the essence. Regulators and government, in collaboration with the financial sector, must move quickly to turn this framework into a practical, independent and science-based tool to evaluate projects and portfolios. As the race for global capital accelerates, demonstrating credible and transition-aligned investment pathways in Canada has never been more important.

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