On September 27, 2021, the Canadian Securities Administrators (the "CSA"), hosted a virtual roundtable on environmental, social and governance ("ESG") related regulatory issues in asset management. This article summarises the discussions during the roundtable, which was co-led by Wendy Berman, Vice Chair of the Ontario Securities Commission (the "OSC") and Hugo Lacroix, Superintendent of Securities Markets of the Autorité des marchés financiers (the "AMF"). The panel was comprised of representatives from RBC Global Asset Management, National Bank Investments, FAIR Canada, BlackRock Investment Stewardship, Morningstar Sustainalytics and NEI Investments. The discussion was focused on the benefits and challenges associated with ESG-related disclosures in connection with the sale of financial products, as well as marketing and other issues from the perspective of asset managers and ESG ratings providers.
Opening Remarks
As part of the opening remarks, Wendy Berman and Hugo Lacroix provided an update on ESG trends in Canada and the work that Canadian regulators have been undertaking. They noted that in Canada, the value of sustainable funds at the end of the first quarter of 2021 was $18 billion, representing a 160% increase from 2020 with a more than 50% increase in the number of sustainable funds. Given this shift in the allocation of capital towards ESG products and the potential for 'greenwashing' (which they described as occurring whenever "disclosures or marketing inadvertently or intentionally misleads investors about the ESG-related aspects of the funds"), they noted the importance of the role of the CSA in enhancing broader ESG-related disclosures. Recently, the CSA has undertaken reviews of regulatory disclosure documents for funds whose objectives referenced ESG factors or funds that marketed themselves as ESG funds. The purpose of the reviews was both to assess the adequacy of the disclosure including whether the disclosure was misleading, and also to assess how well the current securities regulatory framework addressed ESG funds and ESG-related disclosures. The outcome of the reviews found that on the one hand, despite the lack of specific ESG requirements in the current securities regulatory framework, the framework was broad enough to effectively address ESG funds and their disclosure, but on the other hand, ESG fund disclosure could benefit from greater detail or clarity, particularly with regard to investment strategies and proxy voting disclosure. The CSA staff is currently working on drafting a staff notice on ESG-related investment fund disclosures, which is expected to "clarify the current disclosure requirements applied to ESG funds and cover a number of areas including fund names, investment objectives and strategies, proxy voting and shareholder engagement, risk disclosure, sales communications and ESG-related changes to existing funds. The guidance will aim to enhance the ESG-related aspect of disclosure document and ensure that sales communications are not untrue, misleading or inconsistent." Exact timing of when the CSA staff notice would be published was not mentioned, but it was noted that the draft is "well advanced."
Panel Discussions
After the opening remarks, the panel engaged in discussions on the following seven topics: investors' risks and needs; common ESG-related terminology; regulatory gaps; proxy voting and shareholder engagement disclosure; ESG-related continuous disclosure; ESG information in marketing materials; and ESG ratings and data providers. Each of these topics is discussed below.
Investors' Risks and Needs
With respect to what investors' risks and needs are, some of the panelists highlighted the risk of 'greenwashing'. This is an especially high risk considering the speed at which ESG investing has grown recently, which was explained as being partly due to investor demand for ESG products outpacing the supply of such products.
The second risk to investors is understanding what the fund or investment product is and how it is thinking about responsible investment. In other words, is the fund catering to investors who are looking to invest in line with a certain sets of values or beliefs (e.g., the primary objective is creating change), or is the fund catering to investors who are looking at responsible investment from a risk-return perspective (e.g., the primary objective is to generate a benefit in the longer term through sustainable investing), i.e., is the fund focussed on "values" or "value"? This is important for identifying the strategies to be employed by the fund. For example, under the values-approach, adopting exclusionary screening (such as excluding investments in alcohol or gambling) is an appropriate strategy. By contrast, under the risk-return value approach, the investment strategy may instead involve assessing the ESG score or reviewing recent ESG controversies that issuers may be involved in, as they may impact the riskiness of the investment.
The third risk discussed was the lack of visibility not at the fund level, but rather, at the security level. Investors are concerned about how asset managers are integrating responsible investment matters. There is a need for asset managers to provide clear disclosure on what they are doing and why they are doing it.
Common ESG-related Terminology
Regarding common ESG-related terminology, there was consensus among the panelists that the use of different terminologies in the industry negatively affects the transparency, consistency and comparability of ESG disclosures, which ultimately increases investor confusion. For example, ESG investing itself has a myriad of names including sustainable investing, best-in-class investing, responsible investing, exclusionary screening, etc. The panel acknowledged the difficulties in coming up with standard disclosures. These difficulties included identifying who would be responsible for this task (whether regulators alone, the industry alone, or the industry working together with regulators), the need for standardization of the disclosures globally (because this issue is a global issue, not just a Canadian issue) and the timing for when standardized terminology would be implemented (considering how rapidly ESG investing is evolving and the hesitation to 'rush' into things without fully understanding the implications).
Regulatory Gaps
As to questions on the adequacy of the Canadian securities regulatory framework in dealing with ESG-related disclosures, some believed that the current framework (which consists of disclosure obligations with respect to prospectus offerings and marketing materials and ongoing disclosure obligations) is sufficient to capture ESG investing both at the asset manager level and ESG fund product level. Others, however, believed that it was insufficient. Here, concerns were raised with respect to prospectuses for ESG-related offerings with little or no discussion on how ESG objectives would be achieved.
Proxy Voting and Shareholder Engagement Disclosure
Turning to the issue of proxy voting and shareholder engagement on ESG issues, the general view by panelists was that these actions are already part of asset managers' fiduciary duties. Asset managers noted that they are increasingly not only disclosing how they voted on certain proxy issues, but also disclosing the rationale as to why they voted a certain way. Part of the reason for this is due to client demand because investors want to know not just what was done, but why it was done.
With respect to the potential for requiring disclosures by asset managers of their engagements with companies, concerns were raised. These concerns included first, the potential to negatively affect the engagement relationship (as companies would be more hesitant to participate in such discussions), and second, the amount of resources required to produce such disclosures including people, data and reporting capabilities (which would especially be amplified in situations where an asset manager is investing in index strategies, given it would involve holdings in thousands of companies).
ESG-related Continuous Disclosure
When it came to the question of the continuous disclosure regime, and specifically, how to measure how well funds are meeting their respective ESG objectives, panelists acknowledged the difficulties of measuring the impact of a fund, especially with respect to long-term impacts such as climate change or social change, or measuring actions such as shareholder engagement or policy advocacy. One proposal to address these issues included encouraging the selling of simpler solutions (e.g., impact funds) that are easily explained and have defined measurability aspects to them. Another proposal for improving the continuous disclosure regime was that even where the final impact could not be disclosed (due to the difficulties in measuring the impact), other disclosures short of the final impact could be made, such as explaining to investors what steps asset managers undertook towards achieving the investment objectives. A third proposal put forth included a four-element framework that consisted of disclosing the following items: (1) the objective (i.e., what is the fund trying to achieve with the responsible investment practise), (2) the processes in place to integrate responsible investment (i.e., how will the objective be achieved), (3) the data (i.e., identify which data and key metrics, in line with the objective and the processes, to disclose), and (4) the description of the source of the definition (i.e., identify whether the definition or key metric was created in-house, from a working group or otherwise).
ESG Information in Marketing Materials
As to marketing communications, some issues highlighted included an absence of a clear connection between what asset managers claim on their website (as to alignment with ESG-related goals) and the products being offered by such asset managers. Others noted that the issue was not about the deliberate misleading of investors, but rather about a misunderstanding by investors arising because not all investors have the same knowledge in the ESG space. The main takeaway was that clearer communication about the processes undertaken by asset managers and how ESG factors are taken into consideration in practise would be beneficial.
ESG Ratings and Data Providers
Finally, on the topic of ESG ratings and ESG data providers, the key underlying problem highlighted by the panelists was the lack of consistency among ESG providers. One of the causes of this problem is the lack of data from issuers. To the extent issuers do not provide the necessary ESG disclosures, then this impacts the consistency and comparability of the ESG data that such ESG data and research providers can produce. Additionally, as most panelists acknowledged, ESG ratings themselves are usually only a first step or a preliminary flag in the assessment process by asset managers. Typically, the methodology employed by the ESG rating agencies is more important to asset managers than the ratings. Accordingly, two proposals for ameliorating the issues around the use of ESG ratings and research providers included the potential for the regulator to determine consistent ESG-terminology, which would allow for improved comparability, and to increase the required disclosures of the methodologies employed by ESG ratings and research providers in assessing the underlying data.
Conclusion
Overall, the discussion involved thoughtful feedback from a range of participants in the industry, including asset managers, investors and ESG ratings providers. This was the first of many conversations that the CSA is planning to have in upcoming months to discuss "important issues affecting capital markets, including disclosures on sustainable finance and diversity". It signals that Canadian regulators, similar to their US, UK and EU counterparts, are taking an active interest in ESG investing. Given the rapid growth in ESG investing, it will be an interesting space to keep an eye on for further developments in the near future, including the publication of the CSA staff notice which the regulators noted will provide guidance on ESG-related investment fund disclosures.
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