There is a significant global trend toward the adoption of ESG-related regulations. Can ESG regulations in other markets impact Canadian companies and institutional investors, and how should Canadian companies respond?
ESG Regulation is an Accelerating Global Trend
There is a significant global trend toward the adoption of ESG-related regulations targeting institutional investors, corporate issuers or both:
- The Principles for Responsible Investment (PRI) has documented more than 730 regulatory or “soft law” policy revisions in the world’s 50 largest economies, across over 500 policy instruments, that required or encouraged investors to consider long-term value considerations, including ESG factors.
- The adoption of ESG-related policies and regulations has been accelerating. 97% of the policy changes identified by the PRI were introduced after the year 2000. Morningstar reported that in 2018, over 170 ESG-related regulatory measures were proposed globally, which was more than the total number proposed in the previous six years, and that over 80% of those measures targeted institutional investors rather than companies.
- Notably, some form of stewardship code outlining the responsibilities of institutional investors has been adopted in 23 markets globally, and the development of a Canadian Stewardship Code was one of the recommendations of the Expert Panel on Sustainable Finance, convened by the Government of Canada in 2018 to explore opportunities and challenges for Canada.
- Comprehensive programs of ESG-related regulation are being developed, based on the strategic recommendations of panels of experts. The most comprehensive approach has emerged from the European Union (EU), in the form of the Action Plan on Sustainable Finance, which was adopted in 2018 based on the recommendations of the High-Level Expert Group on Sustainable Finance.
- Increasingly, financial regulators are becoming involved in the development of international ESG policy frameworks. The Task Force on Climate-related Financial Disclosure (TCFD) recommendations were developed under the auspices of the Financial Stability Board (FSB), the international body that addresses vulnerabilities to the global financial system. The Network for Greening the Financial System (NGFS), a global sustainable finance network for central bankers and supervisors established in 2017 that includes the Bank of Canada (BoC), has expanded to 69 members and 13 observers, and recently published guidance on integrating climate and environmental risk to prudential supervision. The International Organization of Securities Commissions (IOSCO), of which the Ontario Securities Commission (OSC) is a member, has established a Sustainable Finance Network and in 2020 agreed to establish a board-level Task Force on Sustainable Finance to enable participation in efforts to improve coordination and consistency in the development of ESG-related regulation.
ESG Regulations Enacted in Other Jurisdictions Can Impact Canadian Companies and Investors
ESG regulatory initiatives in other markets might be expected to have little impact in Canada, but this overlooks the fact that capital is global. In fact, ESG regulations enacted in leading markets can significantly impact Canadian companies and investors. Three key types of regulation can be distinguished, with differing impacts on Canadian companies and investors.
Type of Regulation
ESG Incorporation Requirements for Investors
Expectations for investor disclosure or practice relating to the integration of ESG factors into investment decision-making and/or stewardship of investments (proxy voting and engagement with investee companies).
Ex: EU – Sustainability Disclosure Regulation
Requirement for investors to disclose how sustainability risks are integrated to investment and establishes disclosure requirements for marketing investment products based on ESG factors.
Potential Canadian Impact
- Canadian asset managers may need to meet these expectations in order to win mandates from asset owners in regulated markets.
- Investors in regulated markets may modify investment decision-making in order to enhance the ESG profile of their portfolios. Canadian companies may be disadvantaged when competing for investment or experience more intensive engagement from global investors and negative vote outcomes if their ESG disclosure and/or practice is considered to be weak.
ESG Taxonomy and Investment Product Labelling Requirements
Formal classification systems defining whether companies or their securities are considered to be “sustainable” investments and setting standards for investment products that are marketed as sustainable.
Ex: EU – Taxonomy Regulation
Establishes criteria for whether an economic activity is considered environmentally sustainable, based on contributing substantially to one or more specified environmental objectives, while not harming the other objectives.
- Canadian asset managers may need to ensure that investment strategies meet these expectations in order to win mandates from asset owners in regulated markets.
- Depending on whether their activities or securities are classified as “sustainable” or otherwise, Canadian companies’ access to capital from investors based in regulated markets may be positively or negatively impacted.
Corporate ESG Disclosure and Due Diligence Requirements
Expectations for companies to disclose ESG information and/or undertake due diligence in relation to environmental or social impacts.
Ex: EU – Non-Financial Disclosure Directive
Requirement for large EU corporations to disclose ESG information relating to the environment, social responsibility and treatment of employees, human rights, anti-corruption and bribery, and board diversity.
- The baseline expectations for corporate ESG disclosure and/or practice may become more exacting among investors based in regulated markets, and Canadian companies may not meet the expectations.
- In third-party ESG ratings and rankings, Canadian companies may be compared unfavourably to companies in regulated markets because of lack of disclosure and/or perceived weakness in practice. This may impact access to capital from passive investors in indices based on ESG ratings.
How Should Companies Respond?
Increasingly, regulators are either requiring or recommending that institutional investors should consider corporate ESG policy, practice and performance and disclose how it factors into their investment decision-making. There are significant potential consequences for Canadian companies and investors:
- Canadian companies seeking capital from the increasing proportion of global investors integrating ESG factors to their investment process may be disadvantaged when competing for capital against companies based in jurisdictions with stronger ESG performance and disclosure requirements.
- ESG-related laws and regulations elsewhere shape the expectations of global asset owners. Accordingly, Canadian asset managers seeking to compete for business from asset owners in other jurisdictions that are subject to ESG expectations will likely need to have processes in place to meet those expectations and provide robust disclosure of them.
It is critically important for companies and investors seeking capital and business in the global capital markets to stay on top of regulatory developments in the ESG space, not only in Canada but in all leading jurisdictions. Companies should be integrating existing and emerging regulation in their ESG materiality assessments and risk assessments. Investors should be tracking existing regulation and emerging regulation to ensure their ESG policies, processes and disclosures meet expectations so that they remain competitive globally.
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This document is for general information purposes only and is not intended to provide legal, accounting, investment, financial or other advice.