Are you meeting Canada’s ESG investment disclosure requirements?

Murray Bender: RBC Investor & Treasury Services is pleased to present insights on the future of asset and payment services across the globe. Coming up on today’s podcast is Lynn McGrade, Partner at Canadian-based law firm, Borden Ladner Gervais, providing her insights on the Canadian regulatory environment for environmental, social, and governance, or ESG, investing. Welcome, Lynn.

Lynn McGrade: Thanks, Murray. I’m pleased to be here with you today.

Murray Bender: To start, Lynn, can you describe the current state of regulation for ESG fund disclosure in the Canadian market?

Lynn McGrade: You know, Murray, actually, there is no specific ESG regulatory requirements in Canada right now. But one new development that did happen is, in January this year, the Canadian Securities Administrators, the CSA, published a notice setting out what their guidance is on how existing non-ESG-specific securities regulatory requirements apply to ESG-related investment fund disclosure.

So I think it’s a really interesting approach that our regulators have taken. They’re not going to produce something specific to ESG, but they’re just going to rely on some of the existing rules that are out there to govern in this area. And I think that’s really important for industry participants to understand. Because what that means is that the guidance, seeing as it’s based on existing regulatory requirements, is in effect with immediate application, even though it just came out in January.

And it was quite extensive. It’s, Murray, about 25 pages long and very broad in its scope, and I can go through the scope of what it covered. It’s very broad. Investment objectives and fund names; it also governs disclosure of fund types; investment strategies disclosure; covers proxy voting and shareholder engagement policies and procedures; obviously, risk disclosure; how a fund discloses its suitability for investors; it impacts funds’ continuous disclosure; it also covers sales communications and ESG-related changes to existing funds; and finally, just a very short bit on ESG-related terminology.

But bottom line, Murray, I think the purpose of the CSA notice is to provide fund managers in Canada with relevant and practical guidance to enhance the ESG-related aspects of their funds disclosure documents. The real goal, I think, is to prevent greenwashing by reminding fund managers that a funds description of its ESG strategies must be written using plain language, and when ESG-related terms are used, then the fund manager really should provide a clear and comprehensive explanation of those terms.

And one other thing I maybe should mention about the notice that we’re finding interesting is what type of fund it applies to. It’s very broad. It says it applies to investment funds, so obviously, retail mutual funds and ETFs, et cetera, especially those that have ESG in their objectives or names, but also those that just mention an ESG strategy as a part of the fund.

And interestingly, it even applies to funds that don’t have any ESG strategies at all, or nothing in their names or objectives, because it specifically says that those types of funds should also consider whether there are any material ESG-related risk factors that are applicable to them and disclose those risk factors.

And the one issue that we’re really grappling with is whether the CSA intended the guidance to apply to pooled funds or hedge funds offered under an OM. And the guidance in the CSA staff notice does not specifically state that it’s intended only for retail prospectus-qualified funds. However, all of the existing requirements discussed in the notice are those that relate to retail prospectus funds. So, from this, one might infer that, really, the CSA staff notice is primarily intended for retail funds.

But that said, the notice does say that staff encourage investment funds, investment fund managers and portfolio advisors to review the notice. And I think we’ve all learned from the past experience, Murray, that when the OSC and other regulators conduct compliance audits of registrant firms that manage pool funds or hedge funds, they do often look to the CSA staff notices that are out there for retail prospectus-qualified funds as a guide as to what they would expect to see as a best practice.

So I think it will be important for all investment funds managers to look carefully at this notice and get policies and procedures revised to ensure it’s followed quite quickly.

Murray Bender: What do you see as some of the challenges faced by investors around existing ESG regulation? Although, as you said, there isn’t really any existing ESG regulation. But what are some of the challenges that investors are facing?

Lynn McGrade: Yeah. I mean, I think it’s a great question. And maybe first, just to note that ESG is a big deal for investors these days, and that’s why we are seeing the regulatory guidance come out on the topic.

And just to sort of speak to that, a report from the Responsible Investment Association in November 2020 showed that retail-responsible investing mutual fund assets had increased by 36% in Canada over the past two years. And the CSA also speaks to this because they indicate that the value of sustainable funds in Canada was 18 billion at the end of the first quarter of 2021, which represented 160% increase from 2020.

And I think in response to this interest from investors in ESG investing and sustainable investing, fund managers are really starting to deliver product. So the CSA noted in its notice that there were 156 sustainable funds in Canada at the end of March 2021. So I think this is why ESG investing is getting some notice by the regulators.

And in terms of challenges for investors, I really see just a couple of challenges. First, I think investors want clear, consistent, and comparable disclosure to help them choose an ESG fund.

And while that sounds simple, I think it’s made more complex by the fact that different investors may have different reasons for wanting to choose an ESG fund. You know, some investors may want to consider how an ESG objective or strategy could impact actual investment performance. They may think that, for example, climate change presents a big risk and that could impact their investment. So they want to make sure, for performance reasons, that that risk is being taken into account.

Some investors may want to align their investment with moral values or principles; and some investors may want their investing power to affect positive change for the planet or their communities.

So I think that’s a real challenge for investors, is to be able to make their investment decision, they need a lot of information and disclosure on the ESG strategies that are becoming available to them in increasing amounts in the marketplace, and how they compare and contrast, and how they can align with what their investment objectives are.

And then I think the second challenge is, once they do choose an investment product, they really want to make sure that the fund is delivering on its ESG strategy. We’ve definitely seen, for years, that people want to make sure when they choose an investment product that it delivers on its performance objectives. Often funds line up against performance benchmarks and people want reporting on what has the fund done to increase its performance, how has it changed, how is it performing against the benchmark.

And I think that’s another challenge now is they want their fund managers to show them what is their ESG strategy and how are they really delivering on that strategy. And sometimes, there are benchmarks to deliver that, like carbon emission objectives, et cetera. So they want to see measurable goals and that their investment choice, that their investment product is meeting those measurable goals.

Murray Bender: So what should Canadian regulators be doing to help investors deal with these challenges?

Lynn McGrade: Well, I think the CSA notice is a great step forward, Murray. It really does clarify the regulatory expectation of the level of disclosure that’s required for ESG strategy. And I would say it’s going to step up the game a little bit. A fund that uses one or more ESG strategies, either as a principal strategy or part of its investment selection process, is going to be required to provide disclosure about the ESG-related aspects of its actual selection process and the strategies. And also, if the strategies include identifying any ESG factors used, they have to explain the meaning of each ESG factor in plain language and, as I mentioned, how those factors are evaluated and monitored.

And specifically, if targets for specific ESG-related metrics are used, such as I mentioned carbon emissions, funds are now going to be required to disclose those targets as part of their investment strategies, and also to report on them in their ongoing continuous disclosure documentation.

And another interesting aspect is that, if a fund uses proxy voting as an ESG investment strategy, then the prospectus is required to provide clarity about how the voting rights attached to the fund’s portfolio securities will be used to further the fund’s ESG-related investment objectives.

So I think this CSA notice is going to go a long way to help investors deal with—to help them make their investment decisions and the challenges they’ve been having there.

Murray Bender: What’s your advice to asset managers who may be in the midst of developing or enhancing their ESG investment strategies?

Lynn McGrade: Yeah, well, they first better make sure they’re very familiar with the notice, I think, because it is quite comprehensive. But then I think a next good step is to really conduct an audit of their existing investment products by looking at existing disclosure in the prospectus, but I think, importantly, also looking at what does marketing material and the website say. And then once you’ve taken that audit of all the disclosure, categorize the products into how they fit into the notice. Are they an ESG fund, one that’s really focused on ESG and the objective or name? Are they just a fund that uses ESG strategies and, therefore, are still subject to many of the aspects of the notice? Or are they really a fund that isn’t in the ESG space at all?

And then once they’ve done the categorization of their products, I think they really should step back and say, is this really how we do want our products to be categorized from an ESG perspective? Because the notice does provide a lot of guidance to fund managers on how to make changes to existing products involving ESG disclosure and strategies, so that’s another good step to take.

And I think another thing is, for new funds, there probably should be implementing processes, new processes to consider whether ESG factors will be incorporated into the fund’s objectives and strategies. And I think as a final step, they should be looking at existing policies and procedures, especially related to sales communications, as I mentioned, including the website, and consider if the ESG disclosure is meeting the guidance from the regulators, and what policies and procedures they need to put in place to make sure that happens.

Murray Bender: So, if you can gaze into your crystal ball for just a moment, what would you like to see, say, three to five years down the road in terms of the regulation of ESG investments in the Canadian market?

Lynn McGrade: Yeah. I think we’re going to continue to see a lot more ESG-focused products in Canada and better disclosure for investors. But the one remaining issue that I think will be a focus in the next three to five years is continuing to build on having consistent terminology. Terminology has become a huge issue; terminology in the ESG area.

So while the CSA notice did include some new terminology—I’ve been mentioning ESG fund, which is a fund focused on ESG and its objectives and name. They also have a new terminology called ESG strategy fund, which is a fund that just has ESG as part of its strategy. But they really didn’t fix any other terminology. I meant fix, not like correct, but fix in terms of set, any other terminology in the notice. All that they really require in the notice is that a fund’s description of the ESG strategies must be written in plain language.

But they do have a callout. They say in the notice that CSA staff encourage investment fund managers in Canada to develop common ESG-related terms and definitions that will enable investors to better understand ESG-related funds and make informed decisions about them.

So I think continuing to come up with consistent terminology in the ESG space will be a focus over the next three to five years. And I think one thing to note is that that process is already underway because we saw the release last fall by the CFA Institute of its ESG disclosure standards for investment products. And we also are expecting an upcoming release to be issued by the Canadian Investment Funds Standards Committee, the CIFSC, of its framework for the identification classification of ESG funds. And all of those initiatives will contain descriptions which will, I think, help the industry start to align on common language and definitions for ESG investment products. So I think that’ll be a focus in the next little while, Murray.

Murray Bender: Right. Some great insights on ESG regulation in Canada, Lynn. We really appreciate your time today.

Lynn McGrade: It’s been my pleasure, Murray. Nice to talk to you.

Murray Bender: For additional insights on topics relevant to corporate investors and financial institutions across the globe, including our previous podcasts, visit I’m Murray Bender. Thanks for listening.

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