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Joy Williams is speaking at the free-to-air RI Digital: Canada 2020 conference on Plenary 1, titled: Is Canada taking a lead on ESG integration in global markets, or dragging its heels?
The conference starts on September 15. Take a look at the agenda and sign up. It’s free to attend!
Ontario, Canada’s largest province and home to many Canadian pension plans, made a bold ESG move in 2016. The province enacted new regulations under the Pension Benefit Act (“PBA”) requiring pension plans to disclose whether ESG factors are incorporated into the statement of investment policies and procedures (“SIPP”) and if so, how. This advancement was consistent with our international reputation for strong pension governance and innovative investment practices. However, in the last four years, no other jurisdictions in Canada have moved to explicitly regulate ESG investing. Furthermore, Ontario has not kept up with the momentum behind sustainable investing or with current thinking on fiduciary duties and ESG issues such as climate change. While there are individual examples of steps being taken, the Canadian pension industry as a whole is lagging.
Canadian pension regulations need a more modern approach to ESG if we want to continue to lead in this industry and address the climate crisis. In our view, this means clear requirements to consider relevant ESG factors, like climate-related risk and opportunity, while still allowing sufficient flexibility for funds to chart their own path. Better member communication about responsible investing could increase engagement in retirement savings. Lastly, transparency through TCFD-aligned disclosures would increase accountability of administrators and investment managers. Failure to raise the bar puts Canadian pension investments at risk.
Will Canada align SIPP regulations with best thinking on fiduciary duties?
In its Final Report, Canada’s Expert Panel on Sustainable Finance (“Expert Panel”) recommended that the federal government require plans to disclose in investment policies whether and how climate issues are considered, as Ontario did, and that the rest of the provinces should do the same. But do we really want pension regulations to follow Ontario’s approach when we could and arguably should aim higher?
Ontario’s SIPP requirement was a positive step because it proved plan fiduciaries are permitted to take ESG factors into account and it provoked conversations about ESG within the funds. However, the PBA does not require, nor encourage plans to consider ESG. The UK introduced a similar regulation in 1999 that required pensions to disclose the extent to which their investment strategy took ESG into consideration, if at all. The Pension Minister at the time referred to this as “light touch legislation, designed to promote cultural change.”
The UK has now moved with the times. In October 2019, ”next generation” regulations came into effect. Pension trustees of plans with more than 100 members must disclose how financially-material factors, including ESG and climate change, have been incorporated into investments. Article 173 of the French Energy Transition Law is another well-known regulatory requirement for investors to report on how they account for ESG criteria. Jurisdictions that are moving in the opposite direction do so against the broader industry. The US Department of Labor has proposed new rules that discourage pension fiduciaries from investing in ESG vehicles. This proposed rule has garnered over 8,500 comments, with more than 95% in opposition to the idea that integrating ESG makes returns subordinate to non-financial objectives.
When Ontario’s rules came into effect in 2016, many plan administrators had not developed an informed approach to ESG. There was fear that disclosing a policy would expose them to increased scrutiny. In fact, of the 6,300 SIPPs filed in Ontario in 2017, only 36% stated the plan’s investments incorporated ESG, with the majority stating that ESG factors are not considered.
However, it is now more widely accepted by legal experts that administrators’ fiduciary duties require the consideration of relevant ESG factors. The International Organization of Pension Supervisors (“IOPS”) (of which the Canadian Association of Pension Supervisory Authorities (“CAPSA”) is a member) has stated, “explicit integration of ESG factors into pension fund investment and risk-management process is in line with fiduciary duties”. Ontario’s SIPP regulations are arguably sending signals inconsistent with the current state of fiduciary law because they permit administrators to state that ESG factors are not taken into account at all.
Ontario’s new pension regulator, the Financial Services Regulatory Authority (“FSRA”), has rule-making powers and is meant to be more proactive than its predecessor. ESG, and in particular climate disclosure, is an opportunity for FSRA to show whether it can provide timely leadership and help drive innovation. The industry also relies heavily on CAPSA to set best practices and help harmonize our fragmented regulatory environment. CAPSA has included the development of guidelines for using ESG factors in its current strategic plan. It is time for FSRA, CAPSA, and legislators in other jurisdictions to establish stronger ESG requirements for pensions that are consistent with fiduciary law.
New incentives programs may promote ESG
Further regulatory advancement may come through incentive programs that encourage members to move their savings to investments that take ESG into account. The Expert Panel proposed a “super-tax deduction” of greater than 100% for retirement contributions that are made to accredited climate-conscious products combined with increased contribution room for eligible investments.
These solutions have the potential to demonstrate Canadian innovation and leadership in the pension industry. Such a program would be supported by regulation and standards for eligible green products, but once the rules are in place, retail agents and advisors will step up to develop these options. We are hopeful that Canada’s new Finance Minister, who stated that the pandemic recovery efforts must be green, will help usher these programs forward.
Bringing TCFD-aligned disclosures into the mainstream
Many pension investors endorse the TCFD framework because it helps provide comparable and consistent information on which to base investment decisions. However, it is just as important to see plans providing their own TCFD-aligned disclosures. A few large pensions are leading this charge, providing a model that could inform a regulatory framework and be followed by other plans. By reporting consistent with TCFD, these funds may drive more companies to follow suit.
We support TCFD-aligned disclosures for pensions. This would not only enable scrutiny of plan administrators, but would also encourage innovation and learning from others. Again, the UK is ahead. Consultations on a TCFD-aligned guide for pension trustee disclosures are complete and a second consultation seeks to introduce mandatory TCFD-aligned reporting for pension funds above a certain threshold by 2022, with penalties for non-compliance. A Pension Schemes Bill currently before Parliament seeks to empower the government to develop the regulatory framework for these changes. Canada’s Expert Panel has recommended that CAPSA work to harmonize provincial approaches in line with TCFD, but it is still just recommendation at this stage.
We would also like to see regulators promote explicit ESG disclosures in member communications, particularly for defined contribution plans. Where members are making their own investment decisions, they need options and information about ESG so they can connect their retirement savings to climate change and other ESG goals.
If Canada continues with passive regulations and non-binding CAPSA guidelines, ESG investing may only develop in pockets of the industry. Canada will risk losing its status as a leader in pension governance and our progress may become just anecdotal. While some plans may be motivated by the leadership of our larger funds, and potential incentive programs might increase member selection of ESG products, a better way to accelerate change is through a progressive regulatory model that sets higher performance standards for all plans. Further regulation of responsible investing could drive the next evolution in pension governance for Canada if we act boldly again.
Joy Williams is Senior Advisor and Alisa Kinkaid is Senior Advisor at Mantle 314.