The Future of Responsible Investing in Canada

In July this year, proposals for regulatory change including enhanced proxy voting rules, board diversity, issuer environmental, social and governance (ESG) disclosures were released for comment by the Taskforce for Modernization of Ontario’s Capital Markets, commissioned by the Ontario Minister of Finance. You can find our comment letter here.

On the back of this development, Morningstar’s latest Executive Forum – the third of 2020 – titled “Sustainable Investing and Canadian Policy”, sought to answer questions that came up, including, from an ESG standpoint, how is Canada stacking up in the regulatory regime? Is ‘Greenwashing’ a thing for Canadian investors? And how should ESG investors be thinking about Canadian energy?

These issues are increasingly relevant in 2020, as society and investors demand more – from governments, law and policymakers, and yes, from investments. Individual and institutional investors continue to look past financial results to ESG factors, to both generate alpha, and manage risk.

Addressing these questions were panellists Melanie Adams, VP & head, corporate governance & responsible investment, RBC Global Asset Management, Michael Jantzi, founder of Sustainalytics (a Morningstar company) and Robert Walker, chair, ICGN & principal, LVC Strategies, Canada. The Panel was moderated by Ian Tam, director of investment research, Morningstar Canada.

One thing that all panellists agreed on was that Canada has made a good start, but has a long way to go.

Ahead of the U.S., Behind Europe
“This is a common position to find Canada in, we’re between the U.S., which is lagging badly and has some hostility towards ESG, and the E.U., which is the gold standard,” said Walker. He pointed out that California is an anomaly in the U.S. in that it is a world leader in diversity beyond gender, but the rest of the country is lagging. The E.U. is at the other end, he notes that it has gone ahead in terms of disclosure requirements, and recent taxonomy requirements to call economic activity ‘sustainable’ has surprised many in terms of its level of ambition. “Canada is behind that level of ambition, but it is something Canada could aspire to,” he said. 

As an asset manager, Adams says that she spends a lot of time looking at both companies and European asset managers for cues, as managers need to feed disclosures down the chain to the investors. “Europe has been at the forefront of responsible investment for many years, and the U.S. is headed in another direction

Jantzi agreed that the E.U. taxonomy would be the standard but pointed out that reporting is as important as disclosure, and in terms of reporting, Canada is even behind the U.S., which is a problem. “When you talk about being behind, small countries like Taiwan have mandated easy reporting, we have a ways to go.”

“The Ontario task force put forward recommendations, it would be nice to see some of them put in action so we can say that Canada is taking steps in the right direction,” Adams agreed.

Still, the conversation has begun, and investors want to know, why now?

Why ESG Now?
Jantzi attributes it to two main reasons – access to good ESG information moving from a nice-to-have to a must­-have, and ESG integration across asset classes, in an inadequate disclosure environment. 

“Just in Canada, we track 70 Canadian oil and gas companies, of which only half have ESG disclosures or good performance on ESG disclosure. When you look at Canadian mining companies, more than 80% don’t disclose, not just on environmental issues, but also on land rights, indigenous issues and others. I used to believe in voluntary disclosures, but that wasn’t happening, so now I’ve moved firmly in the camp on mandatory ESG reporting, and we need distribution channels to disclose properly. The failure of the voluntary system is clear, we have to move past that,” he said.  

“It’s like an overnight success that has been decades in the making,” Walker says. He explains that the infrastructure has been building for a while, ESG thought leadership is in place, and momentum is building. “It’s because the risks are undeniable. The Deepwater Horizon oil spill was a red flag, but evidence of the financial costs of climate change, diversity, social issues are apparent and have been driven home.”

The financial aspects are relevant for RBC Global Asset Management, and Adams points out the company uses ESG disclosures as a valuation tool. “We cannot properly value companies without incorporating ESG information and need these disclosures for valuations. If there are regulations, we will have consistent, comparable information so we can compare companies to their peers”, she said, adding that disclosures need to be material and relevant. For example, banks would need to disclose cybersecurity risks, but these risks would be less relevant for a drink manufacturer, where disclosures around wastewater management would be more relevant.

“There is an opportunity for companies to spread the word about the good they are doing and attract capital, and if they don’t disclose, it would be disclosed for them,” she said, pointing to third-party data providers that indicate carbon emission details for companies reluctant to do so.

And speaking of carbon emissions, it is impossible to have an ESG discussion in Canada without talking about our oilsands – and the ESG risks there.

Glide Path to Carbon Neutral a ‘Pipe Dream’?
“There’s no better example of why ESG enriches an investment conversation than oil and gas, whether it is the environmental or social issues in the sector. We have no special need to support the Canadian oil and gas industry,” Jantzi said. 

This may sound charged, but he explains that Canadian investors have the responsibility to look at ESG issues as a whole, and evaluate the sector broadly based on the ability to manage what is coming down the pipe. “We are in a transition period, so there are investment opportunities in oil and gas, but look at what the global companies are doing. Climate change is an important issue, and global oil and gas companies are writing down fossil fuels,” he says.

Adams agrees and points out that carbon neutral is different from low carbon, and we need a transition to a low carbon economy, reducing greenhouse gas emissions, leading to a greener pathway. There needs to be a transformation in infrastructure, supply chain, emissions, food production. She admits that “There is no single path. What we need is disruption. Disruption in government policy and regulation, like carbon pricing, removing subsidies on fossil fuels. Technological innovation is already happening in renewables and electric vehicles and changing customer expectations. In Canada, we are seeing all of these drivers of disruption,” she says.

It won’t be easy, especially with multiple players and multiple agendas. Walker addressed this and pointed to the need for multi-stakeholder buy into these ideas. “I don’t see a clean path, it will take multiple efforts on multiple fronts. We need Alberta and Saskatchewan on board. We also need to engage with some industry bodies. We need gatherings of industry, First Nations, investors, communities, government and labour,” he says.

“We are at peak oil now, and demand is going to decline. It is a global play, we owe it to investors to look at it that way, not just Canada,” said Jantzi, adding that the politicization of this issue is tragic.

“Moving forward, we need to look to the oil and gas industry’s deep technical expertise and knowledge to fund energy solutions to these problems, play on a global stage, and apply these innovations to other aspects of the economy,” Adams said.