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The concept of fiduciary duty has emerged as a major fault line in the debate over ESG investing, with some arguing it offers a legal foundation to compel institutional investors to take seriously the risks posed by climate change, and others using it to justify an approach focusing primarily on financial returns.
In the latest example of the former argument, Principles for Responsible Investment (PRI), an international group backed by some of Canada’s largest pension funds, is making the case that Canadian investment law permits and in some cases requires sustainability to be considered by institutional investors.
In a report published Feb. 13, PRI — an organization that arguably carries weight when it comes to institutional investing because its founding members include large pensions such as Canada’s Caisse de dépôt et placement du Québec, Canada Pension Plan Investment Board and BC Investment Management Corp. — concluded that the idea that fiduciary duty should encompass the pursuit of sustainability goals is supported by a legal framework in Canada that pre-dates the legally binding Paris Agreement on climate change.
The impact of these laws was bolstered in 2021 by Supreme Court of Canada declaration that “global warming is an issue of national concern,” according to the legal analysis done by PRI, whose membership has grown to 4,900 signatories, which together manage US$121 trillion in assets.
“Considering the implications of climate change for a pension fund is consistent with, and likely required by, an administrator’s fiduciary duties,” the report argues. “Specifically, the duty of prudence coupled with the duty of loyalty requires an administrator to consider factors that are financially relevant to fund performance and its ability to provide pensions.”
PRI said the legal framework even provides for some cases where sustainability impact goals can be pursued “for reasons other than achieving financial return goals.”
For example, if a mutual fund is marketed as addressing sustainability impact goals as part of its investment objectives, the investment fund manager is legally required to pursue the sustainability impacts stated in the fund prospectus, said Kelly Krauter, senior policy analyst for Canada at PRI. In such a case, “the stated sustainability impact goal or goals are not pursued wholly a means to achieving the financial objectives,” she said.
Despite this legal framework, the report says not enough is being done by Canadian institutional investors and suggests this is due to a “narrow interpretation” of the laws coupled with a “reluctance to change established practices.”
In addition, disclosure is largely voluntary, leaving regulators and beneficiaries in the dark about crucial decision-making and providing less incentive to challenge portfolio companies on their carbon emissions than if the disclosure was mandatory.
“Our … analysis shows that many Canadian investors may be interpreting their legal duties in ways that discourage them from considering sustainability impact goals, even where pursuing such goals can help them discharge their duty to achieve financial returns,” said the report, which was done in partnership with the United Nations Environment Programme Finance Initiative and the Generation Foundation.
“The main reason for this lies in a lack of legal clarity about investors’ duties and insufficient action by policy makers to encourage and enable responsible investment, rendering Canada a low-regulation jurisdiction by international standards.”
Such hard-line insistence comes at a difficult time for institutional investors as they try to balance government climate commitments and the demands of environmental groups — including accusations that their stated goals are mostly talk and “greenwashing” rather than action — against pushback from beneficiaries and legal groups that argue pensions are forgoing profits, jeopardizing returns and acting in an anti-competitive manner by coordinating investment criteria based on climate-related goals.
On the latter front, BlackRock Inc., the world’s largest asset manager, has faced recent challenges from Republican lawmakers and attorneys general in the United States, particularly in oil-rich states, as well as activist investor Bluebell Capital Partners, which in December sought to oust chief executive Larry Fink, shake up the board and compel BlackRock to rethink its ESG strategy.
While Fink has been outspoken about the role of environmental and social goals in investing, some institutional investors have pushed back against blanket demands for climate action and disclosure.
Jim Keohane, who sits on the board of directors of Alberta Investment Management Corp. and was previously chief executive of Healthcare of Ontario Pension Plan (HOOPP), a PRI member, said there is already evidence of the cost of pressure to divest of oil and gas producers.
“Oil and gas stocks were the top performing group in the market last year, so if you had previously divested of oil and gas stocks you would have significantly underperformed the market,” he said.
“If you compound that underperformance forward for 20 years it may make a material difference in the ability to pay pensions.”
Keohane pointed out that one of PRI’s partners in the report, Generation Foundation, has a stated goal to “pursue a wholesale shift in capital flows to drive a net zero economy.”
This suggests, he said, that there may be an interest in “trying to use pension plans to pursue their climate change alarmist agenda.”
Keohane said this is particularly problematic if government policy and legislation is used to sway the behaviour of institutional investors, as recommended by the PRI report.
Such measures would be tantamount to using pensions “as instruments of public policy,” which he deemed “a step in the wrong direction” for Canada’s large pension plans.
“One of the main reasons for the success of the Canadian pension model has been the governance structure which has allowed the Canadian funds to remain independent and free of government interference, which enables them to make decisions which are in the best interests of the members of the pension plan.”
Another Canadian pension official noted that funds across the country are bound by different mandates, which influences their investment decisions. The Caisse de dépôt, for example, has a dual mandate which includes an obligation to support Quebec, while the Canada Pension Plan Investment Board is guided by a mandate to “maximize sustained long-term returns without incurring undue risk.”
Not surprisingly, perhaps, those two pensions have come to very different conclusions about investing in the oil and gas sector.
In 2021, the Caisse pledged to divest all oil producing assets by the end of the following year as it aimed to reduce the carbon emissions generated by assets in its investment portfolio.
The same year, CPPIB’s incoming chief executive John Graham said blanket divestment was “essentially a short on human ingenuity” and pledged to invest in the entire energy ecosystem, including continuing to invest and oil and gas assets while also backing companies transitioning to lower carbon output. More recently, Canada’s largest pension plan has highlighted how it uses its shareholder voting power to pressure companies to step up when it comes to ESG, including on efforts related to the energy transition.
In November, Graham told the Bloomberg New Economy Forum in Singapore that CPPIB is willing to sever ties with companies that aren’t committed to net-zero targets, if efforts to change their approaches fail.
Margarita Pirovska, PRI’s director of policy, said her organization is aware that mandate-specific decisions must be made in some cases, and noted that some funds have made progress beyond what her organization is prescribing.
She said it was not the intention of the new report to single out certain investors or praise or shame anyone in particular for their level of progress.
As for the current backlash against mandating action on climate and other ESG factors, Pirovska said she believes it stems from “quite a lot of misunderstanding” about what responsible investment is.
“We have been working in this field, supporting investors to be more responsible investors, not because we want them to focus on something else (other) than financial returns,” she said.
“We want them to make more sustainable investment decisions to essentially aim to generate more sustainable financial returns.”
The bottom line, though, is that PRI sees little wiggle room when it comes to Canadian pensions and the consideration of climate-related factors.
The report said pension administrators in Canada should be required to incorporate assessment of sustainability risks and impacts into their investment policies and processes. Furthermore, a plan’s statement of investment policies should include information on how and to what extent administrators take into account relevant sustainability risks and impacts when investing plan assets in line with their duties.
While all pensions are required to establish and adhere to a statement of investment policies and procedures, or SIPP, disclosing what the plan invests in, how it manages its relationships with external managers, how it measures performance and what it considers as acceptable risk, ESG tends to fall outside that framework.
“It is not mainstream practice for investors to systematically consider the importance of ESG risks, opportunities and system-level sustainability impacts to the fund’s purpose and financial objectives over time,” said PRI’s Krauter.
“Incorporating this understanding in the fund’s investment beliefs would provide a solid foundation for the fund’s investment strategy and approach. That’s why PRI recommends that the relevant regulatory authorities spell this out clearly for investors.”
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In addition, mandatory disclosure of governance around climate-related risks and opportunities would enable beneficiaries and regulators to understand whether the pension’s board and investment managers are paying sufficient attention to climate change.
“Given the many credible voices pronouncing that climate change will have broad and dramatic implications for the natural world and economies which depend upon it, an administrator should be able to conclude that climate change is financially relevant to fund performance and its ability to pay pensions,” the report said.