ESG continues to take centre stage in securities regulation in Canada and abroad

Investors and regulators are upping the ante on environmental, social, and governance (“ESG”) disclosure, especially regarding climate change.

Introduction

It’s no secret that the growing influence of ESG has accelerated during the pandemic. Defying the expectations of many cynics, environmental, social, and governance factors were not relegated to the margins when the economic going got tough. Instead, COVID-19 laid bare many deep-seated inequities in our society and highlighted our collective vulnerability to factors such as climate change. Stakeholders of all stripes took notice, and expectations on companies to demonstrate strong and measurable ESG performance are escalating.

The investor community and the financial services industry more generally appear to have taken this to heart. Investors are placing a premium on the value of companies with strong ESG performance and asking some tough questions of businesses in which they invest or are considering investing.[1]

Regulators, too, are taking up the ESG call to action and are beginning to implement disclosure requirements aimed at boosting transparency and standardization as investors and businesses struggle to navigate the ‘alphabet soup’ of ESG and compare apples to oranges. As such, it should come as no surprise this past year has brought a proliferation of ESG-related developments in securities regulation:

1. Ontario securities regulator recommends stronger ESG measures in Ontario and adoption of the TCFD guidelines nationally

In January, Ontario’s Capital Markets Modernization Task Force issued a final report recommending mandatory ESG disclosure for all non-investment fund issuers that complies with the recommendations of the Task Force on Climate Change-Related Financial Disclosure (“TCFD”). The report suggests a transition period dependent on an issuer’s market capitalization, with the largest issuers (those that have a market capitalization over $500 million) being required to comply within two years and the smallest issuers (those that have a market capitalization under $150 million) having up to five years to comply.

Although the task force’s mandate is limited to Ontario, it called for the Canadian Securities Administrators (the “CSA”) to impose a uniform standard across all provinces. The report also recommends changes to Ontario’s securities legislation to increase regulatory oversight of proxy advisory firms and to promote greater corporate board diversity through enhanced disclosure and novel term limits for directors of public issuers.

Until Canadian securities regulators impose additional ESG-specific guidance, issuers will be required to work within the existing framework, which mandates disclosure of material information regarding certain ESG issues. Guidance about these disclosure requirements is set out in CSA Staff Notice 51-333 (Environmental Reporting Guidance) and CSA Staff Notice 51-358 (Reporting Climate Change-related Risks). These staff notices reinforce the fact that there is no bright-line test for materiality, which must be must be considered on a case-by-case basis in light of the available facts.

The Ontario task force and report are one of many ESG-related developments in Canada since the emergence of COVID-19. For example, shortly after the pandemic, Canada made certain federal loans contingent on large employers’ compliance with the TCFD recommendations (see more on that in our recent article). Since then, a number of institutional investors have expressed the need for enhanced ESG disclosure. To learn more about the state of ESG in Canada, see our recent Canadian ERA Perspectives article. We will be closely following whether the task force’s recommendations are implemented in Ontario and/or on a national scale, as well as other ESG-related developments in Canadian securities law.

2. Biden administration expected to push ahead with new ESG rules for United States securities market

Under the Biden administration, the United States’ Securities and Exchange Commission (the “SEC”) seems poised to tighten ESG disclosure requirements. In the weeks following President Biden’s inauguration, the SEC announced that it would appoint a Senior Policy Advisor for Climate and ESG, as well as create a “Climate and ESG Task Force” in its enforcement division.

Acting Chair Allison Herren Lee has repeatedly emphasized the SEC’s renewed focus on climate issues, noting that the SEC plans to update its outdated disclosure guidance to facilitate the disclosure of consistent, comparable, and reliable information on climate change. In March 2021, Lee announced a public input period, giving investors, registrants and other market participants an opportunity to weigh in on such disclosure.

The SEC also issued a risk alert on April 9, 2021, noting that it has observed deficiencies related to ESG investing and disclosure under its existing requirements.

It therefore appears that the SEC is ramping up prioritization of ESG in its regulatory efforts, although its precise strategy is not yet available. This enhanced focus on ESG is seen as long overdue by many investors, as the United States’ regulatory environment – which had not emphasized ESG prior to 2020 – has caused the country to fall behind in the ever-evolving ESG market, particularly when compared to the European Union. Although Biden nominee Gary Gensler was recently confirmed as chair of the SEC, it is expected that the SEC’s next ESG announcement will come after the above mentioned input period closes in June 2021.

3. European Union rolls out mandatory ESG disclosure regime, securities regulator calls for increased regulation of ESG ratings

In April, the executive arm of the European Union began rolling out a comprehensive sustainable finance package containing the following elements:

  • The EU Taxonomy Climate Delegated Act, which the EU will adopt at the end of May, sets out screening criteria for activities that contribute to climate change adaptation and mitigation, based on scientific advice from a technical expert group. It will also introduce disclosure obligations for companies and financial market participants;
  • The Corporate Sustainability Reporting Directive, which will extend the EU’s sustainability reporting to all listed companies and large unlisted companies, capturing an additional 39,000 companies. The reporting standards are intended to be a “one-stop-shop” regime, allowing all companies to comply with a single standard; and
  • The package also introduces amendments to six delegated acts, which aim to strengthen fiduciary duties, investment and insurance product oversight and governance practices. These amendments will also require insurance and investment advisors to discuss sustainability preferences with clients in suitability assessments.

The adoption of this package is part of a tsunami of ESG developments for the EU, who is at the forefront of the ESG movement globally. It follows the EU’s recent adoption of the Sustainable Finance Disclosure Regulation, which creates mandatory ESG disclosure obligations for manufacturers of financial products and financial advisors (see more on this regulation in our recent Canadian Securities Regulatory Monitor post). The EU’s securities regulator, the European Securities and Markets Authority, has also recently issued calls for increased oversight of ESG ratings to ensure their quality and reliability amidst risks of “greenwashing, capital misallocation and products mis-selling”.

4. United Kingdom moves ahead with mandatory climate disclosure

The UK declined to import EU legislation related to sustainable finance prior to Brexit and instead are pursuing their own ESG agenda. In November 2020, the UK announced its strategy to become the first country with mandatory TCFD-compliant disclosure across the entire economy by 2025.

The UK “Roadmap” towards mandatory climate-related disclosures provides timelines for such disclosure, some of which have already come into effect. For example, premium listed companies in the UK are now required to make TCFD-compliant disclosures, according to the country’s financial conduct authority. The UK’s ESG strategy promises to tailor the country’s ESG laws to the UK market while keeping it on equal footing with the EU. The degree to which the UK and EU work to standardize their ESG disclosure requirements will be a development to watch in the coming years.

5. New Zealand proposes mandatory climate-disclosure

The Government of New Zealand introduced legislation in April requiring certain financial sector participants to disclose the impacts of climate change on their businesses. These mandatory climate-related disclosures would apply to most publicly listed issuers, as well as large registered banks, licensed insurers, and registered managers of investment schemes. Mandatory disclosures would be required for financial years commencing in 2022, to be published in 2023.

The Financial Sector (Climate-related Disclosure and Other Matters) Amendment Bill is currently in the committee review stage, but as the governing Labour Party has a majority of seats, and the Green Party’s support can be expected, the Bill is likely to pass in a form similar to what was initially introduced. The progress of the Bill can be monitored here. The introduction of mandatory climate-related disclosure would put New Zealand at the forefront of the codification of ESG requirements internationally, though it is a much different context than other jurisdictions owing to the small size of New Zealand’s financial markets. The mandatory disclosure requirements are expected to apply to approximately 200 entities.

In addition to the proposed legislation, the Financial Markets Authority in New Zealand released guidance for issuers of financial products that incorporate “non-financial” factors, including green bonds or products that claim positive environmental impacts. This principles-based guidance clarifies how existing prohibitions against misleading or deceptive conduct or representations can be applied to such products. It also outlines how existing disclosure obligations for those issuing financial products apply to ESG-related claims.

We’re here to help

McCarthy Tétrault has a multidisciplinary ESG and Sustainability team that is equipped to provide clients with a full suite of advice and support to assist them in integrating ESG thinking into their organizational DNA. With a robust understanding of business, industry, and market drivers, we are well suited to provide contextualized guidance. More information on our ESG Strategic Issues Group is available here. Please contact Bob Richardson, Awi Sinha, or Will Horne to learn more – we would be happy to assist you.

 

[1] See Larry Fink's 2021 letter to CEOs.

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