Michel Charron has had a front-row seat for the revolution in the Canadian investment industry’s approach to environmental, social and governance issues.

Following the foundation of the United Nation’s principles for responsible investment in 2008, his firm, PBI Actuarial Consultants Inc., immediately signed up. But the concept required explanation for some pension plan sponsors, he says. “The response was initially lukewarm. Some would say they were interested in ESG, but it wasn’t part of their mandate. And the other thing we heard was they weren’t willing to leave money on the table for that.”

Over time, institutional investors became more receptive to ESG information, he says, initially as a defensive tool to boost their risk mitigation efforts. Since then, many have opened up to a more proactive approach, targeting assets, investments and projects that promise to make a positive impact on the world around them.

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Still, as late as 2018, Charron says he struggled to fill a fossil fuel-free portfolio for an institutional client, due to the lack of products on offer. More recently, the market has exploded. “Now I’m getting new product information every week from asset managers. Every firm has a climate fund now, because that’s the next crisis that everyone is looking to.”

Richard Manley, head of sustainable investing at the Canada Pension Plan Investment Board, says heightened expectations among all stakeholders have helped propel the business case for ESG integration from the periphery to the mainstream.

“A clear consensus has emerged globally among institutional investors that ESG is a financial necessity and an integral part of their responsibilities as an investor, not a distraction from them. This change is backed by a growing body of evidence showing companies that fail to integrate consideration of the business risks and opportunities tied to ESG can severely undermine value.”

In the volatile early days of the coronavirus pandemic, many suspected ESG considerations would return to the backseat as investors sought comfort in a purely financial assessment of investment performance, says Bruce Winch, Canadian lead at T. Rowe Price Inc. “In fact, the opposite has happened. Instead, the focus has been on getting companies to understand the importance of providing ESG data.”

Key Takeaways

• The entire Canadian investment industry, including institutional investors, public companies, asset managers and the general public have all become more attuned to ESG issues in the past decade, with the pandemic accelerating the trend

• All ESG data aren’t created equal and the recent proliferation of data isn’t all good news for investors, which must find their own ways to make sense of the numbers.

• Standardization of disclosure requirements for both public companies and financial products could be the key to future ESG data improvements, with major Canadian pension funds leading the quest for more comparable information.

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Confronted with the precariousness of the world during the pandemic, investors doubled down on ESG issues, says Winch. Meanwhile, the racial justice outcry that followed the murder of George Floyd in the U.S. and Canada’s recent reckoning with its residential school past have helped push the social component of ESG closer to the forefront.

“It’s a long journey, but we’ve never seen this kind of unity on diversity and inclusion,” he says. “The tragic events of the last year or so have really accelerated the commitment to change. Companies and investors no longer see ESG as secondary factors.”

Answering the call

Publicly listed companies have answered the call for data, with the majority (71 per cent) of companies on the S&P/TSX composite index producing a dedicated ESG report as part of their annual filings in 2020. That proportion has almost doubled in the last three years, according to ESG consultants Millani.

But as the market for ESG-friendly investments matures, they’re not the only ones spewing out data points. A whole rating industry has also sprung up, with various agencies offering their own assessments of the ESG bona fides of individual companies and financial products.

“One of our most important tasks is cutting through the noise to identify who tomorrow’s winners are,” says Sophie Cousineau, vice-president of stewardship investing and ESG risks at the Caisse de dépôt et placement du Québec.

Read: Pension fund managers calling for stronger ESG disclosure

But that’s easier said than done, as several academic papers have recently demonstrated. In the last few years, researchers at Duke University and the Massachusetts Institute of Technology’s Sloan School of Management have raised questions about the reliability of ESG ratings, after finding that one agency’s scores bear little, if any, relation to another’s.

Depending on the study, the correlation between the ESG ratings that agencies have assigned to firms was estimated at somewhere between 0.3 and 0.61. That pales significantly in comparison to credit rating agencies such as Moody’s Investors Service or S&P Global Ratings, where the correlation between their individual assessments comes out at 0.99, or almost aligned.

“I think we have to take [ESG ratings] with a little grain of salt, but they are a reference and they do provide some sort of benchmark,” says Cousineau.

As the Caisse continues its quest to hit net-zero carbon emissions for its portfolio by 2050, her team oversees transactional analyses, scoring investment targets based on a materiality chart that isolates ESG risks depending on the specific industry in which a company operates.

Read: Caisse among investors committing to carbon-neutral portfolios by 2050

The stewardship investing department adds particular value on private equity deals because of its early involvement in the investment process and ability to steer the fund’s due diligence plan. “It’s rarely a deal breaker,” says Cousineau, noting the ESG team’s findings often influence negotiation and informs post-transaction followups. “If they’re lacking on health and safety, we can position that as a key focus for us after we join the board and influence the company to make sure it’s being taken into account.”

At the CPPIB, Manley’s sustainable investing division also makes use of raw data from various vendors, only for it to be re-scored in the plan’s own proprietary database, which also incorporates information from companies’ annual reports, as well as machine-read material from various online sources.

Although ESG disclosure is improving among public companies, Manley says the majority of what’s labelled ESG data is actually made up of policy statements on issues such as health and safety, diversity and supply chains.

A much smaller proportion is issued as numeric data focused on performance and targets, but the CPPIB’s scoring system emphasizes any quantitative information it can find at the expense of simple policy disclosure.

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“The fact that a company has comprehensive health and safety policies is good, but what we want to see is that those policies have transmitted themselves into a robust culture of health and safety in the workplace, such that the company has a low incidence of lost time incidents and hopefully zero fatalities.”

Engaging in data

For Quebec-based pension fund Bâtirente, ESG efforts focus more on engagement than investment decision-making as a result of its corporate organization. The plan — whose 23,000 members belong to more than 300 unions — outsources the management of its assets to external providers, but continues to steer its investment managers in the direction of ESG integration.

“We strongly believe it’s our duty to incorporate these issues not only into portfolio construction, but also into the stewardship of capital once invested,” says Daniel Simard, the fund’s chief executive officer.

Bâtirente relies on information from Aequo Shareholder Engagement Services Inc. to identify areas of ESG concern and possible improvement at public companies. Although the pension fund founded Aequo in 2016, the company has since been spun off, facilitating dialogue and goal-setting between its clients and the businesses where they’ve invested their money on topics including human rights, employee well-being and diversity and inclusion.

Read: Bâtirente continuing to reduce carbon footprint of investments

According to Simard, statistics on greenhouse gas emissions associated with particular portfolios provide Bâtirente with a useful indication of how seriously their asset managers take ESG integration. “Providers do an excellent job at gathering this information and building algorithms to capture data from those that do not report publicly. There are limits as to the quality of information, but in terms of ESG estimates and assessments, I think we have reached a pretty good point. And they will only get better with time, as companies release this data publicly more and more.”

Shannon Rohan, chief strategy officer at the Shareholder Association for Research and Education, says requests for better ESG data have become a critical part of its growing engagement program.

This summer, the recently launched University Pension Plan became the latest investor to team up with the association, taking its partners’ total assets under management past the $80 million mark, a figure that’s up from $25 billion in 2019. In a statement announcing the agreement, the jointly sponsored pension plan said it would be challenging public companies in its investment portfolios on their records for climate action, reconciliation and human rights.

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“It’s one thing for investors to use ESG data to decide which companies are worth investing in, but it’s also important in how they steward their assets,” says Rohan. “Investors need good data to make properly informed decisions. We’ve seen a lot of improvement, particularly around climate-related data, but there’s still work to do on the social indicators.”

Back to the source

Whatever they’re using it for, the imperfections in ESG data stems from the source, according to Dustyn Lanz, CEO of the Responsible Investment Association.

“There is a ton of data available, but it’s almost entirely contingent on what corporations wish to disclose. Some do an amazing job and some don’t, so it’s very uneven and not always comparable.”

ESG by the numbers

8 — The number of major Canadian pension funds that teamed up in late 2020 to demand corporations adhere to the Sustainability and Accounting Standards Board and the task force on climate-related financial disclosures when reporting ESG disclosures $1.6 trillion Combined value of assets under management by those eight pension funds

73% — Proportion of Canadians who believe responsible investment portfolios are the way of the future, according to a January 2020 survey by RBC Global Asset Management Inc.

$888 million — The BCI’s cumulative participation in sustainable bonds by the end of 2020, up from $356 million in 2019; it expects to hit $5 billion by 2025

38% — The reduction in the carbon intensity of Caisse’s portfolio since 2017

$3.2 trillion
 — Value of Canadian investments that incorporate ESG issues, accounting for 61.8% of all assets under management, according to a November 2020 survey by the Responsible Investment Association

72% — Proportion of global institutional investors implementing ESG strategies in 2020, up from 61% in 2018, according to a April 2021 survey by Natixis Investment Managers

There’s a ton of data available, but it’s almost entirely contingent on what corporations wish to disclose. Some do an amazing job and some don’t, so it’s very uneven and not always comparable.

In late 2020, eight of Canada’s largest pension funds — the Alberta Investment Management Corp., the British Columbia Investment Management Corp., the Caisse, the CPPIB, the Healthcare of Ontario Pension Plan, the Ontario Municipal Employees Retirement System, the Ontario Teachers’ Pension Plan and the Public Sector Pension Investment Board — put themselves at the forefront of efforts to improve the state of ESG disclosure.

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Their CEOs teamed up to demand that companies adhere to the Sustainability and Accounting Standards Board and the task force on climate-related financial disclosures framework when reporting ESG disclosures. “When you approach investing with a long-term view as we do, sound ESG practices are imperative to achieving strong, risk-adjusted returns,” said Kevin Uebelein, CEO at the AIMCo, in a statement accompanying the joint letter. “Seeking transparent and standardized disclosures is something we will continue to do, in the best interest of our clients.”

The TCFD framework was developed by the Financial Sustainability Board, a group affiliated with the G20, but a recent Millani study found just 23 per cent of companies on the S&P/TSX composite index are currently reporting in alignment with the task force’s recommendations.

Meanwhile, the CFA Institute is working on its own set of international disclosure standards for investment products. In an ideal world, Lanz envisions an RIA certification that would verify claims made by providers in their CFA Institute-compliant disclosures. “We could have a third-party auditor come in and audit their performance against thresholds established by the RIA.”

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With greater standardization comes the potential for a responsible finance taxonomy, allowing investors to assess which products and projects can and do actually deliver on their promises of sustainability, according to Ian Russell, president and CEO of the Investment Industry Association of Canada.

“It just complicates matters when investors have three or four agencies out there with their own measurements. The idea is for us to get to a set of commonly understood metrics, because that’s better for all the players in the market.”

Michael McKiernan is a freelance writer.