Increasingly, defined contribution plan sponsors are grappling with adding environmental, social and governance investing options to their plans as a growing number of members ask for them, but the legal landscape for ESG investing is complicated, according to Kathy Bush, partner at Blake Cassels & Graydon LLP, during Benefits Canada’s 2022 DC Investment Forum in late September.

In Canada, there aren’t any minimum standards legislation dictating what plan sponsors can and can’t do around ESG, which Bush pointed out isn’t inherently bad and allows plan sponsors some flexibility.
However, pension plan administrators and sponsors have a legal obligation to the financial best interests of members, even in cases where a high-performing investment doesn’t meet ESG thresholds — something that’s been confirmed by old common law cases around fiduciary duties and short-formed in the industry to the adage ‘value, not values.’

Read: Investors cite returns, risk management as drivers for ESG integration

“It’s one of those ones where it sounds really easy. ‘ESG makes sense and that sounds good so I guess that’s what we’ll do for our members.’ [But it’s] not so easy,” she said, noting research and trends on whether ESG funds actually have outperforming returns is still unclear.

For DC plan sponsors that want to dabble in ESG funds, Bush suggested they first check if their plan documents have language prohibiting certain investments, which is common in old plans and trusts. “You have to make sure that you don’t shoot yourself in the foot, that your plan documents permit whatever you’re going to do on ESG.”

Plan sponsors also need to rigorously evaluate any ESG options to ensure they’re good investments and can’t rely on a defence of meeting plan member demand. “You can’t just say, . . . ‘They wanted a green fund and I gave them a green fund. It provided lousy returns, but that was their choice,’” she said, pointing to language in the Income Tax Act that says the primary purpose of a pension plan is to provide retirement income. She suggested that plan sponsors could risk being deregistered by the tax authorities if they provided funds that were there for social good, rather than helping plan members save for retirement.

But divestment and outright exclusions of certain types of investments — such as a ban on Russian companies due to current geopolitical issues or values-based exclusions of cigarette makers, nuclear arms manufacturers and more — aren’t compliant with common law decisions.

Read: What are the legal risks of ESG?

“It’s tough because I understand why you don’t like nuclear arms, but courts actually say, ‘Well, are they a good investment?’ And if so, it’s not up to you to make decisions for the pension plan about what you like or don’t like, but that is a tough message [to hear],” said Bush, noting plan sponsors are allowed exclude sanctioned companies because to invest in them would be illegal. 

To date just two provinces, Manitoba and Ontario, have specific rules around how pension plan sponsors should disclose the way they consider ESG factors, which provide limited guidance, she said. But changes are underway. The 2022 federal budget introduced a new requirement for federally regulated pension plans to disclose ESG considerations, including climate-related risks. And the Canadian Association of Pension Supervisory Authorities recently stepped in to help plan sponsors navigate these murky waters.

In June, CAPSA issued guidance that said using ESG factors to decide between two otherwise equivalent investment opportunities could be compliant with pension plan sponsors’ fiduciary duties. The document, which was open for comment until mid-September, also cautioned plan sponsors that “ignoring or failing to consider ESG factors that may be potentially material to the fund’s financial performance could be a breach of fiduciary duty” and that these factors shouldn’t be seen differently from other types of risk.

Read: CAPSA seeking feedback on risk management guidelines

In comparison to major defined benefit plan sponsors like the Canada Pension Plan Investment Board, the new guidance can be more practically difficult to execute for DC plan sponsors, said Bush. “You’re going to have to be way more prescriptive and you’re going to need more governance and that is going to be a challenge for a lot of plans. Unfortunately, it’s going to take time and effort, especially at the outset. . . . It’s clear that regulators are looking at this seriously.”

She said she expects to see DC plans, particularly smaller ones, rely more on the insurance companies they invest with and investment consultants to navigate new guidance and requirements. Statements of investment policies and procedures will also have to evolve to include more detailed information on ESG, but she said the question of which factors are relevant will be difficult for plan sponsors to muddle through.

“I think we’re all still feeling our way around what’s material. It’s not very easy to assess yet and that’s where I think boards and pension committees are really struggling.”

Read more coverage of the 2022 DC Investment Forum.