With environmental, social and governance considerations hovering on the agendas of legislators, shareholders and consumers, it’s easy to overlook the fact that responsible investment can be fraught with legal risks for pension plan sponsors.
However, plan sponsors can mitigate much of that risk with a proper understanding of the distinction between ESG factor integration and socially responsible investing. “ESG factor integration is part and parcel of evaluating an investment, but that’s something different from socially responsible investing, where investments are selected for the specific goal of affecting change or attaining certain outcomes,” says Jana Steele, partner and department chair of the pension and benefits team at Osler, Hoskin & Harcourt LLP.
Unfortunately, legislation and regulatory guidance frequently blurs the distinction. “Ontario’s investment guidelines on ESG disclosure suggests that ESG and SRI are part of a continuum, but they aren’t,” says Randy Bauslaugh, leader of McCarthy Tétrault LLP’s national pensions, benefits and executive compensation practice. “And Manitoba’s legislation also confuses things by referring to ESG factors as non-financial factors.”
Generally speaking, plan trustees have a fiduciary duty to put aside their personal views and act in the best interests — generally, the best financial interests — of the plan’s beneficiaries by providing a lifetime retirement income.
“So if the non-financial benefits do not enhance the financial benefits, they shouldn’t be considered,” says Bauslaugh. “But another way of looking at it is that, when ESG factors inform performance assessment, sustainability or risk, they are, in fact, financial factors.”
From this perspective, ignoring ESG isn’t really an option, he adds. “If there are ESG factors relative to value and you ignore them and they are accessible to you, you do so at your peril.”
Still, ESG buzzwords, like “sustainability,” can be precarious from a legal perspective. Pension funds are institutions that look to the long term, says Bauslaugh, noting that doesn’t mean an ESG proposition can be justified without thinking about short- and medium-term implications.
“Pension funds that give too much weight to long-term sustainability risk legal exposure because they may need to consider short- and medium-term factors and investments that override the longer-term ones.”
It boils down to keeping the distinction between value and values in mind, says Bauslaugh. “ESG consideration is a way of integrating certain factors into the assessment of an investment, while SRI refers to a moral or ethical imperative based on personal values. In other words, in the context of value, ESG factors are always relevant, but values, not so much.”
This doesn’t imply plan fiduciaries are prohibited from responding to ESG concerns in a manner that achieves certain goals. “Investors who take ESG factors into account have often urged companies to address poor labour and human rights practices, climate change, improve health safety and environmental records or promote racial or gender diversity. And that’s perfectly legal, as long as the primary motivation is to improve financial performance, improve sustainability in the short, medium or long term or to mitigate risk.”
Less is more
That said, there are certain circumstances in which the pursuit of non-economic goals as part of a pension fund investment strategy may be allowable.
While Bauslaugh notes these are relatively rare, he cites five instances: sponsors of defined contribution plans in which members can choose their own investments may provide a choice of SRI funds to these members; fiduciaries must consider SRI if the plan documents specifically direct them to take moral or ethical factors into account; fiduciaries can use an SRI policy as a lens through which they seek to implement a policy on ethical, moral or socially responsible investment, as long as the financial interests of the beneficiaries remain paramount and the investment policy follows the appropriate legal standards of care; non-economic goals can be used as tie-breakers in the choice of investments where economic factors are equal; and where the plan’s foundational documents allow the fiduciaries to conduct a vote or survey among members as to their preference for SRI investments. For the latter, Bauslaugh cautions that doing so will raise “practical and legal difficulties” if the result of the vote or survey isn’t unanimous.
In any event, Ontario law requires the disclosure of any ESG factors considered by fiduciaries. Here, Bauslaugh says less is more. “Fiduciaries should not be fettering, restricting or pre-guessing future context by detailed written statements or policies of what will and won’t be done. How fiduciaries deal with any ESG factor is a matter of discretion.”
Following recommendations on disclosure will most likely result in broad investment policy statements, he adds. “These statements should simply indicate that ESG factors are considered to evaluate the economic benefits of investments, to identify economically superior investments or to assess materiality to financial performance and risk in a way that informs decisions to buy, sell, retain, engage or pursue.”
It may also be useful for ESG disclosure to signal that the fund prefers investments in companies that try to report ESG risks and opportunities. “This approach will encourage efforts by issuers to provide more detailed ESG reporting and, ultimately, that will leave open a myriad of options that can respond reasonably to particular ESG factors and circumstances,” says Bauslaugh. “The actual action taken can then be documented to support the reasonableness of any fiduciary decision taken that either relies on or ignores ESG considerations.”
Julius Melnitzer is a Toronto-based freelance writer.