Even with new rules implemented in Ontario this year, the issue of environmental, social and governance (ESG) factors remains a tricky question for Canada’s pension plans as they face a lack of perfect clarity around the definition of what they entail.

That was definitely the experience of RBC’s defined contribution pension team as it tried to wrap its head around Ontario’s new ESG requirement. Under new rules implemented this year, Ontario’s pension plan administrators need to mention in their statement of investment policies and procedures whether they’ve incorporated ESG factors into the investment process and, if so, how and if not, why not.

Even though these are “seemingly easy questions,” they really aren’t, said Angela Lin-Reeve, portfolio manager, pension investments, at RBC, during Benefits Canada’s 2016 Benefits and Pension Summit in Toronto on March 31. “We had to get educated because this wasn’t an angle we were used to in evaluating investments,” she said, adding that the small size of her team — just two full-time employees — made things even more difficult.

Read: Ontario SIP&Ps: Plan administrators should pay attention

The most basic definition — environmental, social and governance factors that are relevant to an investment and might have a financial impact — still confuses pension plan sponsors, said Andrew Sweeney, institutional portfolio manager at Phillips Hager & North Investment Management, during the Benefits Canada event.

“It hasn’t helped anybody understand what ESG is,” he added.

If plan sponsors choose to answer yes to the question about ESG on their statement of investment policies and procedures, they have to meet additional disclosure requirements by listing the factors they considered, said Lin-Reeve. “The problem with listing factors was that there was no list of factors [provided by the government] and that could open you up to criticism for not including a factor.”

In those types of tricky situations, it helps employers to step back and try to understand what ESG is and isn’t, Andrew said.

Read: Should institutional investors divest from carbon?

ESG isn’t about socially responsible or ethical investing, nor does it have to be about screening out entire sectors such as alcohol, tobacco, guns and fossil fuels, he noted. “These are all relevant topics, but when we’re talking about ESG, we’re talking much more broadly than any of these areas.”

Instead of dropping companies from their portfolios, plan sponsors could simply confront them on ESG-related issues and urge them to improve their track record, Sweeney added. “You can engage with companies and be much more productive. . . . We don’t believe that shrinking the investment universe is helpful.”

But supporters of carbon divestment beg to differ. For example, 350.org, a global grassroots organization that calls on institutions to drop fossil fuels from their portfolios, says investors’ engagement efforts won’t be effective in terms of phasing out fossil fuels. The organization insists that it’s practically impossible to convince energy companies whose core business model relies on fossil fuels to completely abandon them.

The other important thing employers need to know about incorporating ESG factors is that it’s not a burden even though plan sponsors, particularly in Ontario, feel they’ve been forced into ESG, Sweeney said. “They view this almost a regulatory cost. But ESG can be a bigger positive.”

Incorporating ESG factors doesn’t come at the expense of strong investment returns and therefore doesn’t compromise plan sponsors’ fiduciary duties, said Sweeney. “The academic work seems to suggest ESG really is good business,” he said, referring to studies which show that using strong ESG standards lowers cost of capital for companies and leads to good share price performance.

Read: Beware of legal issues around Ontario’s pension regulator review

Once plan sponsors understand what ESG actually means and they decide to answer yes on the statement of investment policies and procedures, they can describe the ESG approach of the various asset management firms they use, Lin-Reeve advised.

That’s the route that RBC took after asking all of the asset managers it works with what their ESG policies were. RBC also decided that it wouldn’t impose any restrictions on managers to invest in a certain way, although it did ask them consider ESG risks, Lin-Reeve explained.

Copyright © 2019 Transcontinental Media G.P. Originally published on benefitscanada.com

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