Canada: DC SIPPs And ESG Factors – FSCO Investment Guidance Notes Provide Useful Information For Plan Administrators (Part II)

In Part I of this series, I discussed the Financial Services Commission of Ontario's (FSCO) Investment Guidance Note  IGN-003 which provides guidance on the preparation of a Statement of Investment Policies and Procedures (SIPP) for a member-directed defined contribution (DC) pension plan, in response to recent changes to federal pension standards legislation that is incorporated by reference into the Ontario pension standards legislation.

In this post, I will focus on FSCO Investment Guidance Note IGN-004, which provides guidance on the incorporation of environmental, social, and governance (ESG) factors into the SIPP.

Effective January 1, 2016, SIPPs for Ontario-registered pension plans will have to include information on whether ESG factors are incorporated into the SIPP and, if they are, how they are incorporated.  This requirement will be found in subsection 78(3) of the Pension Benefit Act (PBA) Regulations. 

The new regulation makes it clear that the incorporation of ESG factors into the investment decision-making process is not mandatory; an administrator may decide not to incorporate ESG factors into the investment selection process.   All administrators must now turn their minds to the issue, however.

The PBA Regulations do not contain a definition of ESG factors nor do they provide any further information on how ESG factors might be incorporated.  FSCO has therefore published IGN-004, which provides plan administrators with additional guidance in this regard.  IGN-004 describes ESG factors in high-level terms as follows:

  • Environmental – how a company or industry interacts with the physical environment;
  • Social – the impact of a company or industry on a community or society;
  • Governance – how companies or countries are governed.

The Investment Guidance Note describes two potential approaches to ESG factors.

  • The first focuses on the impact of ESG factors on an investment's financial performance over the short, medium, or long term.  (For example, the administrator may believe that, all other things being equal, a company with transparent and robust corporate governance policies is likely to financially out-perform a company with poor governance practices.)
  • Alternatively, investors can approach ESG factors from a moral or ethical perspective (for example, eschewing investments in companies involved in military arms production).

FSCO cautions administrators about adopting the latter approach, advising that the administrator's fiduciary duty requires that it act in the best interests of the plan members, and that the courts have typically equated members' best interests with their financial best interests.  The Investment Guidance Note suggests that administrators obtain legal advice before adopting such "ethical screens".

According to the Investment Guidance Note, each plan administrator must:

  • Decide whether or not to incorporate ESG factors into its investment policies and procedures; and
  • Establish and document its own views on what is meant by ESG factors.

If the administrator decides not to incorporate ESG factors, it must make a statement to that effect in the SIPP.  In addition, it may also wish to include a brief explanation of the rationale for its decision.

If the administrator decides to incorporate ESG factors, it must make a statement to that effect in the SIPP, and also include information on how ESG factors have been incorporated.  For example, the administrator may have decided to focus on certain factors (e.g., corporate governance) rather than all ESG factors.  The SIPP should contain sufficient information on the incorporation of ESG factors so that everyone involved in plan investments can comply with the SIPP in that regard.

As noted my previous blog post, all plan members, including retirees starting in 2017, must be sent written pension statements, which must now include information on whether and how ESG factors are incorporated into the SIPP, and information on how the individual can obtain a copy of the SIPP.  Administrators may therefore expect that plan members will have more questions about the plan's investments, including the incorporation of ESG factors, than they have in the past.

FSCO Investment Guidance Notes

FSCO has only recently begun publishing policies related to pension plan investments in the form of "Investment Guidance Notes".  Much like other FSCO policies, while they do not have the force of law, pension plan administrators are well-advised to follow them, as they represent FSCO's views on the proper application of the PBA and the PBA Regulations.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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