The Financial Services Commission of Ontario (FSCO) published Investment Guidance Note — IGN-004 Environmental, Social and Governance (ESG) Factors on October 21, 2015 (Note). The purpose of the Note is to provide information and guidelines to administrators of Ontario registered pension plans to meet the requirements under section 78(3) of Regulation 909 under the Pension Benefits Act (Ontario) (the PBA) which comes into force on January 1, 2016, to include information in a pension plan's statement of investment policies and procedures (the SIPP) as to whether ESG factors are incorporated into the plan's investment policies and procedures and, if so, how those factors are incorporated.
A draft version of the Note had been released for public consultation on June 30, 2015 with the comment period closing August 28, 2015. Investment guidance notes are issued by FSCO from time to time to set out FSCO's expectations of plan administrators relating to the investment of pension plan assets, and the administrators investment-related obligations under the PBA and Regulation 909 thereunder.
These new requirements are set against the increasing recognition that investment decision-making must consider a range of relevant factors beyond those typically enumerated in traditional securities analysis and portfolio management.1
FSCO's guidance makes it clear that all investment decisions made by the administrator (or its delegates), including whether to incorporate ESG factors, must be made in accordance with the administrator's fiduciary duties. In contrast to the draft released in June 2015, that offered no definition of ESG factors, FSCO makes some small attempt by stating in the Note that "ESG Factors" can be described "as a broad term that encompasses a wide range of environmental, social and governance factors. Environmental factors relate to a company or industry's interactions with the physical environment, social factors concern the social impact of a company and/or industry on a community or society, and governance factors typically relate to how companies and/or countries are governed."
As with its earlier version, the Note outlines two approaches, considered at opposite ends of the spectrum, to incorporating ESG factors into investment policies and procedures. One approach involves integrating ESG factors into fundamental investment analysis to the extent that they are "relevant" to investment performance. This approach sees ESG factors as among the many factors that may impact the investment performance of an asset. It is interesting to highlight that FSCO deleted the word "material" from the earlier draft inserting "relevant" in its place, stating that "it is up to the administrator as fiduciary to evaluate which factors are relevant and how to take them into account." Materiality, and in particular, whether an ESG factor is financially material to the performance of an investment over time is often cited as a useful way to frame whether an ESG factor is included in investment practices and processes.
The second approach is to incorporate ESG factors into the investment process from an ethical or moral perspective by using, for example, ethical screens. FSCO cautions that the best interests of plan beneficiaries has traditionally been defined by the courts in terms of the beneficiaries' financial interests, with the result that there is a potential conflict with investing with other goals in mind, such as ethical or moral considerations. FSCO encourages an administrator considering such an approach to consult with its legal counsel.
It is FSCO's expectation that the administrator, after consulting with a plan's trustees, investment committee and/or investment advisers, as appropriate, will by January 1, 2016:
- establish and document (in minutes of the meeting(s) where the issue was discussed, or in an internal memorandum) its own view or understanding on what is meant by ESG factors; and
- consider whether it will incorporate ESG factors and document the basis for its decision.
Once this process is completed the administrator must state in the SIPP that it has decided not to incorporate ESG factors into its investment policies and procedures (if this is the case). The support/rationale for the decision could also be included.
If the administrator decides to incorporate ESG factors into its investment policies and procedures, a statement to that effect must be made in the SIPP together with information on how those factors have been incorporated. In a tip of hat to a less prescriptive approach, the Note deletes the words "description as to [how]" using the words "information on [how]" in their place. Additionally FSCO expects a listing of all ESG factors that are incorporated or a broad statement that all ESG factors are incorporated. Investment managers may be consulted and provide assistance in drafting this language but caution is advised. FSCO states that it will interpret general references to incorporating ESG factors as including the broadest range of ESG factors. It may be more helpful to focus on specific factors within an ESG category — for example, shareholder rights within "Governance", or labour relations within "Social".
FSCO also expects an explanation of the approach taken by the plan to incorporate ESG factors as well as a description of the scope of the application of ESG factors (for example, should the factors be considered across the entire pension fund or only certain portions of the pension fund).
While the changes are not effective until January 1, 2016, for pension plans currently registered in Ontario, the SIPP must be filed with FSCO within 60 days of January 1, 2016. For plans registered after January 1, 2016 the SIPP must be filed within 60 days after registration. Any amendments that are made to the SIPP must be filed with FSCO 60 days after the amendment is made.
Effective July 1, 2016, member, former member and retiree statements must include a statement that the administrator of the pension plan must establish a SIPP that contains information about whether ESG factors are incorporated into the SIPP and, if so, how those factors are incorporated.
1. Articulated in papers published by, among others, the UNEP Finance Initiative, PRI Association and UK Law Commission. Please also see the United States Department of Labor's Interpretive Bulletin IB 2015-01 Relating to the Fiduciary Standard under ERISA in Considering Economically Targeted Investments released on October 26, 2015.
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