On January 19, 2022, the Canadian Securities Administrators (CSA) published CSA Staff Notice 81-334 (the "Staff Notice") to provide guidance to investment funds (funds) relating to environmental, social and governance (ESG) disclosure. According to the CSA, the Staff Notice is intended to clarify and explain how existing regulatory requirements apply to ESG-related fund disclosure, without creating any new obligations. The Staff Notice also provides best practices that "would enhance ESG-related disclosure and sales communications."
In publishing the Staff Notice, the CSA note the considerable growth in interest among Canadian institutional and retail investors in ESG investing. According to the Staff Notice, the value of "sustainable funds" in Canada increased 160% in the year previous to the first quarter of 2021, to $18 billion. In light of the increased interest in such investments, the Staff Notice cites the potential for "greenwashing", whereby a fund's disclosure misleads investors about the ESG aspects of the fund.
ESG-Related Terms and Strategies
The Staff Notice begins by providing an outline of common terms used by funds that reference ESG factors in their investment objectives, or that use ESG strategies (ESG-related funds), as well as the factors that funds may consider in their investment decision-making process. For example, environmental considerations that may affect a fund's investment decisions may include such things as air and water pollution, deforestation, or water scarcity. Social considerations may include human rights, labour standards, or indigenous inclusion and reconciliation. Meanwhile, governance considerations may include whistleblower schemes, board diversity or executive compensation.
The Staff Notice also outlines common ESG strategies employed by ESG-related funds. For example, funds may use negative screening to exclude certain companies from its portfolio, strive to invest in companies that exceed certain ESG benchmarks (sometimes referred to as positive screening) or use proxy voting to vote on shareholder resolutions based on ESG considerations.
Domestic and International Developments
The Staff Notice outlines the recent International Organization of Securities Commissions (IOSCO) report setting out recommendations for policymakers and regulators to improve sustainability-related policies and practices. IOSCO's report, published in November 2021, specifically outlines a number of recommendations relating to product disclosure requirements, supervision and enforcement, and investor education.
The Staff Notice also discusses findings and observations arising from a continuous disclosure review by CSA staff of funds marketing themselves as ESG-related funds. This disclosure review included 32 funds managed by 23 fund managers, with CSA staff reviewing, among other things, each fund's prospectus, fund facts or ETF facts document, and sales communications.
The CSA made a number of observations as a result of the disclosure review, including that (i) some funds using a negative screening investment strategy did not adequately explain the factors used to screen prospective investments; (ii) while over half of the funds reviewed used a proxy voting strategy, many of the funds did not disclose this in their investment strategies; and (iii) about 75% of the funds reviewed did not report on changes to the composition of their investment portfolios as a result of ESG-related aspects of their investment objectives and investment strategies.
Ultimately, the review led the CSA to conclude that clarification was needed on how existing disclosure requirements apply to ESG-related Funds.
Guidance
In light of the findings of the disclosure review, as well as the IOSCO recommendations, the Staff Notice provides guidance on how existing disclosure regulations apply to ESG-related funds, including in respect of the following:
- Investment objectives and fund names. According to the Staff Notice, to prevent greenwashing, the fund's name and description of investment objectives should "accurately reflect the extent to which the fund is focused on ESG";
- Fund types. The CSA note that while not required, a fund may want to, where relevant, identify itself as a fund that focuses on ESG in addition to its primary fund type (i.e. an ESG Canadian equity fund, ESG Global equity fund, etc.);
- Disclosure of investment strategies. The requirement that a fund's prospectus disclose its investment objectives and processes applies to ESG-related objectives and strategies. As such, a fund is required to provide adequate disclosure about the ESG-related aspects of its investment strategies and selection process;
- Proxy voting and shareholder engagement. Where a fund uses proxy voting as an ESG investment strategy, the fund must include a summary of the ESG aspects of the proxy voting policies and procedures. While funds are not required to disclose their shareholder engagement policies, the Staff Notice encourages funds to provide transparency in regards to the scope and nature of shareholder engagement as an ESG strategy.
- Risk disclosure. Funds should consider whether there are material risks associated with its ESG strategies and disclose where applicable. Such ESG-related risks may include concentration risk and the risk of underperformance due to the fund's ESG focus or reliance on third-party ESG ratings.
- Suitability. According to the CSA, a fund's suitability statement should "accurately reflect the extent of the fund's focus on ESG" and where applicable the specific aspects of ESG on which the fund focuses. Where appropriate, the suitability statement may state that the fund is suitable for ESG-focused investors, provided such statement accurately reflects the ESG aspects of that fund.
- Continuous disclosure. A fund's annual and interim management reports of fund performance must, among other things, disclose how the fund's portfolio composition, and changes to composition, relate to the fund's ESG-related investment strategies and objectives. Further, as funds with ESG-related objectives will also aim for ESG-related outcomes, the Staff Notice encourages funds to disclose performance indicators towards achieving the outcomes.
- Sales communications. CSA Staff consider sales communications that fail to accurately reflect the extent to which a fund is focused on ESG, as well as the particular ESG aspect(s) the fund focuses on, to be misleading. According to the Staff Notice, examples of misleading disclosure may include suggesting that a fund is focused on ESG when it is not, misrepresenting the extent and nature of the fund's use of ESG strategies, and making inaccurate claims about the fund's ESG performance or results. Further, guidance is provided related to accurately providing fund-level ESG ratings, scores or rankings.
- ESG-related changes to existing funds. A change in a fund's name to reference ESG factors should result in a corresponding change of fundamental investment objectives (which will require prior securityholder approval); and
- ESG-related terminology. Funds using ESG-related terms that are not commonly understood should clearly explain the terms in plain language.
According to the Staff Notice, the CSA intend to continue monitoring disclosure documents and marketing materials and consider "future policy initiatives" as appropriate. For more information, see CSA Staff Notice 81-34 ESG-Related Investment Fund Disclosure.
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.