Investing and Corporate Performance Measurement Must Incorporate ESGs

How do you define “responsible investment” and what are the trends defining Canada’s responsible investing ecosystem?

Responsible investing (RI) refers to investments that incorporate environmental, social and governance (ESG) issues. There are numerous different strategies for incorporating ESG factors into investment decisions. These include: negative or exclusionary screening; positive screening or best in class; integration of ESG factors into traditional financial analysis; shareholder engagement; thematic ESG investing; norms-based screening; and impact investing, which refers to investments in organizations whose core business models are intentionally solving societal problems.

The rapid growth and development of RI in Canada is being driven largely by the growing business case. A company is more than just the numbers, so it’s becoming increasingly obvious that you cannot fully understand a business by looking at financial statements alone. You need to look at companies more holistically to understand the full scope of risks and opportunities they may be exposed to, and ESG analysis gives you a lens to do that.

“You cannot fully understand a business by looking at financial statements alone. You need to look at companies more holistically to understand the full scope of risks and opportunities they may be exposed to.”

Looking at a company’s ESG performance in addition to financial metrics provides a more complete picture of the company’s quality of management, which leads to more informed investment decisions. And when it comes to managing money, more informed decisions are better decisions. That’s why responsible investing is good for financial performance. A growing body of research from Harvard University, Carleton University, Morgan Stanley, MSCI, and others shows that responsible investment portfolios tend to perform just as well, if not better than traditional investments over the long term. Companies may be exposed to ESG risks and opportunities that don’t show up in their financial statements, and ESG analysis puts investors in a better position to manage their exposure.

For example, climate change and the drive for gender equality are two of the more prominent megatrends that are making RI an imperative for financial professionals. It’s well-known that women are hugely underrepresented in corporate leadership, occupying some 16% of all board seats of publicly traded companies. This has got to change – not only from a moral standpoint but also from a business perspective. A diversity of perspectives is good for a business.

“Climate change and the drive for gender equality are two of the more prominent megatrends that are making RI an imperative for financial professionals.”

And climate change is one of the biggest drivers of change in the world economy today. Governments are pricing carbon emissions, renewable energy costs are dropping, consumers are buying more sustainable products, and some oil companies are actually facing lawsuits related to climate change. Investors are recognizing that it would be reckless to ignore these issues.

How would you rank Canada’s financial service community’s performance in terms of supporting the RI sectors’ growth by educating clients and companies about its benefits?

Research has shown that the vast majority of Canadian retail investors would like their financial services provider to inform them about responsible investments. So we would like to see securities regulators making it mandatory for advisors to ask about their clients’ ESG preferences. This would be a huge catalyst for the growth of responsible investing in Canada.

In this vein, credit unions are taking big steps to provide their advisors with the skills and knowledge to offer responsible investment advice. Desjardins, Vancity, Kindred, Assiniboine and other credit unions are putting their investment teams through the RIA’s Responsible Investment Specialist program. Some institutions are also including questions about responsible investing in their client questionnaires as part of the “Know Your Client” process. These are important steps for engaging and educating clients around responsible investing.

I believe that if investors are given the option to invest responsibly, the vast majority will do so.  So that’s the tipping point: financial advisors should be required to ask their clients if they are interested in responsible investing. That’s the key ask I would make to regulators. If financial advisors were required to ask their clients about their ESG preferences, it would open the floodgates for responsible investing in the retail market.

“That’s the tipping point: financial advisors should be required to ask their clients if they are interested in responsible investing.”

Companies are increasingly recognizing the growing importance of ESG factors to investors. For example, Suncor has hired an ESG analyst within their investor relations department to address investor enquiries related to responsible investing. We are also seeing the stock exchanges and other bodies such as CPA Canada and the Canadian Investor Relations Institute taking steps to educate corporate issuers about the importance of ESG disclosures.

The government is starting to catch up. In 2018, the federal government launched Canada’s Expert Panel on Sustainable Finance to make recommendations for aligning Canada’s financial system with a sustainable future. This shows that the current administration is engaged in a positive way. The Panel will deliver their final report in Spring 2019. I suspect we will see some recommendations that will support the growth of RI in Canada.

How do Canadian companies rank in terms of disclosure and ESG transparency? What must be done to improve their performance in this respect?

There are ESG leaders and laggards in every sector. Following its review of climate-related disclosure practices in Canada in 2017, the Canadian Securities Administrators (CSA) announced plans to develop new guidance and initiatives to educate issuers about the disclosure of climate-related risks and opportunities. The CSA is also considering new disclosure requirements related to sustainability and other emerging risks such as cybersecurity. Progress in both of these areas could lead to major improvements in corporate performance on ESG disclosures and practices.

What is needed at the management and board level to ensure that a company identifies the right ESG metrics and impact goals?

Buy-in from the top is a powerful catalyst. CDPQ’s CEO Michael Sabia has turned his institution into the leading pension fund in North America on climate change. But there are more subtle examples as well. For example, BMO has provided climate training to its board of directors, making them knowledgeable about the Task Force on Climate-Related Financial Disclosures. Leadership from the top was the catalyst in both cases.

 What is your vision for Canada’s future economy?

I want to see a Canadian economy that is financed by responsible capital markets and aligned with a 1.5C warming scenario, and one in which there is a gender-balance in corporate leadership and people receive equal pay for equal work regardless of their gender or any other identifiers.