In 1996, the Social Investment Organization (now the Responsible Investment Association) partnered with other responsible investment institutions to establish the Active Shareholder Working Group (ASWG). Working quietly and behind the scenes, the ASWG was set up to kick-start the use of shareholder proposals in Canada.[1] At that time, the largest socially responsible mutual fund at the time believed that proposals were made impossible by the Canada Business Corporations Act (CBCA) as the law allowed companies to exclude proposals filed “primarily for the purpose of promoting general economic, political, racial, religious, social or similar causes.”
The ASWG targeted a Canadian mining company experiencing significant environmental challenges. A proposal was designed to closely link the company’s environmental performance to its financial performance and outlook. The expectation was that the company would exclude the proposal from the information circular. At that point, the group would take the company to court and force the inclusion of the proposal in its proxy. All this, it was believed, would establish a precedent and drive home the point that environmental issues were material to financial performance. This, it was hoped, would open the floodgates for active engagement and shareholder proposals in Canada.
The proposal was filed but the rug was pulled out from under this grand plan when the company agreed to circulate the proposal - implicitly acknowledging the material impact of its environmental challenges on its financial performance. A loss to the ASWG on the one hand. A victory on the other.
Twenty years later, ESG investing is booming. Over the years, various laws have been identified as barriers to the consideration of ESG issues and revised as regulatory agencies have become increasingly convinced of their materiality. The country's largest institutional investors are moving ESG issues to the centre of their investment strategies and now run active engagement teams who are not shy about filing proposals when necessary. This is not done out of the goodness of their hearts. It is done because ESG issues are deemed material to the investment process.
Mission accomplished? Well, not in all markets. In the US, the Department of Labor (DoL) is today, in 2020, advancing a proposal that would send a deep chill over pension plans governed by Employee Retirement Income Security Act (ERISA), placing ESG squarely in a non-financial, non-material bucket. Under the proposal, plan trustees seeking to place ESG investing options on pension platforms will need to justify and document how consideration of ESG issues will not be a hindrance to financial performance. Trustees failing to justify the use of ESG products to the satisfaction of the DoL could be found in violation of their fiduciary duty to plan beneficiaries.[2]
The framing of the proposal utterly ignores the performance evidence on hand and modern thinking on investment risk mitigation beyond diversification. The performance of ESG funds is compelling to the point where the Chartered Financial Analysts (CFA) Institute has acknowledged: “the consideration of relevant and material ESG information and risks is consistent with an asset manager’s fiduciary duty and is required [emphasis added] for investment professionals who adhere to the CFA Institute Standards of Professional Conduct.” The Institute is now embarked upon a project to establish standards for ESG disclosure.[3]
The DoL also ignores 15 years of legal opinion on fiduciary duty. Starting with the 2005 and 2007 Freshfields Reports and followed by the Fiduciary Duty in the 21st Century Report by the UNEP FI and PRI , the legal community has repeatedly and in markets around the world concluded: ESG issues are material; the failure to acknowledge and manage that materiality represents a breach of fiduciary duty. Trustees could be sued.[4]
The proposed regulation and the DoL framing of ESG investing are astonishing. Almost twenty-five years ago, a beleaguered, underperforming mining company acknowledged the materiality of ESG issues. Since that time, much water has passed under the bridge. It is difficult to know how to deal with the archaic views now in play south of the border. But many are trying.
Thought leaders, academics and market intermediaries in the US have expressed their opposition during the comment period in the strongest terms noting the proposed regulation “is wrong in its assumptions about what ESG is, wrong about the cost of the proposed regulation, would impoverish Americans saving for retirement, is out of step with both foreign regulators and the capital markets, ignores facts about ESG performance, is wrong about costs of ESG products, ignores the pecuniary benefits of ESG products to plan fiduciaries, would cause plan fiduciaries to violate their duty of care by placing an impost to their examination of systematic risks and opportunities which will determine 75%-95% of return, and ignores the duty of impartiality.”[5]
The International Corporate Governance Network (ICGN), a membership-based organization consisting of the world’s largest pension funds and investment managers with more than US$54 trillion in assets, has piled on, arguing that the DoL logic is backward: The DoL "...should instead ask investors who do not use ESG information to explain why this will not impact their returns. In our view at ICGN, particularly for long-term investment strategies, we believe it is a breach of fiduciary duty if investors do not take ESG into account.” The ICGN submission notes that global investors make up roughly 35% of the S&P 500 and characterizes the DoL position as cynical and willfully ignorant.[6]
Well, then, it’s on. A clash of titans. The DoL regulation, if adopted, would put the US completely out of step with the now accepted conceptions of fiduciary duty and how investment managers are professionally obligated to address ESG issues. Let’s see how the DoL responds.
While we don’t face anything like the DoL proposed regulation in Canada, the debate south of the border does present some questions Canadians should be asking. Do we have sufficient clarity on ESG and fiduciary duty? Are fiduciaries on this side of the border still confused and uncertain? Are they simply permitted to examine ESG information or do they now have a positive obligation to acknowledge, review and incorporate into their decision-making? If further clarification is needed, will this happen through consultation and regulation? Or do we need a legal strategy and litigation as was planned almost a quarter-century ago?
[1] Share, “The Promotion of Active Shareholdership for Corporate Social Responsibility in Canada”, (November 1996)
[2] Gov Info, Federal Register Volume 85, Issue 126 (June 30, 2020)
[3] CFA Institute, “ESG Disclosure Standards for Investment Product”, (August 2020)
[4] Fiduciary Duty 21 Org, “Fiduciary Duty in the 21st Century”
[5] Jon Lukomnik, “Comment Letter on Proposed Regulation of ESG Standards in ERISA Plans”, Harvard Law School Forum on Corporate Governance, (July 21, 2020)
[6] Karrie Waring (CEO of International Corporate Governance Network), letter to Office of Regulations and Interpretations, “IGCN Response to the Department of Labour proposal on Financial Factors in Selecting Plan Investment Proposed Regulations: RIN 1210-AB95”, (29 July, 2020)