ESG considerations are playing an increasingly important role across Canadian companies’ functions. This includes at the board level where directors are tasked with overseeing ESG-related risks and opportunities, or at the operational level where management is dealing with matters such as supply chain management.
As a result, ESG disclosure – whether mandatory or voluntary – by Canadian public companies is becoming a norm demanded by institutional investors in Canada and around the world as they decide where they will allocate their investment capital.
MANDATORY ESG DISCLOSURE
Under Canadian securities legislation, disclosure requirements around governance are well known but there are no specific requirements mandating environmental & social-related (E&S-related) disclosure. Rather, issuers must disclose in a meaningful way material information in their continuous disclosure documents, including information that, if omitted or misstated, would likely influence a reasonable investor’s decision to buy, sell or hold a security. This requirement applies to E&S information as it would to any other information.
In recent years, the Canadian Securities Administrators (CSA) has published guidance to assist issuers in determining what environmental information is material and should be disclosed in their continuous disclosure documents. The guidance lists the following guiding principles for determining materiality, which the CSA notes can also apply to non-environmental information:
- No bright-line test – There is no quantitative threshold at which information becomes material, and qualifying materiality varies by industry, issuer and context. Issuers should consider both quantitative and qualitative factors in determining materiality
- Context – The materiality of certain facts and information should be considered in light of all available information, not in a silo
- Timing – Issuers should consider when the impact of such information will occur and whether early disclosure is warranted
- Trends, demands, commitments, events and uncertainties – Issuers should consider the probability that any trends, demands, commitments, events or uncertainties will occur and the anticipated magnitude of such impacts
- Err on the side of materiality – If there is any doubt as to whether information is material, issuers are encouraged to err on the side of materiality and disclose the information.
In a management’s discussion and analysis (MD&A), for example, an issuer must disclose material information that may not be fully reflected in its financial statements, and trends and risks that are reasonably likely to affect the issuer’s future performance. Trends relating to consumer preference, supply chain management, availability and price of carbon credits or offsets are examples of E&S information that may be considered and may require disclosure in a MD&A.
In an annual information form (AIF) an issuer must describe, among other things, risk factors relating to the company and its business most likely to influence an investor’s decision to purchase securities of the company and what E&S policies have been implemented that are fundamental to its operations. Climate-change risks – such as potential exposure to effects of extreme weather patterns, emissions-limiting regulations, the transition to a low-carbon economy – and risks associated with modern slavery are examples of such potential risks that may require disclosure if considered material.
The guidance also reminds issuers that forward-looking information regarding environmental matters, whether disclosed in continuous disclosure documents or in voluntary reports and on websites, may be subject to securities legislation. Forward-looking information might be expressed as targets, goals, projections, possible events or results of operations, and includes future-oriented financial information (FOFI).
When the forward-looking information disclosed is material, reporting issuers must include certain details, including the material risk factors that could cause actual results to differ materially from the forward-looking information and the material factors or assumptions that were used to develop the forward-looking information. If such information is FOFI, additional requirements will apply.
The social issue of modern slavery was the subject of a notice issued by Québec’s securities commission – the Autorité des marches financiers (AMF) – to provide guidance to issuers on existing disclosure requirements with respect to modern slavery. The notice indicates that this social issue particularly impacts the construction, manufacturing, entertainment and agricultural industries.
Similar to the CSA’s guidance, the AMF’s notice indicates that it does not modify existing legal requirements nor create new ones; it focuses on materiality, assessed in light of the reasonable investor, as the test for risk-factor disclosure in the MD&A. The AMF notes that an issuer could face litigation risks, regulatory risks, reputational risks and operational risks in regard to modern slavery that may have to be discussed in continuous disclosure documents.
The AMF also notes that when carrying out their oversight duties, boards of directors as well as audit committees and certifying officers ‘should examine, among other things, management’s assessment of the materiality of issues related to modern slavery and satisfy themselves that the disclosure provided in the documents filed under securities regulation is consistent with that assessment.’
On October 29, 2020, Bill S-216, An Act to Enact the Modern Slavery Act and to amend the Customs Tariff was introduced to the Senate of Canada for its first reading. If passed, the bill will enact Canada’s first modern slavery disclosure legislation, which would impose supply-chain reporting requirements with respect to forced or child labor on an entity that:
- Is listed on a Canadian stock exchange
- Has a place of business in Canada, does business in Canada or has assets in Canada and this entity meets certain financial and employment criteria, or
- Is prescribed by regulations, and that:
- Produces or sells goods in Canada or elsewhere
- Imports into Canada goods produced outside Canada, or
- Controls an entity engaged in any activity described in (i) or (ii).
The bill also provides for enforcement mechanisms in the event that such entities do not comply with the reporting requirements.
Issuers should also be aware that Toronto Stock Exchange (TSX) and the TSX Venture Exchange have adopted policies regarding timely disclosure that are in addition to their obligations under securities legislation. In August 2020 TSX released an updated version of its Primer for Environmental & Social Disclosure, which provides information on these policies in addition to other resources intended for issuers seeking to start or enhance their E&S disclosure.
Finally, Bill C-97, which received Royal Assent in 2019, introduced amendments to the Canada Business Corporations Act that will require boards to disclose certain social information to its shareholders. This includes information relating to diversity on the board and in senior management roles, as well as the well-being of employees, retirees and pensioners, and certain governance information dealing with remuneration clawbacks. At time of writing, these amendments had not yet come into force.
VOLUNTARY ESG DISCLOSURE
Many companies, both public and private, choose to publicly disclose a broad range of ESG information in different forms, including in annual sustainability reports or on company websites. Voluntary ESG disclosure can provide valuable information to a company’s stakeholders including consumers, the communities in which they operate and investors.
Public issuers should be aware, however, that such disclosure does not replace the need to make mandatory disclosure in their continuous disclosure documents as required by securities legislation and that, as noted in the previous section, such information may be subject to securities legislation regarding forward-looking information.
When making voluntary ESG disclosure, issuers should therefore consider whether: (i) the disclosure contains any forward-looking information and (ii) whether any of the information disclosed consists of material information that is required to be included in its continuing disclosure documents, including in an MD&A or AIF.
In addition, issuers should ensure consistency and accuracy of ESG-related information across all documents, including voluntary reporting and mandatory continuous disclosure documents, and be cognizant that any misrepresentations of ESG-related information in voluntary (as well as mandatory) disclosures are subject to potential civil liability for secondary market disclosure.
The CSA’s guidance recommends that boards and management have a robust process to review voluntary disclosure prior to dissemination to the public to ensure the information is reliable and accurate. ESG disclosure should be supported by fact and data and not be overly aspirational. Disclaimers are also critically important. In addition, when making investor-facing E&S disclosures, issuers may want to consider the following recommendations made by the Canadian Coalition for Good Governance in The Directors’ E&S Guidebook:
- Convey key considerations related to governance, strategy and risk management with a level of detail, context, supporting information and metrics based on the perspectives and needs of investors
- Establish E&S metrics that are clear, measurable, forward-looking and comparable. There are several widely accepted rubrics that companies can use for guidance
- Describe the reporting framework chosen, and the rationale, in the corporate reporting. This is advisable with both mandatory and voluntary reporting
- Ensure some level of board accountability where the E&S reporting is separate from financial reporting. At a minimum, approval for E&S reporting should be under the mandate of the board committee charged with the E&S oversight, and the board should have controls in place to provide reasonable verification and assurance of the facts and assumptions relied on by management in preparing the reports.
POTENTIAL LIABILITY AND RELATED RISKS
Issuers may face legal challenges regarding their decisions about whether and how they make ESG disclosures, both mandatory and voluntary. In addition to the risk of losing a lawsuit and being ordered to pay damages, simply defending a claim will cost an issuer time and money. Further, the attention that litigation can attract may be considerable and can contribute to reputational damage for the issuer.
Issuers should, therefore, take care to make informed decisions when determining what information to disclose and how it will be done. Building on the AMF’s comment in its notice about the oversight duties of boards, audit committees and certifying officers, issuers may wish to consider implementing sufficient internal controls (and perhaps external assurances) to ensure ESG disclosure made in mandatory or voluntary disclosure documents are reviewed for accuracy and consistency.
Examples of E&S-related claims and complaints made against companies in jurisdictions outside Canada may shed light on the types of claims that might be brought in Canada under securities law. One such example is the action brought by the New York attorney general against Exxon Mobil in 2018, in which it was argued that the company had materially misrepresented and omitted information from its public disclosure documents regarding how it accounted for climate change risks.
Following a 12-day trial and testimony from 18 witnesses, the court dismissed the action finding that the Office of the Attorney General ‘failed to prove, by a preponderance of the evidence, that Exxon Mobil made any material misstatements or omissions about its practices and procedures that misled any reasonable investor.’
As investors increasingly come to view E&S information as material to their decision-making, litigation in this area will likely also increase, and this decision leaves open the possibility that such a claim could succeed in the future on different facts.
Although the 2007 securities class action case Kerr v Danier Leather Inc dealt with financial forecasting in a prospectus, it also is relevant in the context of ESG disclosure. In its unanimous 2007 judgment, the Supreme Court of Canada concluded that ‘while forecasting is a matter of business judgment, disclosure is a matter of legal obligation. The business judgment rule is a concept well-developed in the context of business decisions but should not be used to qualify or undermine the duty of disclosure.’ Thus, directors should be aware that their decisions about disclosure, including regarding ESG disclosure, will not be protected by the business judgment rule.
INCREASING FOCUS ON ESG DISCLOSURE
In 2020 and continuing in 2021, large institutional investors such as BlackRock and State Street Global Advisors, the International Business Council of the World Economic Forum and, in the Canadian context, leading pension plan investment managers, have recognized the importance of ESG-related disclosure. In many cases they have called for improved and more robust ESG disclosure and have endorsed reporting standards and frameworks such as those of SASB and TCFD.
For example, BlackRock CEO Larry Fink in his January 2020 annual letter to CEOs stated: ‘We believe that all investors, along with regulators, insurers and the public, need a clearer picture of how companies are managing sustainability-related questions... Each company’s prospects for growth are inextricable from its ability to operate sustainably and serve its full set of stakeholders.’
He went further to state that ‘[BlackRock] will be increasingly disposed to vote against management and board directors when companies are not making sufficient progress on sustainability-related disclosures and the business practices and plans underlying them.’
In his 2021 annual letter to CEOs, Fink strengthened his call for specific disclosure on how a company’s business model will be compatible with a net-zero economy, specifically requesting companies to ‘disclose how this plan is incorporated into your long-term strategy and reviewed by your board of directors.’
In November 2020 the CEOs of eight leading Canadian pension plan investment managers representing a combined roughly C$1.6 tn ($1.3 tn) of assets under management issued a joint statement calling on companies and investors to provide ‘consistent and complete’ ESG information in order to ‘strengthen investment decision-making and better assess and manage their collective ESG risk exposures.’ They stated that they will ‘allocate capital to investments best placed to deliver long-term sustainable value creation.’
In January 2021 Ontario’s Capital Markets Modernization Taskforce issued its final report, including a recommendation mandating disclosure of material ESG information, ‘specifically climate change-related disclosure that is compliant with the TCFD recommendations for issuers through regulatory filing requirements of the [Ontario Securities Commission].’ The taskforce also recommends a phased-approach to implement this new requirement based on an issuer’s market cap and encourages the CSA to implement a similar requirement across Canada.
Leading proxy advisory firms have also updated their Canadian voting guidelines for 2021 and beyond placing greater emphasis on ESG considerations. For example, Glass Lewis’ Canadian guidelines for 2021 onwards include a new focus on board oversight relating to ESG issues. Starting this year, Glass Lewis will note a concern when boards of companies listed in the S&P/TSX 60 index do not provide clear disclosure concerning board-level oversight given to E&S issues. In 2022 it will generally recommend withholding votes from the chair of the governance committee of companies that fail to provide such disclosure.
It will also examine a company’s proxy statement and governing documents, such as its committee charters, to determine whether directors maintain a meaningful level of oversight of, and accountability for, a company’s ESG-related impacts and risks.
Similarly, ISS has added ‘demonstrably poor risk oversight of environmental and social issues, including climate change’ to its list of examples of failure of risk oversight. ISS generally recommends voting against or withholding votes from individual directors, committees or the entire board under extraordinary circumstances where there has been, among other things, ‘material failures of governance, stewardship, risk oversight or fiduciary responsibilities at the company.’
Stephen Erlichman is a partner and Sophie Langlois is an associate with Fasken
