Introduction
What are regulators looking for?
Portfolio and fund management
Compliance
Marketing and disclosure
Regulatory standards for disclosure
Reference point: ESG disclosure in United States and Europe
Comment
The Ontario Securities Commission and the British Columbia Securities Commission are currently performing desk reviews of registrants identified as participants in environmental, social and governance (ESG) investing. Fund managers, portfolio managers and exempt market dealers should be prepared to respond on their ESG-related portfolio and fund management, and their compliance, marketing and disclosure practices. Misleading practices may result in regulatory enforcement action and investor claims for misrepresentation.
As retail and institutional investors continue to incorporate ESG factors into their investing philosophies, many new products and services purporting to meet investors' ESG needs have entered the market. The Canadian Securities Administrators (CSA) has kicked off an initiative whereby regulators such as the Ontario Securities Commission and the BC Securities Commission are conducting ongoing desk reviews or "sweeps" of the ESG practices of select investment fund managers, portfolio managers and exempt market dealers. These registrants have been identified as participants in ESG investing because they manage and/or offer ESG investment products or offer advisory services with an ESG element.
These reviews have generally focused on two areas:
- whether ESG factors have been integrated into the registrant's service offerings; and
- marketing practices and materials relating to a registrant's corporate brand, including marketing of key people and product lines.
What are regulators looking for?
Securities regulators wish to confirm that the representations registrants are making about the incorporation of ESG principles in their investment decision-making processes are consistent with their actual policies and procedures. Both continuous disclosure documents and marketing materials are being examined.
To do this, securities regulators have contacted registrants with a questionnaire seeking information on the following topics.
ESG investing
ESG investing relates to:
- information about ESG products that the registrant offers to clients and/or ESG concepts that it integrates into its investment process; and
- information on the features of ESG products that the registrant offers to clients, such as investment objectives, methods used to consider ESG issues, active ESG screens and percentage of portfolio holdings expected to adhere to ESG objectives and restrictions.
ESG principles and metrics
ESG principles and metrics relate to:
- information about specific ESG principles, such as the United Nations principles of responsible investment, to which the registrant adheres; and
- whether the registrant employs any quantitative or qualitative ESG metrics.
ESG firm framework
The ESG firm framework includes:
- information about the registrant's approach to applying ESG principles and metrics;
- whether a third-party vendor is used for ESG data, research or analysis;
- the nature of the registrant's ESG policies and procedures (including whether policies exist on active ownership and proxy voting); and
- the manner in which the registrant engages with issuers and industry groups on ESG-related matters.
ESG oversight framework
The ESG oversight framework includes:
- information about how the registrant conducts ESG compliance, including the personnel involved in ESG oversight;
- whether the registrant's board of directors receives reports of ESG compliance; and
- whether staff are trained and/or required to be accredited on ESG matters.
ESG marketing
ESG marketing includes:
- information about the types of marketing that the registrant uses to promote ESG investing;
- the degree of oversight applied to this marketing; and
- how alignment is ensured between marketing statements and the registrant's ESG processes, policies and procedures.
ESG disclosure
ESG disclosure involves information about the type, frequency and dissemination of the registrant's ESG disclosure, including whether educational materials about ESG investing are provided to interested investors.
In addition to this questionnaire, securities regulators are reviewing registrants' websites and other publicly available materials and may follow up with questions, regardless of whether the registrant is part of the broader desk review.
Regulatory standards for disclosure
In the absence of a standardised framework for ESG disclosure or even a standardised glossary of ESG terms, securities regulators are concerned about "greenwashing," which is when investors are misled or deceived about the environmentally responsible nature of a registrant's products, aims and policies. Securities regulators want to ensure that a registrant's marketing claims regarding ESG practices align with the registrant's actual portfolio management practices or fund investment objectives.
Although there is no specific standard regulating ESG disclosure, the CSA has existing tools to address this issue. In addition to the requirement in the National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations that all registrants must deal fairly, honestly and in good faith with their clients, there are specific rules that apply to marketing prospectus-qualified mutual funds:
- Paragraph 15.2(1)(a) of the National Instrument 81-102 Investment Funds (NI 81-102) states that sales communications must not be untrue or misleading.
- Section 13.1 of the Companion Policy to NI 81-102 lists some of the circumstances in which, in the view of the CSA, a sales communication would be misleading. An example of a misleading statement is one that lacks the explanations, qualifications, limitations or other statements that are necessary or appropriate to make the statement not misleading.
- The OSC Staff Notice 81-720 Report on Staff's Continuous Disclosure Review of Sales Communications by Investment Funds states that sales communications should not contain statements that are vague, exaggerated or that cannot be verified.
In addition to the risk of regulatory enforcement action from misleading marketing materials, ESG claims in fund disclosure documents (such as prospectuses and offering memoranda) that do not correspond with actual portfolio management activities may expose a fund manager to investor claims for misrepresentation. Disclosure documents should be closely reviewed to confirm the manager has accurately described the ESG philosophy and process used by the fund. Further, managers may wish to consider ESG risk disclosure, explaining that their view of ESG may not align with the view of all investors and that the manager's ESG screens may eliminate investments that could outperform investments that satisfy the screening requirements.
Reference point: ESG disclosure in United States and Europe
The US Securities and Exchange Commission (SEC) has conducted a similar "green" sweep. The SEC has examined whether US-based investment firms are accurately disclosing their ESG investing approaches and whether they have implemented policies, procedures and practices that align with their ESG-related disclosure. These findings are a helpful indicator of what Canadian securities regulators may find favourable or unfavourable in their ESG reviews.
The European Union also took a step closer to harmonising its framework for ESG disclosure when Level 1 of the Sustainable Finance Disclosure Regulation (SFDR) came into effect on 10 March 2021, and Level 2 was phased-in on 1 January 2022. ESG disclosure mandated by the SFDR may help Canadian registrants understand regulatory expectations and provide a useful reference point for developing an ESG compliance regime in Canada.
The key takeaways are the following:
- Canadian securities regulators are reviewing registrants' ESG disclosure and marketing materials to ensure that they are consistent with registrants' actual ESG policies and practices.
- Disclosure that could potentially mislead investors into believing that a registrant's ESG policies and procedures are more stringent or effective than they actually are could expose that registrant to regulatory enforcement and potential liability for investor claims of misrepresentation.
- All registrants that participate in ESG investing need to ensure that they have clearly defined ESG policies and principles and that their disclosure documents and marketing materials align with these policies and principles.
For further information on this topic please contact Lynn McGrade, Kathryn M Fuller or John P Stanley at Borden Ladner Gervais LLP by telephone (+1 416 367 6000) or email ([email protected], [email protected] or [email protected]). The Borden Ladner Gervais LLP website can be accessed at www.blg.com.
Sienne Lau assisted in the preparation of this article.