In review: Sustainable disclosure requirements and taxonomies in Canada

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Sustainable disclosure requirements and taxonomy

At the time of writing, there are limited legally mandated sustainability disclosure requirements. The principle legal requirements relate to mandatory diversity disclosure by public companies. For example, since 2014, companies listed on the Toronto Stock Exchange (TSX) have been required to make diversity-related disclosures in their annual disclosure documents on a 'comply or explain' basis, including:³⁷

1. on their policies and targets regarding the representation of women on the board of directors and in executive positions;
2. how representation of women is taken into account in selecting board and executive officer candidates;
3. gender representation on the board and in executive officer positions; and
4. term limits.

See also National Instrument 58-101 of the CSA Disclosure of Corporate Governance Practices.³⁸

Public corporations governed by the Canada Business Corporations Act have been required to make diversity-related disclosure regarding women, indigenous peoples, persons with disabilities and members of visible minorities (designated groups) since 2020 on a comply or explain basis.³⁹ These requirements include disclosure of term limits or other board renewal mechanisms, a description of written diversity policies for the selection of individuals from the designated groups as board nominees, and a description of progress made in achieving the policy's objectives, whether the level of representation of designated groups on the board or in senior management is considered in appointing new candidates, whether targets have been established for representation of the designated groups on the board and in senior management, as well as progress towards those targets, and the number of members of each of the designated groups on the board and in senior management. New guidelines for making this disclosure were published by Corporations Canada in February 2022.⁴⁰

Increasingly, governance ratings organisations and industry groups developing best practices are focusing on gender and other diversity measures as critical elements of measuring or rating corporate governance (see, for example, the Canadian Coalition for Good Governance and The Globe and Mail Board Games).

Through 2021, a series of reports and reviews were prepared by the Ontario Securities Commission, the CSA and Corporations Canada, focusing on board and senior management diversity data, term limits and targets, and looking at diversity based on gender, visible minorities, persons with disabilities and indigenous peoples, to provide the basis for consultation towards further regulatory changes. The CSA continue to consider whether the diversity disclosure model should move from comply or explain to mandatory quotas in order to accelerate increased diversity. Further proposals to change the current diversity disclosure framework will be coming.

On 18 October 2021, the CSA published a proposed National Instrument 51-107 Disclosure of Climate-Related Matters and its proposed Companion Policy 51-107CP (Climate Disclosure Proposals) for comment.⁴¹ The proposed instrument would apply to public companies in Canada, regardless of jurisdiction of incorporation. For TSX-listed corporations with 31 December year ends, the proposed rules would take effect for annual filings made in early 2024.

Canadian companies have started to make voluntary disclosure of climate-related matters following the various voluntary frameworks and standards. Companies have adopted different approaches to the location, style and content of their disclosure, and one of the stated aims of the CSA proposals is to bring some standardisation to the disclosure to allow greater comparability for investors.

The Climate Disclosure Proposals would require disclosure based on recommendations of the TCFD. The Climate Disclosure Proposals would require issuers to make disclosure in the following areas:

1. governance: describing the board's oversight of climate-related risks and opportunities and management's role in assessing and managing climate-related risks and opportunities;
2. strategy: describing any climate-related risks and opportunities identified over the short, medium and long term, and describing the impact of these risks and opportunities on its business, strategy and financial planning;
3. risk management: describing its processes for identifying, assessing and managing climate-related risks and how these processes are integrated into overall risk management; and
4. metrics and targets: describing its metrics used to assess climate-related risks and opportunities and targets used to manage these risks and opportunities.

The TCFD contemplates that issuers should disclose GHG emissions (Scope 1, 2 and 3). The Climate Disclosure Proposals would require issuers to make this disclosure or explain why they do not. The Climate Disclosure Proposals would not require issuers to disclose the resilience of their strategy with reference to various climate scenarios – a key element of the TCFD recommendations.

Subsequent to the release of the Canadian proposals, the US Securities and Exchange Commission (SEC) released its own proposal on the same disclosure area, and the International Sustainability Standards Board (ISSB) released two disclosure proposals on sustainability and climate change disclosure. Both the SEC's and the ISSB's proposals arguably go further than the CSA proposals in a number of areas. Since the Canadian capital markets are very integrated into the North American and global capital markets, it is generally expected that the CSA will seek to avoid creating a unique 'made in Canada' disclosure rule on climate-related matters and will finalise its proposal once there is clarity on the SEC and ISSB final requirements. The CSA is also likely to want to avoid being seen as a 'laggard' in this area by adopting less onerous disclosure requirements, except for some limited circumstances where the nature of Canada's capital markets clearly justifies that approach (e.g., to recognise the significant small public company venture start-up part of the Canadian capital markets). This anticipated approach means that the adoption and implementation schedules for the requirements are somewhat uncertain.

On 19 January 2022, the CSA released Staff Notice 81-334 ESG-Related Investment Fund Disclosure (Notice) to provide guidance on the disclosure practices of investment funds as they relate to ESG considerations.⁴² The issuance of the Notice follows a considerable increase in interest in ESG investing in Canada for both retail and institutional investors.

The CSA have emphasised that the guidance provided in the Notice is based on existing securities regulatory requirements and does not create any new legal requirements or modify existing ones. Rather, the Notice clarifies and explains how the current securities regulatory requirements apply to ESG-related investment fund disclosure, with the view of enhancing and bringing greater clarity to ESG-related disclosure and sales communications to enable investors to make more informed investment decisions.

i Key developments

An increase in ESG interest among investors, as well as the potential for 'greenwashing', whereby a fund's disclosure or marketing intentionally or inadvertently misleads investors about ESG-related aspects of the fund, are cited in the Notice as having led securities regulators and international organisations to directly address issues relating to ESG investing. Notably, the International Organization of Securities Commissions published a final report in November 2021, setting out recommendations for securities regulators and policymakers to improve sustainability-related practices, policies, procedures and disclosure in the asset management industry. In the same month, the CFA Institute published its Global ESG Disclosure Standards for Investment Products with the aim of providing greater transparency and comparability to investors by facilitating clear communication of ESG-related features of investment products from asset managers.

In Canada, the CSA have conducted continuous disclosure reviews of regulatory disclosure documents and sales communications of ESG-related funds. The findings of these reviews are summarised within the Notice. Although the CSA consider current disclosure requirements to be broad enough in scope to address ESG-related disclosure, in their view, additional guidance was needed to clarify how the current disclosure requirements apply to improve the quality of ESG-related disclosure and sales communications.

ii Guidance

The Notice sets out guidance on how existing securities regulatory requirements apply to investment funds as they relate to ESG considerations in the following areas.

Investment objectives and fund names

Under securities laws, an investment fund (in its prospectus) is required to disclose the fundamental investment objectives of the fund, as well as information that describes the fundamental distinguishing features of the fund. To prevent greenwashing, a fund's name and investment objectives should accurately reflect the extent to which the fund is focused on ESG and, where applicable, the particular ESG-related aspects the fund is focused on. To ensure consistency, where a fund's name references ESG, the fundamental investment objectives of the fund are required to reference the ESG-related aspect included in the name.

Fund types

Non-exchange traded mutual funds are required to identify the type of mutual fund that the fund is best characterised as in its prospectus. In the CSA's view, where a fund does not include ESG considerations in its investment objectives, it should not characterise itself as a fund focused on ESG, and, conversely, where ESG considerations are so included, a fund may characterise itself as a fund focused on ESG.

Investment strategies disclosure

The Notice sets out guidance in relation to investment strategies disclosure applicable to all funds and specific guidance applicable only to funds that use any of the following: (1) proxy voting or shareholder engagement as an ESG strategy; (2) multiple ESG strategies; and (3) ESG ratings, scores, indices or benchmarks.

Guidance applicable to all funds

An investment fund is required to provide full, true and plain disclosure of all material facts in its prospectus. To enable investors to understand the ways in which a fund will meet its ESG-related investment objectives, where applicable, and make investments, full, true and plain ESG-related investment strategies disclosure must be made. ESG strategies, if used either principally or as part of its investment selection process, require disclosure of the ESG-related aspects of the fund's investment selection process and strategies. Description of these strategies must be written using plain language.

Further, the CSA take the view that investment strategies disclosure should identify the ESG factors used and explain their respective meanings, as well as how they are evaluated and monitored.

Guidance applicable to certain funds only

Funds that use proxy voting or shareholder engagement as a strategy to select investments are required to disclose how they are used by the fund. In the CSA's view, disclosure should include the criteria used by the strategy, the goal of the strategy and the extent of the monitoring process used to evaluate progress towards such goal.

If multiple ESG strategies are used, disclosure explaining how the different strategies are applied during the investment selection process is required. In addition, if the strategies are not applied simultaneously, disclosure must include the order in which they are applied.

In the CSA's view, where an ESG-related fund uses ESG ratings, scores, indices or benchmarks as part of its principal investment strategies or investment selection process, disclosure in relation to how these ratings, scores, indices or benchmarks are used should be provided.

Proxy voting and shareholder engagement policies and procedures

An investment fund that uses proxy voting as an ESG investment strategy must include a summary of the ESG aspects of the fund's proxy voting policies and procedures in the fund's prospectus or annual information form, as applicable. Such inclusion can provide clarity about how voting rights will be used to further the fund's ESG-related investment objectives.

Further, the CSA encourage investment funds that use shareholder engagement as an ESG strategy to make their shareholder engagement policies and procedures publicly available to achieve greater transparency for investors.

Risk disclosure

In keeping with the requirement for a fund to disclose any material risks associated with an investment in the fund, the CSA encourage all investment funds to consider whether any material ESG-related risk factors are relevant to the fund and to disclose such risk factors, if applicable.

Suitability

As mentioned above, a fund's name and investment objectives should accurately reflect the extent to which the fund is focused on ESG. Similarly, the CSA highlight that brief statements of a fund's suitability for particular investors should also accurately reflect the extent of the fund's focus on ESG and any particular aspects of ESG that the fund is focused on.

Continuous disclosure

Funds that have ESG-related investment objectives can help prevent greenwashing by providing useful continuous disclosure that allows investors to monitor and evaluate the fund's ESG performance. ESG-related funds are required to disclose how the composition of the investment portfolio relates to the fund's ESG-related investment objectives or strategies, as applicable, in its management reports of fund performance. Further, the CSA encourage funds with a measurable ESG outcome to report whether the outcome is being achieved in the same reports. Investment fund managers are also encouraged to regularly assess, measure and monitor the ESG performance of the funds they manage, to ensure that useful disclosure is provided.

If a fund uses proxy voting as an ESG strategy to meet its ESG-related investment objectives, the fund is encouraged to include disclosure of all of the fund's annual proxy voting records on its websites, despite the current requirement that only the most recent annual proxy voting record be made available. The CSA take the view that such disclosure would provide greater transparency into how the fund has historically made use of proxy voting to meet its ESG considerations. For the same reason, funds that use shareholder engagement as an ESG strategy are also encouraged to provide disclosure of past shareholder engagement activities.

Sales communications

Sales communications containing ESG considerations must not be misleading or untrue and should be consistent with a fund's regulatory offering documents so as to not intentionally or inadvertently mislead investors about ESG-related aspects of the fund.

Sales communications indicating that a fund is focused on ESG

The extent to which a fund is focused on ESG should be accurately reflected in any sales communication pertaining to an investment fund. Further, the CSA believe that a fund should not indicate that it is focused on ESG in its sales communications unless ESG is referenced in its investment objectives.

Sales communications referencing a fund's ESG performance

A fund must not include misleading statements about ESG performance of the fund in its sales communications.

Sales communications including ESG ratings, scores or rankings

Similarly, sales communications that include fund-level ESG ratings, scores or rankings must not be misleading. In the Notice, the CSA provide specific guidance on how to avoid issues such as: (1) conflicts of interest involving the provider of the ESG rating, score or ranking; (2) cherry-picking ESG ratings, scores or rankings; (3) selecting ESG ratings, scores or rankings that are not representative of the ESG characteristics or performance of the fund; and (4) omission of necessary or appropriate explanations, qualifications or limitations.

ESG-related changes to existing funds

To the extent that any references to ESG are added or removed from the fundamental investment objectives of a fund, that fund will be subject to the requirement that approval of its security holders be obtained prior to the making of any change to the fund's fundamental investment objectives. If an investment fund changes its name to add or remove a reference to ESG, as mentioned above, similar consideration should be given to changing the fund's fundamental investment objectives.

ESG-related terminology

A fund's prospectus should provide a clear explanation of any ESG-related terms that are not commonly understood.

Investment fund manager-level commitments to ESG-related initiatives

If investment fund managers are signatories to certain international or regional ESG-related initiatives and publicly disclose this information, the CSA highlight the importance of clarifying that commitments to these initiatives are at the entity level, rather than at the fund level.