Fasken released its second annual study on ESG disclosure trends in Canadian corporate governance
Gordon Raman is the chair of Fasken’s ESG & sustainability practice. His practice also focuses on mergers and acquisitions, corporate governance and capital markets.
Fasken recently released its second annual study on ESG disclosure trends in Canadian corporate governance. The study also examines how law firms can help companies and their boards navigate this area.
For our CL Talk podcast, he spoke to us about his career, how ESG is evolving, and insights companies can glean from Fasken’s recent ESG study.
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Below is a summary of the conversation, edited for length and clarity:
Tell me about your background as a lawyer and your professional journey.
I began my career as an engineer. Many engineers pursue MBA degrees, so I decided to do the same. While exploring MBA programs, I found a joint law and MBA program. During my studies, I secured a summer job at a law firm, loved it, and my career took off from there. Initially, I worked in the banking group, handling various banking tasks. At that time, law firms were smaller, allowing associates to request different types of work. I sought M&A assignments, which led me to focus primarily on private M&A. My practice expanded to include securities work, IPOs, and capital markets, eventually leading to public M&A. Advising public company boards on M&A transactions involved significant fiduciary duty advice, drawing me into corporate governance. Thus, I approached the ESG practice at Fasken with a strong background in corporate governance.
As the chair of Fasken’s ESG & sustainability practice, how do you see the role of ESG evolving in corporate governance?
When discussing ESG with boards of directors, defining what we mean by ESG is crucial. Various groups have co-opted the term, and it can have different meanings. From a corporate perspective, ESG should be viewed as a risk assessment tool for identifying material risks relevant to a corporation. The 'E' and 'S' categories encompass many of these risks. Climate change poses environmental risks, and societal polarization creates social issues that corporations are expected to address. Governance (the 'G') involves the structures a corporation uses to manage and oversee these risks. By considering ESG as a risk assessment framework, we can better understand and manage emerging risks in the future.
What motivated Fasken to conduct the "2024 ESG Disclosure Study?"
The genesis of this project began about two years ago when we considered what ESG means to our clients. Many clients felt overwhelmed due to the varying definitions of ESG and the unclear disclosure requirements. Large companies, with ample resources, could dedicate multiple people to these issues, reviewing and disclosing information. However, mid-cap and small-cap companies often lack these resources. We examined how large companies approached ESG disclosure practices to guide smaller companies. This review aimed to provide an overview of existing practices, allowing companies to determine what applies to them. Over time, our study could reveal emerging trends and common directions in ESG practices, which was the primary reason for starting this publication.
The study highlights the increased involvement of boards in ESG oversight. What are the main benefits of having the entire board, rather than committees, oversee ESG matters?
To address that question, let's step back. Under corporate law, a company's board of directors must manage the business and affairs of the company. In doing so, the board can create committees to focus on specific issues, helping to discharge its duties. For example, an audit committee handles financial statements, requiring members with financial literacy.
Regarding ESG matters, a committee might also be designated to handle these issues. Often, a health and safety or governance committee takes on ESG responsibilities, depending on the company's focus. Generally, committees have been involved in ESG, but recently, more boards have been overseeing these issues instead of solely relying on committees.
We describe this shift by emphasizing that the more strategic an issue is, the more the board should address it. As ESG issues become more strategic for some companies, there is a growing recognition that these are not matters to delegate entirely to committees. Instead, the whole board should be involved in thinking about and managing ESG risks.
How do you see the integration of ESG metrics into executive compensation influencing corporate behaviour and performance?
When I first started practising, a partner told me, “Your compensation system is your strategy,” which holds some truth. Compensation drives behaviour and companies are increasingly linking parts of their compensation systems to ESG metrics, particularly short-term bonuses. This trend acknowledges the importance of aligning pay with strategic objectives. However, it's crucial to view ESG as a risk assessment framework. If ESG risks are strategic for your company, it makes sense to tie compensation to ESG metrics. If not, it may not be necessary.
For example, 20 years ago, Kodak faced a strategic decision with the rise of digital cameras, transitioning from its history in film. Compensation tied to this transition would have been logical. Similarly, the more strategic an ESG issue is for a company, the more likely compensation will be tied to those ESG metrics.
What are the key challenges that companies face when disclosing ESG information?
Disclosure is a challenging topic because the legal requirements for ESG disclosures are still minimal. Due to corporate statutes or securities laws, most public companies must include some diversity, equity, and inclusion disclosures. However, climate change and greenhouse gas emissions disclosures are not yet mandated, though investors are increasingly demanding this information. As a result, companies have started to disclose such data voluntarily.
Canada has draft proposals, and the EU and US had rules suspended shortly after implementation, dealing with greenhouse gas disclosures. While not yet mandatory, these rules indicate the direction of future requirements, prompting companies to prepare for more comprehensive disclosures.
The main challenge with disclosure is managing how information is generated, vetted, and released. For instance, after the Enron scandal 20 years ago, securities regulators established rules for internal controls over financial reporting. This system ensures that financial data is accurately reviewed and disclosed. However, no similar system exists for ESG or climate information, leading companies to struggle with ensuring accuracy and materiality in their disclosures.
The process involves multiple departments and functions within a company. Larger companies may already have systems in place, but smaller companies will need to develop these processes over time. The biggest challenge is ensuring that disclosed ESG information is accurate, vetted properly, and comes from the correct sources within the company.
What are the benefits and potential drawbacks of seeking third-party assurance for ESG-related information?
Financial statements are a great example. They come with an audit report, where an auditor verifies that the statements are prepared according to GAAP standards, providing assurance. Similarly, there is growing interest in having third-party assurance for ESG disclosures. This assurance would give management confidence that their ESG information is accurate and compliant with certain standards, offering protection from a due diligence perspective. Investors would also feel more confident, knowing that a third party has verified the disclosures, lending credibility like that of audited financial statements.
However, unlike GAAP, which has well-established standards, ESG disclosure standards are still being developed. Companies are starting to consider what aspects of their ESG reports should be assured. Initial steps might include limited assurance on specific disclosures, such as greenhouse gas emissions (scope 1 and 2). Limited assurance means a third party reviews the disclosures and confirms they align with the company's stated standards. This assurance area for ESG information will evolve and grow in the coming years.
The study notes a trend toward setting GHG emissions reduction targets. How should companies balance ambitious environmental goals with practical business considerations?
The two should be linked. When considering your business operations, start by assessing whether you emit greenhouse gases and, if so, how much. Understanding your emissions helps determine how material this issue is to your company. Looking ahead 10, 15, or 20 years, consider the likelihood that the cost of emitting greenhouse gases will increase. If this risk is high, it's crucial to understand and potentially reduce your emissions to avoid future costs.
Once you establish the materiality of your emissions, set relevant goals and ambitions. If you emit a significant amount and expect future costs, ambitious targets to reduce emissions align with your business interests, as failing to address them could have financial repercussions.
However, if your company’s emissions are low and the future financial impact is minimal, setting ambitious reduction targets might not be as critical. In this case, ambitious goals could be more about positioning than necessity. The key is to have internal discussions to understand why you are setting these targets and how they align with your business objectives. These are the kinds of discussions companies need to have.
The report highlights Indigenous engagement and reconciliation. What are some best practices for companies in this area?
Different people have different perspectives on Indigenous issues. Broadly, these issues involve a company's place in society and its relationships with Indigenous communities, often under the ESG umbrella. This consideration varies by industry. For instance, a software company might not have immediate obligations, but understanding Canada's work on Indigenous reconciliation is still important.
In contrast, industries like mining or real estate, which involve development projects, must consider their impact on Indigenous communities. They must consider how to engage these communities and explore avenues for Indigenous equity participation in their projects.
While it’s company-specific, all businesses should understand Canada's history and ongoing efforts towards Indigenous reconciliation. This involves learning about Inuit, Métis, and First Nations communities and considering them in business development.
What should lawyers keep in mind about the ESG’s future?
This area will continue to grow, and changes in terminology, such as shifting from ESG to sustainability, shouldn't be surprising. The focus should be on a risk-based approach to business operations, ensuring long-term sustainability. That's the critical point.
