The winding road to meeting ESG goals

It might already be on every board director or company CEO’s mind these days, but navigating the complex world of ESG (environmental, social, and governance) is not getting any simpler. Governments and regulators continue to unveil mandatory ESG disclosure guidelines as these principles become more widely accepted.

“The way I see it, there have basically been two ESG waves,” says Conor Chell, counsel with MLT AikIns’ ESG practice in Calgary. “The first was more about marketing or promotion, where companies would just pick things that they knew they were doing well on and put that in a sustainability report. That period is over.” He notes that governments and regulators are coming down harder on so-called greenwashing – a combination of cherry-picking, boiler-plate platitudes, and promises about delivering the goods on ESG goals.

Conor Chell

What’s more, Chell adds, is that “tougher rules around mandatory reporting are coming into play, and with that, there is a huge potential for legal liability.... So now there are strong signals for companies to get on top of their ESG strategy, performance, and reporting.”

In the latest federal budget, the government outlined its plan to require federally regulated financial institutions to begin reporting climate-related financial risks under the Task Force on Climate-Related Financial Disclosures (TCFD) framework.

Indeed, beginning this year, the Office of the Superintendent of Financial Institutions (OSFI) will consult with banks and insurers on developing climate disclosure guidelines regarding ESG disclosure, aiming to gradually phase in reporting requirements for financial institutions beginning in 2024. In the budget, the government also announced plans to require federally regulated pensions to disclose the ESG considerations they use in their portfolio construction. However, there were no specific details on how or when the government would roll out that requirement.

And while the OSFI guidelines will for now focus on reporting requirements for financial institutions and pension funds, they are expected to have an impact throughout the Canadian economy, regardless of the industry or sector, given the role that regulated banks and financial institutions play.

Banks and other financial institutions will have to collect climate risks and emissions data from their clients, forcing companies with which they do business to make climate-related disclosures to access financing and other financial services.

Aaron Atkinson, a partner with Davies Ward Phillips & Vineberg whose practice focuses on mergers and acquisitions, shareholder activism, capital markets and securities, and corporate governance, says it makes sense for government and regulators to focus on the role that financial institutions and pension funds play in helping get to a net-zero reality. “They obviously have clout when it comes to where to put their money, and any time you have large sources of capital, they can help dictate the terms of investment.”

Aaron Atkinson

He adds, “We wouldn’t be talking about ESG as much if we didn’t have pension funds and large governance groups like the Canadian Coalition for Good Governance being open advocates for taking ESG more seriously.”

It might seem counterintuitive, but extractive industries such as energy and mining can often be at the forefront of good ESG. Andrew McLaughlin, VP of Legal Affairs and General Counsel at Major Drilling Group, points out that companies in these sectors have had years of dealing with regulators and communities concerning their projects and have a framework to help them develop ESG standards.

Andrew McLaughlin

McLaughlin adds that, in his company’s experience, it is best to focus on ESG from a “holistic” perspective. This approach helps achieve broader goals on climate, diversity, sustainability, and good governance, and “it also is a pretty good indication that a company that takes this into account is a well-managed company.” And, of course, being a well-managed company means you’ll have the investment and financing to continue being a well-managed company.

Looking at the whole ESG picture also means companies may find they are doing more on ESG than they realize. “ESG is an extremely broad topic, and one that might be a bit daunting to companies,” he says. “But as they dig deeper into what they are doing on the ESG front, organizations will often realize that they are probably farther down the road than they might have thought.”

For example, areas such as good health and safety practices, working with Indigenous communities to get support for projects, and encouraging more diversity in hiring are all areas that are part of an ESG framework.

Not paying attention to the broader view of ESG, and focusing on just one of the letters, could also backfire. One might assume, for instance, that electric vehicle manufacturers would have high ESG ratings. But earlier this year, Tesla, the world’s largest manufacturer of electric vehicles, was taken off the S&P 500 ESG Index, a broad-based index of publicly traded securities deemed sustainable based on their S&P DJI ESG scores.

Tesla’s ESG score ranked in the bottom quarter of its industry peers, with the lower ranking largely relating to competitors such as GM improving their ESG scores and controversies at Tesla regarding claims of racial discrimination and poor working conditions at the car manufacturer’s plant in Fremont, California.

Another factor that hurt Tesla’s ESG score was the company’s handling of a National Highway Traffic Safety Administration investigation into multiple deaths and injuries linked to its autopilot vehicles, and the company’s lack of a low-carbon strategy.

However, just because a company is in the mining or energy sector, considered “dirty” industries environmentally, doesn’t mean it can’t perform well from an environmental perspective. MLT Aikin’s Chell notes that Exxon Mobil recently announced an ambitious plan to reach net zero emissions by the year 2050 – the same type of plan that Tesla was penalized for not having – following a successful campaign by activist investors in 2021 to advance decarbonization.

Ravipal Bains, a Vancouver-based partner with the capital markets and securities practice with McMillan LLP, says it’s not always appropriate to take a “black-and-white” approach to ESG, particularly in Canada, where the natural resources industry plays a significant role in the economy.

Ravipal Bains

Regardless of what sector it is in, “If a company is working to demonstrate its leadership and to demonstrate its improvement from a sustainability perspective, the market is paying attention,” Bains says. Fewer large investors are now considering divesting entirely from a particular industry if individual companies within that sector have a solid commitment to their ESG goals.

The road ahead for companies, investors, pension funds, and banks may not be straight. Regulators and governments in Canada and worldwide are still developing a baseline harmonized framework for defining and meeting ESG goals while considering the differences and complexities between sectors and individual firms.

Lawyers in this area say it’s essential that firms work with in-house counsel or outside law firms in this practice to develop credible net-zero plans, while not forgetting the importance of the S and the G.

“As a starting point,” says Chell, “I want to educate clients and tell them that if they are putting out a sustainability report and it’s not done right, it has the potential to create legal risk. And to produce a credible report, you need data – good data, and lots of it.”

He adds that once credible data is obtained, it must be used to create a baseline with realistic targets. “You can’t say, ‘Hey, we’re going to be net-zero by 2030 or 2050’ or whatever if there is no plan with steps to achieve that.”

Canadian Lawyer explores these issues October 12 at Toronto’s ESG Summit. Visit legalesgsummit.com for more information.

Institutional investors who use ESG factors

USA

2019- 66%
2020-65%
2021-64%

Canada

2019- 80%
2020-89%
2021-81%

Europe

2019- 90%
2020-94%
2021-96%

Asia

2019- 46%
2020-72%
2021-76%

_{Source: RBC Global Asset Management}

Canadian Companies’ ESG Reporting

Has a sustainability plan-75%
Discloses a net-zero target-35%
Discloses timeframes for ESG targets-30%
Identifies material ESG issues in their organization-62%
Explicitly identifies ESG opportunities-28%
Report is extremely assured-20%

_{Source: PwC (based on publicly available ESG reporting information from Canada’s top 150 publicly traded companies)}