Twelve of Canada’s biggest pension funds were analyzed by Corporate Knights, in partnership with the Smart Prosperity Institute and The Natural Step Canada. Over the past decade, these funds have quietly unloaded their fossil fuel stocks as their values have plunged, to the point where they now make up less than a few percent of total investments. Canadian pension portfolio exposures to fossil fuel stocks are down to a 10th of what they were 10 years ago, notwithstanding some controversial private equity investments.

For instance, the two largest funds in Canada (Canada Pension Plan and Caisse de dépôt et placement du Québec) have slashed the value of their fossil fuel holdings by more than 90% over the past 10 years, from more than 22% of total equity investments to less than 2% and 3% as of September 20, 2021.

On the flip side, we found that collectively, their self-defined environmentally sustainable investments have gone from negligible to more than $150 billion – 7% of their total assets – over the last few years.

Many pension funds are also taking a more active role with the companies they invest in, engaging on environmental, social and governance (ESG) issues ranging from board gender diversity to responsible lobbying and payment of taxes. Similarly, many funds are making efforts to improve their own governance by increasing management diversity. This involves aligning their own executive bonuses with ESG targets and increasing ESG competency on their boards.

Pension funds represent a major pool of Canada’s investment capital: the top 12 funds alone control $2.1 trillion, roughly equivalent to Canada’s entire GDP. Many stakeholders – governments, businesses, non-profits like Shift Action for Pension Wealth and Planet Health, and certainly beneficiaries – are increasingly interested in how pension funds are addressing the challenge of the transition to sustainability. A new tool called the Sustainable Investment Dashboard, developed by Corporate Knights with input from the Smart Prosperity Institute, The Natural Step Canada and a panel of experts, aims to highlight which pension funds are pulling their weight on these issues and which ones are falling behind.

As the transition to a climate-friendly economy speeds ahead, global investors are embarking on what is in all likelihood the largest reallocation of capital in our civilization’s history. This could be more than $100 trillion between now and 2050, according to Mark Carney, former governor of the Bank of England.

There still exists tremendous potential for pension funds to play an active ownership role in helping carbon-intensive companies leverage their assets to make the transition from “grey to green,” through initiatives like Say on Climate and Climate Engagement Canada. This engagement must be underpinned by an honest assessment of what kind of future companies are investing in. Many companies claim to be aligned with net-zero emissions, but if they are still plowing most of their growth investments into high-carbon assets, then net-zero is just a slogan.

Ziad Hindo, the chief investment officer for the Ontario Teachers’ Pension Plan (OTPP), told The Globe and Mail that Canadian pension funds need “a fundamental shift.” Some of Canada’s largest pension plans are realizing that they need to keep up with the pace of change and capture their fair share of clean-growth investment opportunities. They’ll need to boost their investments in low-carbon solutions to roughly 20% by 2025 and fully decarbonize across all asset classes. Given the multi-decade ripple effects of capital allocations made today, this will need to happen well before the 2050 net-zero target for the real economy.

This fall, Canada’s second- and third-largest pension fund managers raised the stakes, announcing plans to achieve net-zero emissions, and linked the objective to executive compensation at the funds.

In September, OTPP set targets to reduce portfolio carbon-emissions intensity by 45% by 2025 and by 67% by 2030, compared to their 2019 baseline. Critically, these targets impact all their assets across public and private markets, including external managers. The pension plan also committed to invest $5 billion in climate and transition solutions so far in 2021 and said they would boost their $30-billion portfolio of green investments.

Also in September, CDPQ updated its climate pledges to boost green assets from $36 billion to $54 billion by 2025 and achieve a 60% reduction in the carbon intensity of the total portfolio by 2030. The plan will also create a $10-billion transition envelope to decarbonize the main industrial carbon-emitting sectors and complete its exit from oil production (currently just 1% of its portfolio) by the end of 2022. Other pension funds are also developing net-zero action plans, which are not yet public. So this trend will almost certainly continue.

While it is encouraging to see the “Maple Revolutionaries” (as The Economist dubbed Canada’s large pension funds for their strong governance and performance track record) rising to the climate challenge, there is a risk that the lack of clear definitions and expectations could result in unnecessary costs, delays, lost opportunities and even risks to financial performance.

As the investment wave toward net-zero takes hold globally, now is the time to position Canadian pension funds (large and small alike) for success.

This will require the federal government to establish a Net-Zero Implementation Standard, a clear definition of what constitutes a net-zero-aligned portfolio. And there should also be a net-zero alignment requirement for all pension funds (a Net-Zero Rule). While Canada has a fragmented regulatory landscape (the 12 largest funds are regulated by eight different supervisory bodies), tax-exempt pensions share a common touch point with the Income Tax Act. This is a powerful tool as pensions currently benefit from $85 billion per year in tax subsidies (a sum equal to 25% of all federal government revenues).

The federal government should consider amending the Income Tax Act to introduce a Net-Zero Rule requiring pension funds to demonstrate net-zero alignment in order to maintain full tax-exemp status. This could be phased in starting with the largest funds, which account for the majority of Canada’s $4 trillion in pension wealth, and would help secure Canadian retirement savings on the right side of the transition to a low-carbon economy.

It would ensure that pension plans generously subsidized with public funds are not investing at cross-purposes to the government’s climate goals, according to Jinyan Li, a professor of tax law and former interim dean of Osgoode Hall Law School. And more generally, it would be in line with the rising recognition of the social role of finance.

A variation on this recommendation could be to provide a small (10 to 20 basis points) limited-duration (two-year) enhanced tax incentive for pension funds aligned with the net-zero requirement, after which a partial reversal of tax-exempt status would kick in for non-compliant funds. In light of the urgency of the climate situation, this could be done surgically for net-zero purposes or, as pension expert Keith Ambachtsheer has called for, as part of an expedited, more holistic overhaul. This could also be used to ensure all Canadian tax-deferred asset pools provide integrated annual reports covering their organizational purpose, governance, business model, performance and strategy, including independent certification that the report deals with reality and not fiction.

Though there is no single incontrovertible global standard for how to calculate net-zero, two of Canada’s three largest funds already have developed best-practice methods (both using the Partnership for Carbon Accounting Financials Standard). And there are other credible international standards upon which Canada could issue guidelines, including the Paris Agreement Capital Transition Assessment (PACTA) tool (a free, open-source methodology and tool the UN helped to finance), which the Bank of England has used.

Portfolio analysis done for this report and by the two large Canadian funds with public net-zero goals (CDPQ and OTPP) both found that there is a financial cost to moving too slowly in this period of unprecedented capital reallocation from high-carbon to low-carbon activities. Any concern about a conflict between net-zero alignment and the duty of pension fiduciaries (to focus on risk-adjusted returns) appears increasingly misplaced. Now is the time to act on implementing net-zero portfolio strategies.

If we get this right, then Canadian pension plans can lead in buying us out of the climate jam while earning healthy returns. Bonus: It’s easier to collect a pension in a world that is not on fire.

Toby Heaps is the co-founder and CEO of Corporate Knights.

Ed Waitzer is a lawyer and former chair of the Ontario Securities Commission.

Derek Eaton is the director of public policy research and outreach at the Smart Prosperity Institute. 

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The amendment to the CBCA was characterized as a “codification” of the Supreme Court of Canada’s 2008 decision in BCE Inc. v. 1976 Debentureholders regarding directors’ duties to act in the best interests of the corporation. The BCE decision helped to shred the notion that a corporation only exists to serve shareholders. It was a watershed moment for the stakeholder capitalism model making clear that a broader array of employee, consumer, environmental interests could be properly considered.

The Supreme Court in BCE was clear that directors owe their statutory duty of loyalty to the corporation itself and that, in considering the best interests of the corporation, the board may consider the impact of corporate decisions on “shareholders or particular groups of stakeholders,” including “the interests of shareholders, employees, suppliers, creditors, consumers, governments and the environment” to ensure that they are treated fairly.

The Supreme Court also stated in BCE that: “The duty of the directors to the corporation is a broad, contextual concept. It is not confined to short-term profit or share value. Where the corporation is an ongoing concern, it looks to the long-term interests of the corporation.” While the Court viewed the long-term interests of the corporation as an essential element of directors’ duties, the proposed amendment lumps it in with stakeholders and the environment, making the consideration permissive.

In addition, by specifying certain types of stakeholders, the proposed amendments may relegate others to a lesser status.  Both would almost certainly be unintended outcomes.  It is unlikely that the government was trying to relieve directors of an obligation to consider long-term interests or limit those stakeholders whose interests a board may choose to consider.

In his 2018 annual letter to shareholders, BlackRock CEO Larry Fink contended that, in the absence of “a sense of purpose,” corporations will “succumb to short-term pressures to distribute earnings and, in the process, sacrifice investments in employee development, innovation and capital expenditures that are necessary for long-term growth.”  As the world’s largest asset manager, Fink argued that this will ultimately result in subpar returns to investors who depend on their investments to fund their retirement, home purchases or higher education. Just as global expectations are converging around an understanding of corporate purpose that focuses on long-term interests, the federal government’s proposed amendment would take a step in the opposite direction. At best, this can only serve to create uncertainty.

There is another logical statutory amendment that should be made to “codify” the BCE decision. The Supreme Court, in BCE, was focused on the fair resolution of conflicting interests in the context of the oppression remedy. That remedy has been widely recognized as one of the broadest and most open-ended in the common law world – allowing certain corporate stakeholders to seek relief for breaches that amount to “oppression,” “unfair prejudice” or “unfair disregard” of their interests.

That said, the statutory language describing which stakeholders can access the remedy is somewhat muddled. While the definition of “complainant” (those who can bring a claim) is open-ended, “in the discretion of the court,” the wording of the statute suggests that the harm complained of must be suffered by a “security holder, creditor, director or officer” of the corporation. The reason for this difference (if it was considered) was not addressed when the remedy was added to the statute in 1975 and is not apparent. Nor is it consistent with the Supreme Court’s discussion in BCE of the remedy as a means of protecting stakeholder interests. A simple fix would be to replace the words “security holder, creditor, director or officer” with “stakeholder” – an open-ended concept that has been judicially defined in the BCE decision.

Rather than potentially creating new problems, hopefully the government will reconsider the proposed amendment and use the opportunity to solve an old one, providing an effective remedial discipline if directors don’t mediate stakeholder interests having regard for the unique circumstances faced by a corporation. This should better enable our court’s understanding of corporate purpose to continue to adapt over time to reflect evolving social norms and expectations as to the proper role of the corporation in society.

Ed Waitzer is a Professor and holds the Jarislowsky Dimma Mooney Chair in Corporate Governance at Osgoode Hall Law School and the Schulich School of Business, York University.

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We have learned, painfully, that neither of these ways of thinking about governance issues is sufficient.  By the turn of the century, Jensen had become an advocate for “enlightened stakeholder theory” – a focus on maximizing total long-term market value.  That concept has become challenging in a world in which change – technological and otherwise – is quicker and more pervasive than ever before.  Only 53 companies have remained on the Fortune 500 list in my lifetime.  Only two of those (Exxon and Johnson & Johnson) have stayed in the top 10.

In the meanwhile, corporate law – the language of our statutes – has been overwhelmed by the advent of “corporate governance” – various governance codes have effectively become global legal norms. This, in turn, spawned an active governance industry and a variety of new analytical models of corporate law.

There is no “right” governance model. Governance is highly contextual, depending on what a particular company does, its ownership structure and the markets and political frameworks in which it operates. Corporate governance is messy and complicated because that is life. The move from corporate law to corporate governance reflects a move from a simple legal view of the corporation to one that has become increasingly complex and dynamic, constantly responding to societal expectations.

This frames the two issues I would like to consider with you this evening. First, the irony that corporate law and regulation have tended to frustrate dynamic adaption and have led to governance systems that underperform. A related problem is the tendency to oversimplify governance issues. I will consider the gap between rhetoric and reality (and relevance) that tends to predominate in thinking about corporate governance.

The second topic I’d like to consider is whether there might be more constructive ways to think about corporate purpose.  I’ll suggest that systems theory may be instructive.

Hopefully, by the time I get through these two concerns you’ll still be listening and will understand why I’m so deeply honoured to be here this evening.

Focusing on issues that matter

One of the most striking features of corporate governance politics is that there are new controversies and consequential regulatory proposals every year. We have spawned a governance reform industry that has become incredibly adept at feeding itself. A related oddity is the fact that many of the regulatory initiatives are “symbolic” – they certainly cannot be explained by their relevance to improving corporate governance or performance.

To take a current example, think of “say on pay”. We now have almost 7 years of data concerning the legal ability of shareholders to cast an advisory vote on executive compensation. Shareholders have typically approved compensation with votes in favour exceeding 90%.  It is striking that shareholder support for executive pay appears to be highly correlated with a company’s short-term stock performance. To the extent that say on pay votes have heightened incentives to focus on short-term stock price at the potential expense of creating sustainable value, this regulatory initiative is surely misguided.

I could give you many similar examples. I could also cite many examples of issues that clearly matter, but that no one seems to want to address in a meaningful manner.  The inability of the Canadian Securities Administrators to agree on even a “comply or explain” climate risk disclosure regime, after over a decade of studying the issues, is a striking current example.

In theory, securities law should already address this disclosure concern – the legal concept of materiality should define the line where sustainability issues become public disclosure obligations.  Yet not only are companies avoiding effective metrics for disclosure, but regulators are accomplices to their inaction.  The suggestion that issues are contingent or speculative doesn’t make them immaterial.  Likewise, the absence of evidence is not evidence of absence.  We know it is feasible to assess the materiality of a company’s exposure to climate-related financial impacts. In fact, a majority of industry-leading companies are already doing so – most often using metrics which lack comparability across industry peers or, worse, boilerplate language which is of little use to investors.

It is unlikely that the explanation for this lies in false perceptions – we are talking about some of the most sophisticated and influential actors in our society. A more likely explanation is that governance is often viewed as a moral crusade – tapping into broader public sentiment without regard for materiality or the challenge of effecting fundamental change. The exercise becomes largely symbolic and, ironically, as a result, it is often conservative. While governance reforms maintain the appearance of solving problems, they often have opposite (or at best, very limited) effects. One systemic danger is that such reforms deflect attention from, and dull the desire for,  deeper introspection.

This account of the gap between rhetoric and reality suggests taking governance reform with a grain of salt. Understanding of exaggerated rhetoric of corporate governance should generate a healthy skepticism about who are the “good guys” and the “bad guys”. It’s a fence I’ve straddled for over 40 years!  In this respect, the politics of corporate governance reform shares much in common with politics generally.  This makes getting beyond the rhetoric – the work of Corporate Knights, and many of you – so compelling.

The relevance of systems theory

This leads to my second theme – whether there might be a more nuanced and constructive way to think about corporate purpose. Bear with me while a high school drop-out tries to describe some basic principles of systems theory. The first is that systems are more than the sum of their parts. Another is that systems are fractal – that is they are comprised of subsystems which in turn are comprised of other subsystems on so on. A third principle flows from the first two – that the overall health of the system depends on the continued health of each of its essential subsystems, as well as of the larger systems in which it is embedded. Think about how each of these principles applies to your organizations.

The next step is to describe the essential focus of systems theory – addressing questions of sustainability and relevance. This suggests mechanisms such as redundancy (i.e., devoting more resources to some purpose than is necessary under current conditions), homeostasis (i.e., information and feedback loops that allow a system to adjust to disturbances in its environment and stay within the parameters necessary for its continued functioning), self-organization (i.e., the ability of a system to learn, diversify and evolve in response to shifts in its environment that might otherwise threaten its survival) and resilience. These mechanisms are common features of well-governed organizations.

Finally, in systems multiple purposes are the rule, not the exception. What we observe about a system’s apparent purpose will depend on our level of analysis.  Indeed, the purpose and functions of a system are often the least obvious parts of the system, especially to outside observers who pay attention to only a few events or stated goals.  The lesson that systems-thinking offers on corporate purpose is that the overall goal of a corporate system should not be subordinated to the goals of any one of its subsystems (such as the share-ownership subsystem). As our Supreme Court has observed in the BCE decision, a critical role of governance is to mediate these tensions.

Consider, for example, the potential risks of extremes of income inequality from a corporate “systems” perspective.  There is pretty compelling evidence that these include risks to economic growth and financial stability, risks of political polarization and the erosion of social cohesion and risks of destabilizing nationalism and populism at both ends of the political spectrum.  The likelihood that we may, at least temporarily, lose our political “centre” in today’s provincial election is but one of many warning signals.  These risks clearly impact long-term corporate (and investment) performance.

Conclusion

Where does this thinking lead? First, systems theory counsels against focusing on any single metric (and in favour of the need for new ones – the relevance of metrics inevitably run down over time). To take the obvious example, short-term profitability is not so much an objective as a constraint a firm may have to meet in order to remain in business. Metrics such as profits, employee turnover, and customer satisfaction are not ends in themselves. Rather, they are a source of information about whether the corporation is relevant, resilient and sustainable.

A second lesson from systems theory is that, given multiple purposes and the complexity inherent in systems analysis, it will be difficult for academics, lawmakers or the corporate governance industry to identify “one size fits all” reforms that can reliably improve the performance of all companies. Attempts to impose such “silver-bullet” solutions are more likely to result in what an academic colleague, Roberta Romano, has described as “quack corporate governance” that often does more harm than good.

The systems challenge is to bring about a paradigm shift that restores connectivity between investors, employees, management, other corporate stakeholders and governments.  This will require thinking differently about how the constituent elements interact and produce results.  Many of us have participated in such paradigm shifting before – think of the last three decades of the 20^th century when an underlying shift took place focused on maximizing short-term returns to shareholders.  It’s time to flip that switch.

What does all of this have to do with my deep respect for Toby, for Corporate Knights and for each of you, who support its (somewhat subversive) mission? Whether by analysis or intuition, I think Corporate Knights has managed to avoid the “governance trap” and to focus on meaningful change – restoring the connectivity within systems.

Change is hard. People dislike it, especially when it may affect them adversely. T.S. Eliot was prescient in diagnosing almost a century ago what, today, is a worrisome phenomenon for democratic institutions:

“When there is so much to be known …, when everyone knows a little about a great many things, it becomes increasingly difficult for anyone to know whether he knows what he is talking about or not.”

Eliot concluded that “… when we do not know enough, we tend always to substitute emotions for thoughts.”

In contrast, Corporate Knights has taken a longer view, being rigorous in analysis while assuming positive intent, encouraging adaptive responses rather than calling for more rigid and formal compliance requirements.

Hence my sense of appreciation and humility for the honour you have afforded me this evening.  I am very grateful and privileged to be in such good company!

Edward J. Waitzer was awarded Corporate Knights Award of Distinction for his seminal work advancing the legal foundations for corporate and pension fund leaders to serve the public good. He presented this speech at the Best 50 Corporate Citizens in Canada Gala on June 7, 2018 in Toronto.

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Consider the behaviour of some of the world’s largest asset managers in response to shareholder resolutions last year at nine major U.S. utilities asking for reporting on their exposure to the forces driving a 2 C transition – regulatory, technological, legal and meteorological. Ten large institutional investors controlled one of every three shares voted, but only one of them consistently voted to support increased climate risk disclosure. Three of the biggest (by shareholdings) voted against all nine resolutions, even as they profess a commitment to engagement on environmental (and other social, environmental and governance) issues and, in one case, sent public letters challenging CEOs of major corporations to explain how their company is “navigating the competitive landscape, how it is innovating, how it is adapting to technological disruption or geo-political events.”

How can we close the disconnect between stated intent and actual behaviour? Following the recommendations of the Task Force on Climate-related Financial Disclosures (TFCD), a group of three large Canadian pension plans called for enhanced climate disclosures from Canadian companies. The $270 billion Caisse de dépôt et placement du Québec has gone further, pledging to increase its climate solutions investments by 50 per cent and reduce its listed company carbon intensity by 25 per cent.

We know that, notwithstanding concerns about the lack of well-developed standards and potential legal liabilities, climate risk disclosure is being implemented. A recent survey of 15 of the largest oil and gas companies listed on the New York Stock Exchange revealed that, taken in the aggregate, all but one was reporting on each of the 11 disclosure recommendations made by the TFCD. This suggests that such disclosure is feasible if companies, investors and the financial sector are interested in translating climate-related issues into financial costs (and opportunities). In Canada, examples of energy companies engaged in such reporting include Canadian National Resources, Cenovus, Devon Energy, Husky Energy, Suncor and TransAlta.

At the recent launch of a federal Expert Panel on Sustainable Finance, Bank of England Governor Mark Carney noted that “Canada’s financial sector has all the building blocks to make sustainable finance a competitive advantage.” Yet, in the same week, the Canadian Securities Administrators released a report calling for more study and monitoring before implementing disclosure requirements, even on a “comply or explain” basis. By requiring such disclosure by publicly listed companies of their scope 1 and 2 greenhouse gas (GHG) emissions, the U.K. boosted disclosure levels from 50 per cent in 2012 to over 90 per cent today, with improved comparability of data. Disclosure of scope 1 and 2 GHG emissions is now considered critical information by a growing number of investors. Ironically, absent comparable disclosures, they are relying on consultant estimates, which tend to overstate the electricity-related emissions of Canadian companies (largely powered by renewable energy).

Article 173 of the French Energy Transition Law requires that publicly traded companies, banks and credit providers, asset managers and institutional investors provide disclosure on climate change physical risks, as well as an explanation and justification of the disclosure methodology used. The European Commission’s recent action plan for sustainable finance sets out its agenda for upcoming actions covering all relevant actors in the financial system. This includes establishing a unified classification system to define what is sustainable and identify areas where sustainable investment can make the biggest impact, creating labels for green financial products on the basis of this classification system, incorporating sustainability in prudential requirements for regulated financial institutions and clarifying the duties of asset managers and institutional investors to take sustainability into account in the investment process and report thereon.

It is in this context that Ontario Premier Kathleen Wynne’s recently announced support for enhanced climate-related disclosures for publicly traded companies, asset owners and asset managers – as well as her commitment to work with the TFCD and the Ontario Securities Commission to strengthen the ability of the province’s financial sector to respond to climate change – is welcome news. Also welcome is the formation of the federal expert panel around the same time, which raises the possibility of coordination between the two levels of governments on this issue.

Countries with significantly less skin in the energy game have concluded that it’s time to better enable their citizens to evaluate climate-related risks on their savings. It’s hard to imagine why Canada wouldn’t follow this lead, if not take it.

Edward J. Waitzer is a senior partner at Stikeman Elliott LLP and a professor at Osgoode Hall Law School and the Schulich School of Business.

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