Canadian Securities Administrators Issue Staff Notice 81-334 Regarding ESG-Related Investment Fund Disclosure
February 8, 2022
Brittany Greenberg Sara Tatelman
Interest in environmental, social and governance (“ESG“) factors is increasing quickly among Canadian investors, spurred in part by the view that redirecting investments towards the climate crisis and our collective social and governance challenges may be an effective way to address portfolio risk and, at the same time, to resolve these larger issues. To date, however, it is not clear how effective ESG funds have been at risk mitigation nor have they made a significant mark on the environmental and social problems they have identified.
Accordingly, the financial press has focused on the challenge of greenwashing – investment fund marketing on the basis of moral or social objectives where the actual investments and practices of the investment fund are not meaningfully different from non-ESG funds or where the investments and practices of the fund do not achieve any meaningful social or climate related objectives.
On January 19, 2022, the Canadian Securities Administrators (“CSA“) issued CSA Staff Notice 81-334, ESG-Related Investment Fund Disclosure (the “Notice“) (linked: here), in order to begin to address the greenwashing problem.
The Notice provides guidance on the disclosure practices of investment funds whose objectives reference ESG factors (“ESG Funds“) and that use ESG strategies (“ESG Strategy Funds”) (collectively, “ESG-Related Funds“).
Unfortunately, the Notice leaves much to be desired for those seriously interested in addressing the climate crisis or social and governance challenges. Importantly, the Notice does not require that ESG Funds adhere to any regulatory definition of what constitutes ‘ESG’. With regard to climate, for example, the International Panel on Climate Change – the world’s pre-eminent international scientific advisory body on climate and climate related issues – has stated that we must reduce greenhouse gas emissions by 45% relative to 2010 levels in order to avoid severe consequences of climate change. The International Energy Agency, in its Special Report titled ‘Net Zero by 2050’, concluded that, apart from already committed projects, there can be “no new oil and gas fields approved for development in our pathways, and no new coal mines or mine extensions are required.” Notwithstanding these very clear scientific warnings, the CSA permits Funds to label themselves as ESG Funds even if they do not target these basic objectives. Ultimately, the CSA Notice therefore continues to allow a formidable gap between the urgency of climate change, and the nature of ESG Fund. Under these circumstances, it is difficult to see how the Notice effectively address the problem of greenwashing.
The Notice does not establish any new or modify existing legal requirements. Instead, the Notice “clarifies and explains how the current securities regulatory requirements apply to ESG-related investment fund disclosure. It also includes best practices that, while not required, may, in the view of Staff, “…enhance ESG-related disclosure and sales communications.” Furthermore, the Notice is intended to “bring greater clarity to ESG-related fund disclosure and sales communications to enable investors to make informed investment decisions”.
In this blog post, we summarize and comment upon some of the key technical recommendations and requirements from CSA Staff (“Staff“) contained in the Notice.
(i) Investment Objectives and Fund Names
In meeting the requirement to disclose the fundamental investment objectives of the fund in its prospectus, and to prevent greenwashing, it is “important that the names and investment objectives of a fund reflect the extent to which such fund is focused on ESG, where applicable, including the particular aspect(s) of ESG that the fund is focused on.” The name of a fund should not reference ESG or related terms, such as “green” or “sustainable”, if its fundamental investment objectives do not reference ESG factors or an ESG strategy. Indeed, the Notice requires that the name of a fund reflect the “extent of’ its ESG focus.”
Staff’s direction on fund naming can be summarized as follows:
The Notice requirements are not particularly robust and may still leave considerable room for qualitative language referencing ESG factors or strategies in a non-specific way that may not disclose the quantitative consequences of the fund’s ESG orientation.
(ii) Fund Types
A non-ETF mutual fund is required to identify in its prospectus the “fund type” that most accurately describes it. Staff concluded that, while not required, a mutual fund that includes ESG in its fundamental investment objectives may wish to characterize itself as a fund focused on ESG (in addition to its primary fund type). However, if a fund does not include ESG in its fundamental investment objectives, it should not characterize itself as a fund that is focused on ESG.
(iii) Investment Strategies Disclosure
Using plain language, a fund that uses one or more ESG strategies (either as part of their principal strategy or that use one or more ESG strategies in their investment selection process) is required to disclose the ESG-related aspects of its investment selection process and strategies. Staff’s views on such disclosure can be summarized as follows:
- Investment strategy disclosure “should” identify any ESG factors used and explaining their meaning;
- Investment strategy disclosure “should” describe how the ESG factors used are evaluated and monitored; and
- Funds “are encouraged” to disclose any targets used for ESG-related metrics and identify if those targets may evolve or change over time.
Staff’s view is that an ESG Fund “should” disclose whether they may, at any point in time, “hold investments that are inconsistent with [their] ESG values.” Funds should also “disclose what those holdings would include (including examples), and how such holdings meet the fund’s objectives.” Further, funds should disclose whether it has discretion over whether a type of investment is included or excluded from its portfolio based on ESG factors.
If a fund uses proxy voting or shareholder engagement as a principal investment strategy or as part of its investment selection process, it is required to disclose this in its investment strategies: “disclosure should include the criteria used by the proxy voting or shareholder engagement strategy, the goal of the proxy voting or shareholder engagement strategy and the extent of the monitoring process used to assess the success of the proxy voting or shareholder engagement strategy.”
If a fund uses multiple ESG strategies, it is required to provide disclosure explaining how the different ESG strategies are applied in the investment selection process. In Staff’s view, funds should also disclose the order in which these are applied (i.e. if the fund uses negative screening as an initial filter and then an ESG integration strategy to evaluate potential investments).
Finally, Funds should clearly identify any benchmarks, indices, or ratings used as part of their principal investment strategies or investment selection process (including any third-party providers used). In Staff’s view, disclosure should also include a description of methodologies used.
(iv) Proxy Voting and Shareholder Engagement Policies and Procedures
Investment funds must include in their prospectuses and/or annual information forms a summary of their proxy voting policies and procedures, including how they may relate to achieving ESG-based objectives. Conversely, while investment funds are not required to make their shareholder engagement policies and procedures publicly available, Staff encouraged funds that use shareholder engagement as an ESG strategy to do so.
(v) Risk Disclosure
Staff have also detailed how a fund may meet its obligation to describe, in its prospectus, any material ESG-related risks associated with an investment in the fund. More particularly, Staff advised that ESG-Related Funds should disclose any “material risk factors” applicable to the fund’s ESG-related investment objectives and/or strategies. Staff advised that all funds should consider and disclose whether there are any ESG-related risk factors associated with an investment in the fund.
Suitability statements should “accurately reflect the extent of the fund’s focus on ESG” and should make clear which aspect(s) of ESG are the focus of the fund. Staff’s view is that since ESG Strategy Funds do not have an ESG-related investment objective, they should not state that they are particularly suitable for ESG-focused investors.
(vii) Continuous Disclosure
In its management reports on fund performance (“MRFP“), a fund must provide material updates on the composition of the investment portfolio and how it relates to the fund’s investment objective. This permits investors to continually evaluate the fund’s ability to meet its ESG performance and objectives, in an effort to control greenwashing.
Staff provided the following commentary for funds in preparing their MRFPs:
- ESG-related funds are required to disclose “how the composition and changes to its investment portfolio relate to the fund’s ESG-related investment objectives and/or strategies”;
- In addition to financial performance, Staff encouraged funds to provide ongoing information about ESG performance in its MRFPs;
- Staff encourage funds that “intend to generate a measurable ESG outcome to report in their MRFPs on whether the fund is achieving this outcome” (e. where a fund’s investment objectives refer to reducing carbon emissions, investors “would benefit” from disclosure that includes the quantitative key performance indicators);
- Staff “encouraged funds to provide investors with additional periodic information on how they are meeting their ESG-related investment objectives);
- Despite the fact that the legal requirement for funds is to maintain a proxy voting record and make its most recent proxy voting record available on its website, Staff encouraged funds that use proxy voting as an ESG strategy to make all historical voting records available online. Staff also encouraged all funds to disclose in their MRFPs their proxy voting results and how they align with ESG objects and/or strategies; and
- While there is currently no continuous disclosure requirement for funds to report on their past shareholder engagement activities, funds that use shareholder engagement as an ESG strategy are encouraged to disclose their past engagement activities on their websites and summarize such activities on their MRFPs.
(viii) Sales Communications
To help mitigate greenwashing, sales communications must align with a fund’s regulatory offering documents, and cannot be untrue or misleading. Therefore, sales communications “should not contain statements that are vague or exaggerated, or that cannot be otherwise verified.”
Sales communications that indicate that the fund is focused on ESG
Sales communications “should” accurately reflect a fund’s ESG focus, including if it is only focused on certain ESG elements, if any strategies are discretionary or optional, or if there is a maximum limit to the fund’s use of such strategies.
In Staff’s view, if a fund references ESG in its investment strategies prospectus disclosure, but not in its investment objectives, it may include details about its use of ESG strategies in its sales communications. It must still refrain from exaggerating the extent of its ESG focus.
If a fund does not reference ESG in either its investment objectives or its investment strategies, such fund may provide “factual information” about the ESG characteristics of its portfolio, but “should not” include any ESG-related claims about “what the fund is trying to achieve.”
Sales communications that reference a fund’s ESG performance
Staff maintained that a fund must not include misleading statements about its performance in relation to ESG. Staff indicated that examples of misleading sales communications may include those that:
make inaccurate claims about the fund’s ESG performance or results;
make inaccurate claims about the existence of a direct causal link between the fund’s investment strategies and ESG performance or results; or
manipulate elements of disclosure to present the fund’s ESG performance or results in a positive light, such as cherry-picking data.
Communications Including Fund-Level ESG Ratings, Scores or Rankings
While beyond the scope of this blog, Staff concluded that communications disclosing fund-level ESG rating, scores or rankings that meet the definition of “performance data” or a “performance rating or ranking” (or comparisons of performance relating to such metrics) risk being non-compliant with National Instrument 81-102. Staff reminded IFMs to review and consider the requirements under Part 15 of National Instrument 81-102 when preparing sales communications.
Staff suggested that the use of ratings, scores, or rankings may be misleading in the following circumstances: (i) if there are conflicts of interest involving the ranking provider; (ii) if the selection of the rating, score, or ranking is the “result of cherry-picking”; (iii) the selected rating, score or ranking is not representative of the ESG characteristics or performance of the fund; and (iv) lacks necessary explanations, qualifications, limitations, or other statements required to make the inclusion of the ratings, scores, or rankings not misleading.
Staff also provided the following recommendations to avoid misleading communications regarding ratings, among other suggestions:
- All fund-level ESG ratings should be prepared by a provider that uses an objective, publicly disclosed methodology, and who is neither a member of the organization of the fund nor paid to assign such a rating;
- Funds should only publish fund-level ESG rankings that are based on a published category of funds, which provide a reasonable basis for evaluating its ESG characteristics and performance;
- Funds are encouraged to disclose fund-level ESG ratings, scores or rankings from at least 2 different providers;
- Funds should ensure ratings represent the entirely of a fund’s ESG characteristics and performance, especially if less than 100% of the fund’s underlying portfolio has been rated;
- Funds should disclose sufficient details about ESG ratings, including:
- The name of the provider that prepared the rating;
- The time period covered by the rating;
- How often the provider updates the rating;
- A brief summary of what the rating assesses; and
- Link to the full methodology of the rating or an explanation of how to easily access it.
This information should be clearly stated, and funds should disclose separate ratings for environmental, social and governance components.
(ix) ESG-Related Changes to Existing Funds
If a fund changes its name to add or remove a reference to ESG, it may need to update its fundamental investment objectives as well. Staff provided a helpful outline for the types of approval that may be required in order to do so:
(x) ESG-Related Terminology
Funds should describe their ESG strategies and any ESG-related language used plain language, and define any ESG terms that are “not commonly understood.”
(xi) IFM-Level Commitments to ESG-Related Initiatives
Staff also encouraged funds to disclose their signatory status or commitment to international or regional ESG-related initiatives (i.e. the United Nations Principles for Responsible Investing and Task Force on Climate-related Financial Disclosures). Funds should note that “[…] the commitment is at the entity-level rather than at the fund-level and where applicable, that the funds managed by the IFM may not be focused on ESG.”
 ESG Strategy Funds include those that use ESG strategies, but do not reference ESG factors in their investment objectives.
 Staff explained that when the phrase “[S]taff encourage” is used, this signals a “best practice” and not a legal requirement. For the sake of clarity, we have mirrored Staff’s language in this regard to signal when certain Guidance is merely a “best practice”.
 We note that Staff seemingly neither encouraged, nor suggested that there is a requirement for, ESG-Related Funds to use or reference targets for ESG-related metrics in their disclosure documents.
 In addition to the requirement that investments funds are required to promptly send a copy of their proxy voting policies and procedures to any securityholder upon request, Staff also encouraged funds to make the most recent copy of any proxy voting policies and procedures available on their websites.
 Under the current regulatory landscape, an investment fund must include in its Fund Facts or ETF Facts, a brief statement of the suitability of the fund for particular investors.
 We point out that Staff seemingly did not suggest in its discussion on continuous disclosure that the inclusion of such measurable, quantitative data is mandatory or a regulatory requirement in the ESG context.
 At Pages 18 and 19 of the Notice, Staff provide a list of ways in which sales communications may be misleading.
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