Clarification On OECD Guidelines Raises Expectations Of Canadian Institutional Investors

Authored By: Professor Roel Nieuwenkamp & Hugues Létourneau | Publish Date: 06/23/2017

Last March, the OECD confirmed that pension plans, mutual funds, and other shareholders in a company that violates the OECD Guidelines for Multinational Enterprises (MNEs) are expected to use their leverage as shareowners to mitigate social and environmental impacts, even if they are minority shareholders.

On June 29 and 30, governments, businesses, investors, and civil society are gathering at the annual OECD Global Forum on Responsible Business Conduct to press forward on the application of the guidelines in the financial sector.

This expectation aligns with a quiet but significant global trend that is redefining the role of investors and enterprises as countries strive to implement the UN Sustainable Development Goals. On one hand, an increasing number of governments are adopting regulations requiring pension plans to disclose their strategy to incorporate environmental, social, and governance (ESG) risks in investment decision-making. For instance, under regulation 909 of the Ontario Pension Benefits Act, pension plans in Ontario are now required to indicate whether, and if so how, ESG issues are incorporated into the investment policy. At the same time, governments (e.g.: UK, France, EU) and stock exchanges (e.g.: London Stock Exchanges) are adopting extra financial reporting and listing requirements for companies. This means that investors have more tools at their disposal than ever before to carry out due diligence in their investment portfolios.

Responsible Business Conduct

The OECD Guidelines for MNEs are a set of recommendations on what constitutes responsible business conduct. Central to the guidelines is the expectation that multi-national enterprises of all sizes should conduct due diligence to prevent or address adverse environmental and social impacts that are directly linked to the MNE. Each OECD country, including Canada, has created a National Contact Point (NCP) to receive complaints by civil society organizations who observe failure around the implementation of the guidelines by companies.

Since its creation in 2001, 12 of the 15 cases accepted by the Canadian NCP have involved extractive sector companies. This is unsurprising given the extractive industry accounts for 33 per cent of the TSX Composite.

Canadian MNEs are also exposed to other human rights risks across the world. These include child labour in coffee supply chains (e.g.: restaurants, grocery stores), forced labour in the sourcing of electronic components (e.g.: auto parts), or disastrous health and safety standards in garment supply chains (e.g.: retail chains).

Increasingly, civil society actors are filing NCP complaints that implicate the financial sector. From 2000 to 2010, eight per cent of complaints filed at NCPs in all OECD countries involved the financial sector. In 2014 and 2015, it was the most prevalent sector in NCP complaints.

Until last March, the lack of clarity regarding the application of the OECD guidelines to those that hold shares in MNEs meant that little attention was paid to the guidelines by Canadian asset owners and managers.

Now that it is clear that the OECD guidelines apply to Canadian shareholders who correspond to an MNE under the guidelines – shareholders that include some of the world’s largest pension funds, large financial institutions investing individual retirements savings, and smaller pension plans.

What does due diligence look like for these institutions? While the largest institutions may have personnel in charge of responsible investment, this is not necessarily the case for smaller pension boards which may hold a small amount of shares in thousands of companies scattered across the world.

Practical Steps

Regardless of size, asset owners and managers can take very practical steps that will enable them to know and show that they meet expectations under the OECD guidelines.

This starts with having a clear and credible incorporation of ESG risks into key policies. Importantly, investor policies that comply with the OECD guidelines will acknowledge that risk-based due diligence includes the analysis of risks to the parties affected by the operations of MNEs such as workers or individuals – not just financial risks. Pension plans may incorporate the ESG issues in line with the OECD guidelines into their investment policy statements, their proxy voting guidelines, or their request for proposals with asset managers. Asset managers may proactively incorporate ESG issues into their mandates.

Secondly, investors need to carry out risk-based due diligence on an ongoing basis. While it can be challenging to prioritize the most pressing environmental or social risks within an investment portfolio, investors could choose to take into account key company risks within specific activity sectors or exposure in geographies with weak rule of law.  Useful tools to prioritize risks include the Sustainability Accounting Standards Board Materiality Map, the Corporate Human Rights Benchmark, and ESG rating agency screens. Investors may supplement their rationale for ESG risk prioritization with consultations. A pension plan can consult its beneficiaries while an asset manager can consult its clients to inform their respective decisions.

Thirdly, to prevent and mitigate adverse impacts, investors should use the leverage they have as shareowners. Asset owners and managers may opt for a shareholder engagement with the company to improve performance on an ESG issue, either directly or through a service provider, and they may file shareholder proposals or vote shares on matters that involve environmental or human rights issues. For instance, investors may consider how their fund’s shares were voted on key shareholder proposals and how this fits with their due diligence under the guidelines. Key proposals in 2017 have included a proposal asking Enbridge to detail due diligence on social and environmental risks (supported by 30.1 of shareholders) and a proposal asking Exxon to report on the impact of climate change policies on company operations (62.3 support).

Finally, investors should track and communicate the steps they have taken to avoid causing or contributing to adverse social and environmental impacts, providing details on company engagement, outcomes, and proxy voting records. Transparent communication on the implementation of due diligence is a key step for investors who wish to avoid being “named and shamed” or involved in NCP complaints filed by civil society organizations. Furthermore, clear communication on the implementation of due diligence constitutes an important opportunity for investors to demonstrate that they recognize their roles and responsibilities in shaping a more sustainable form of capitalism.

Professor Roel Nieuwenkamp is chair of the OECD Working Party on Responsible Business Conduct and Hugues Létourneau is a senior ESG analyst at the Shareholder Association for Research and Education.