Fiduciary Duty: ESG Disclosure 101

Authored By: Randy Bauslaugh | Publish Date: April 21, 2017

Plan administrators face corporate and personal liability for breach of fiduciary duty if they fail to adequately protect or invest the assets of a registered pension plan. Where do environmental, social, and governance (ESG) considerations fit into that mix? And what about socially responsible investment (SRI)? What should plan administrators be saying or doing?

The purpose of this article is to provide some practical guidance on these issues. A bit of understanding can help administrators avoid making statements or disclosures about ESG or SRI investment practices that could provide proof that they don’t understand their fiduciary duty or, worse, that they are in breach of it. After all, SIPPs and other disclosures are evidence.

On January 17th a consortium supported by the United Nations, released Fiduciary Duty in the 21st Century, Canada Roadmap. That document makes a series of recommendations to enable the market-wide adoption of ESG factor integration.1 This includes recommendations for regulatory change that urges Canadian jurisdictions outside of Ontario to at the very least adopt Ontario-style ESG disclosure rules.

ESG Investing – The Law

Unlike many other areas of fiduciary responsibility, the law on ESG investing in all parts of Canada is very clear. If ESG factors relate to financial performance or risk mitigation, taking them into account is not only allowable, but may be legally required. As a consequence, administrators should probably avoid saying they never take ESG factors into account.

SRI investing – The Law

The legality of investing to achieve social or ethical purposes is different. For administrators of registered pension plans, there are has two distinct pieces.

First, plan fiduciaries can be SRI investors if the plan’s foundation documents clearly and unambiguously permit the fiduciaries to take specific social or ethical purposes into account and provide explicit directions. By foundation documents, I mean the plan text or preferably the trust agreement, if there is a trust. What the SIPP says is not, all by itself, likely to provide the necessary legal authorization to invest for social or ethical purposes. The SIPP is a policy or governance document that guides strategy and conduct, it does not dictate conduct.

The second requirement for SRI investing is that stipulated SRI purposes cannot take precedence over income tax requirements necessary to maintain the tax sheltered status of registered pension plans. Under tax rules, the primary purpose of a registered pension plan must be to provide financial benefits, namely pensions, to participants. SRI considerations cannot trump that primary purpose.



A major barrier to understanding the legal obligation of plan fiduciaries on ESG seems to be the confusing language that shades the boundary between taking into account financially relevant ESG factors on the one hand and promoting ethical or social behaviour for its own sake on the other. Legislation and regulatory guidance notes blur these distinctions. Ontario’s 2016 Investment Guidance Note on ESG disclosure suggests they are part of a continuum.2 They aren’t. They’re distinct. One relates to ESG; the other is a moral or ethical imperative.

It is also not helpful to talk about ESG factors as being ‘non-financial factors’ as Manitoba’s legislation seems to do.3 This is because if they are not financial factors, then they cannot be advancing the primary purpose of a registered pension plan, which by law must be to provide financial benefits. If they are not relevant to providing financial benefits, they shouldn’t be considered. When ESG factors inform performance assessment, sustainability or risk, they are ipso facto financial factors and can be, and arguably must, be taken into account by fiduciaries.

ESG Investing – How To

If ESG factors are considered, disclosure rules also require an explanation of how ESG factors are considered.

The how should be broadly stated, because specific actions or strategies must be reasonable in the particular circumstances. How administrators deal with any ESG factor is a matter of discretion. Administrators should not be fettering, restricting, or pre-guessing future context by detailed statements of what will or won’t be done. The ‘how’ should also be consistent with the proxy voting policy and the rest of your investment policy.

For many, this will result in broad statements that simply indicate they are taken into account to evaluate the economic benefits of investments, to identify economically superior investments, or to assess materiality to financial performance and risk in a way that informs decisions to buy, sell, retain, engage, or sue. The ESG policy might also signal that pension funds and their managers are more likely to invest in companies that make efforts to report material ESG risks and opportunities. This approach will encourage efforts by issuers to provide more detailed ESG reporting and, ultimately, that will leave open a myriad of options that can respond reasonably to particular ESG factors and circumstances. The actual action taken can be specifically documented in minutes or file notes if necessary to support the reasonableness of any fiduciary decision taken that relies on or ignores ESG considerations.

ESG Investing That Prompts Social Change

As noted above, administrators cannot use the pension fund to achieve social goals – at least not directly, unless the plan’s foundation documents authorize it. This does not mean administrators cannot respond to ESG concerns in a manner that has the effect of achieving social goals.

If a company’s record on the environment is dismal, and there are reasonable grounds to believe that this may be a factor that bears on the performance or financial sustainability of that company as a pension fund investment, then the administrator may, and arguably must, take those factors into account. Then what?

Selling may not be the best fiduciary move, particularly if the plan holds large positions or the investment is an important part of a long investment horizon.

Engagement, or nudging the company to do better (or nudging your fund manager to nudge investee companies), might be a more productive response from a financial performance and fiduciary point of view. Investors that take ESG factors into account have often worked hard to persuade publicly held companies to address poor labour and human rights practices in their global supply chains, address climate change, improve health, safety, and environmental records, or promote racial or gender diversity on their boards. This might be perceived to be social activism. Maybe it is. But as long as the motivation is to improve financial performance, to improve short-, medium-, or long-term sustainability or to mitigate risk, then it is perfectly okay from a legal perspective. It’s only when investments are made or avoided and actions are taken to better society without giving primary consideration to the financial impact on the pension fund that an administrator crosses a line that takes it out of ESG territory and puts it in SRI territory ‒ where it may not be compliant with its fiduciary obligations unless its foundation documents properly allow for it. The specifics of engagement should not be part of the policy statement; that will be dictated by circumstance. The policy statement only needs to accommodate it.

Engagement on ESG factors is not likely to be fundamentally different than it would be for other more traditional financial factors. The details of engagement will, and should be, driven by particular circumstances, overall investment style (passive or more active), the investment time frame for that investment, the urgency of the situation, the administrator’s level of confidence that the investee company can respond, whether direct conversations with directors or senior management are possible, whether collaboration with other investors is possible, consistency with proxy voting guidelines, the nature of the ownership structure and the plan’s investment in it, the company’s history of response to shareholder engagement, and ‒ bottom-line ‒ whether you, as plan administrator, can identify a path to improvement that can be driven by engagement.

ESG Vs SRI: Performance

Another way to view the distinctions between ESG and SRI is to look at performance. There is a growing body of academic research that shows a strong link between taking into account ESG factors and financial outperformance. SRI is not so consistent.

The reasons for this are fairly obvious. ESG investors are guided by financial performance. Taking ESG factors into account provides them with more financial information that may have a direct relationship to the economic value of the investment. So it is logical that investors who take ESG factors into account may be in a better position to make better financial decisions.

SRI is different. This is because SRI does not seem to have any single point of financial focus to guide it. Instead it tends to be a mixed bag of different personal values, goals, and philosophical connections. SRI doesn’t always insist on financial outperformance or risk mitigation. It has other focal points that relate to many different concerns, some of which overlap with ESG concerns, like climate change, equal employment opportunity, diversity, alleviation of poverty, and human rights. The difference is often one of motivation. SRI tends to be motivated by the specific concern itself – for example, the protection of the environment for the sake of the environment – or by a particular religious perspective or ethical cosmology. SRI investors are often exclusionary investors. They exclude certain companies or whole industries because of their products or services; for example, companies involved in tobacco, pornography, alcohol, gaming, or the production of weapons, regardless of profitability, performance, or sustainability.

The differences between ESG and SRI are confusing not only to governments, plan sponsors, and administrators, but to their service providers as well, including consultants, investment managers, and, yes, even lawyers. In an era where ESG disclosure is being promoted as a minimum legal compliance issue for fiduciaries, it behooves plan fiduciaries to understand where the boundary line is. Frankly, I don’t think the legal line is that vague and I don’t think it is the wide spectrum suggested by FSCO’s guidance note.

Documenting ESG Disclosure – Dos And Don’ts

In Ontario, the plan administrator must now disclose whether, and if so how, ESG factors are incorporated into investment policies. Here are some dos and don’ts.

  • Get the disclosures checked by a lawyer.

Any written statement can and will be used in evidence in any matter where a proper understanding of fiduciary duty is in issue. Sure, engage with your investment professionals, but check the final copy with your lawyer.

  • Keep the disclosure short and to the point.

I am not sure why more than five or six sentences cannot cover off even the most sophisticated ESG policy disclosure. You may need more documentation to support particular actions that are taken.

  • Never say ‘never.’

Your fiduciary duty is to consider relevant factors. If a relevant ESG factor arises, you shouldn’t ignore it. If you say never, you better explain it.

  • Don’t get too specific.

Your fiduciary duty is to consider relevant factors and ignore irrelevant factors relating to financial performance or risk mitigation. Many factors are contextual and cannot be anticipated. A general reference is less likely to provide evidence that you unreasonably restricted your discretion or ignored or excluded relevant ESG factors that come to your attention. A general reference should be interpreted as including the broadest range of ESG factors, so you may also have to indicate what radar system you have in place for picking them up.

  • Don’t confuse ESG investment practices with SRI or ethical investing.

If you engage in SRI, you better make sure your foundation documents support it. You might also indicate that you appreciate the differences and that you are not violating your fiduciary duty to act in the best financial interests of plan members or the primary purpose test for income tax purposes by taking SRI factors into account.

How you take into account ESG factors should also be broadly stated because how they are incorporated is likely to be influenced by what is relevant in the circumstances. And keep the ‘how’ consistent with your proxy voting statement and the rest of your investment policy and philosophy.

Since most plans use external managers, most plans will not be able to say much more than that they take their manager’s ability to identify and take ESG factors into account in manager selection, retention, and termination. It doesn’t mean it will be a governing consideration, since ESG abilities may be completely offset by management fees, expense ratios, or manager experience. In cases where it’s a close call, written reasons for any particular decision to hire, fire, or keep a manager that has to do with their ability to consider ESG ought to be set out in minutes or file notes relating to the decision.

For DC plans where investment options are provided, there may be some additional language required if the plan grants investment options to plan members.

For larger plans that make direct investments, general statements of principle are likely to be the best course for SIPP disclosure, along with some indication that they use those factors in making decisions to hire, fire, invest, sell, engage, or sue. Again, keep it short. It is the reaction to circumstances and facts that drive the reasonableness of fiduciary behaviour; policy disclosure should not be a ‘how to’ manual, it is more of a strategic guidance. The detail of engagement and of other actions taken can ultimately be set out in minutes of meetings or file memoranda that may or may not end up being in the public domain. At that point, the reasons for what was done can be contextualized to the circumstances, so the policy should be broad enough to allow a contextual approach that demonstrates reasonableness.

ESG disclosure and the confusion around use of ESG factors has contributed to considerable discussion. But it has also raised consciousness, resulting in better information about ESG risks and opportunities that could materially affect corporate performance. ESG factors should not be viewed as mere collateral considerations or tie-breakers, but rather, and certainly in any case where the information is readily available, they ought to be viewed as proper components of the fiduciary’s primary analysis of the economic merits of competing investment choices.

The bottom line is that a proper fiduciary perspective on ESG is one that sees it as financial insight. As a result, administrators and fund managers should be demanding better and more fulsome ESG disclosure. It ought to be dealt with just like any other consideration in the risk-performance-assessment matrix. Administrators who understand this will no doubt gain more confidence in devising and disclosing appropriate ESG investment policy that first and foremost serves their fiduciary duty to plan beneficiaries.

Who knows, it may also be socially responsible.

Randy Bauslaugh leads the national pensions, benefits, and executive compensation practice at McCarthy Tétrault.

  1. Principles of Responsible Investment (PRI), United Nations Environmental Protection Financial Initiative (UNEP FI) and The Generation Foundation, Fiduciary Duty in the 21st Century, Canada Roadmap, January 17, 2017 The recommendations address core areas like corporate reporting, shareholder engagement, investor education, and regulatory change. It also partially helps to breakdown the differences between ESG and socially responsible investment.
  2. Superintendent of Financial Services Ontario, Environmental, Social and Governance (ESG) Factors, Investment Guidance Notes IGN-004, October, 2015, pp.2-3.
  3. The Pension Benefits Act, CCSM c P32, section 28.1(2.2).

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