Governments, as well as investors, increasingly recognise that long-term financial returns depend, to a large extent, on the viability of environmental and social systems. As a result, there has been a dramatic increase in sustainable finance policy reforms around the globe, intended to align financial flows with sustainability goals. Still, most investors and other financial actors are not yet playing their full role in addressing evolving sustainability challenges.
The extent to which legal frameworks enable investors to do so is examined in a 2021 report, A Legal Framework for Impact (LFI), authored by Freshfields Bruckhaus Deringer and commissioned by the PRI, the United Nations Environment Programme Finance Initiative and the Generation Foundation.
The report finds that in the 11 jurisdictions analysed, including Canada, investors are broadly permitted to consider working towards positive sustainability impacts where this would contribute to their financial return objectives. Specifically, the extensive legal analysis concludes that:
- financial return is generally regarded as the primary purpose for investors;
- investors generally have a legal obligation to consider pursuing sustainability impact goals where that can help achieve their financial objectives;
- in some circumstances, investors can pursue sustainability impact goals for reasons other than achieving financial return goals (i.e., as an ultimate end);
- investors are legally required to pursue improved sustainability impacts if the objective of the financial product commits them to doing so.
The LFI report finds that Canadian law does permit and may even require investors to consider pursuing positive sustainability impacts – or investing for sustainability impact – as a way to achieve financial returns and protect financial value (so-called instrumental IFSI), though Canadian law limits the pursuit of positive sustainability impacts as an end in itself (ultimate ends IFSI).
Our own analysis shows that many Canadian investors may be interpreting their legal duties in ways that discourage them from considering sustainability impact goals, even where pursuing such goals can help them discharge their duty to achieve financial returns. Others may be reluctant to change established practices and allocate resources to the pursuit of sustainability impact goals.
The main reason for this lies in a lack of legal clarity about investors’ duties and insufficient action by policy makers to encourage and enable responsible investment, rendering Canada a low-regulation jurisdiction by international standards. For example, sustainability-related reporting and disclosure of stewardship activities by Canadian investors remain overwhelmingly voluntary. Making these disclosures mandatory could result in greater awareness of ESG factors among investors and deeper engagement with investee companies.
Building on the LFI report, this paper argues that policy changes are required if investors are to contribute fully to Canada’s long-term environmental and social sustainability. We examine the relevant aspects of the Canadian legal and regulatory framework and identify areas where more clarity and guidance are needed.
We then recommend reforms that would enable investors to consider sustainability risks and pursue sustainability impact goals, in particular where these are relevant to financial returns. A number of our recommendations are based on the Final Report of Canada’s Expert Panel on Sustainable Finance.
Our proposals include suggested changes to legal duties – due to the complexity of the Canadian legal framework, we make recommendations specific only to pension funds. Other recommendations in this paper apply to all institutional investors
- Clarify when sustainability impacts can or must be considered by pension administrators in discharging their legal duties
- Clarify in which cases fiduciary duties permit or require pension administrators to consider pursuing sustainability impact goals
- Introduce implementation requirements and guidance regarding sustainability risks and impacts
- Facilitate consideration of climate-related risks and opportunities via legislation and regulatory guidance
- Introduce sustainable finance tools that enable investing for sustainability impact
- Sustainable finance taxonomy
- Sustainability-related disclosures
- Explore measures to encourage consideration of retail investors’ views