The concept of fiduciary duty has emerged as a major fault line in the debate over ESG investing, with some arguing it offers a legal foundation to compel institutional investors to take seriously the risks posed by climate change, and others using it to justify an approach focusing primarily on financial returns.
“Considering the implications of climate change for a pension fund is consistent with, and likely required by, an administrator’s fiduciary duties,” the report argues. “Specifically, the duty of prudence coupled with the duty of loyalty requires an administrator to consider factors that are financially relevant to fund performance and its ability to provide pensions.”
PRI said the legal framework even provides for some cases where sustainability impact goals can be pursued “for reasons other than achieving financial return goals.”
Despite this legal framework, the report says not enough is being done by Canadian institutional investors and suggests this is due to a “narrow interpretation” of the laws coupled with a “reluctance to change established practices.”
In addition, disclosure is largely voluntary, leaving regulators and beneficiaries in the dark about crucial decision-making and providing less incentive to challenge portfolio companies on their carbon emissions than if the disclosure was mandatory.
“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.”
Such hard-line insistence comes at a difficult time for institutional investors as they try to balance government climate commitments and the demands of environmental groups — including accusations that their stated goals are mostly talk and “greenwashing” rather than action — against pushback from beneficiaries and legal groups that argue pensions are forgoing profits, jeopardizing returns and acting in an anti-competitive manner by coordinating investment criteria based on climate-related goals.
While Fink has been outspoken about the role of environmental and social goals in investing, some institutional investors have pushed back against blanket demands for climate action and disclosure.
Jim Keohane, who sits on the board of directors of Alberta Investment Management Corp. and was previously chief executive of Healthcare of Ontario Pension Plan (HOOPP), a PRI member, said there is already evidence of the cost of pressure to divest of oil and gas producers.
“Oil and gas stocks were the top performing group in the market last year, so if you had previously divested of oil and gas stocks you would have significantly underperformed the market,” he said.
Keohane pointed out that one of PRI’s partners in the report, Generation Foundation, has a stated goal to “pursue a wholesale shift in capital flows to drive a net zero economy.”
This suggests, he said, that there may be an interest in “trying to use pension plans to pursue their climate change alarmist agenda.”
Keohane said this is particularly problematic if government policy and legislation is used to sway the behaviour of institutional investors, as recommended by the PRI report.
“One of the main reasons for the success of the Canadian pension model has been the governance structure which has allowed the Canadian funds to remain independent and free of government interference, which enables them to make decisions which are in the best interests of the members of the pension plan.”
Another Canadian pension official noted that funds across the country are bound by different mandates, which influences their investment decisions. The Caisse de dépôt, for example, has a dual mandate which includes an obligation to support Quebec, while the Canada Pension Plan Investment Board is guided by a mandate to “maximize sustained long-term returns without incurring undue risk.”
In 2021, the Caisse pledged to divest all oil producing assets by the end of the following year as it aimed to reduce the carbon emissions generated by assets in its investment portfolio.
The same year, CPPIB’s incoming chief executive John Graham said blanket divestment was “essentially a short on human ingenuity” and pledged to invest in the entire energy ecosystem, including continuing to invest and oil and gas assets while also backing companies transitioning to lower carbon output. More recently, Canada’s largest pension plan has highlighted how it uses its shareholder voting power to pressure companies to step up when it comes to ESG, including on efforts related to the energy transition.
Margarita Pirovska, PRI’s director of policy, said her organization is aware that mandate-specific decisions must be made in some cases, and noted that some funds have made progress beyond what her organization is prescribing.
She said it was not the intention of the new report to single out certain investors or praise or shame anyone in particular for their level of progress.
As for the current backlash against mandating action on climate and other ESG factors, Pirovska said she believes it stems from “quite a lot of misunderstanding” about what responsible investment is.
“We want them to make more sustainable investment decisions to essentially aim to generate more sustainable financial returns.”
The bottom line, though, is that PRI sees little wiggle room when it comes to Canadian pensions and the consideration of climate-related factors.
The report said pension administrators in Canada should be required to incorporate assessment of sustainability risks and impacts into their investment policies and processes. Furthermore, a plan’s statement of investment policies should include information on how and to what extent administrators take into account relevant sustainability risks and impacts when investing plan assets in line with their duties.
“It is not mainstream practice for investors to systematically consider the importance of ESG risks, opportunities and system-level sustainability impacts to the fund’s purpose and financial objectives over time,” said PRI’s Krauter.
“Incorporating this understanding in the fund’s investment beliefs would provide a solid foundation for the fund’s investment strategy and approach. That’s why PRI recommends that the relevant regulatory authorities spell this out clearly for investors.”
“Given the many credible voices pronouncing that climate change will have broad and dramatic implications for the natural world and economies which depend upon it, an administrator should be able to conclude that climate change is financially relevant to fund performance and its ability to pay pensions,” the report said.
