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Environmental, Social and Governance Factors: Does Failure to Consider ESG Issues Constitute a Breach of Fiduciary Duty?

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Changes made to the Ontario Pension Benefits Act and Regulation (the “Ontario PBA”), which came into force on January 1, 2016, now require a pension plan’s statement of investment policies and procedures (“SIPP”) to include information as to whether environmental, social and governance (“ESG”) factors are incorporated into the plan’s SIPP and, if so, how those factors are incorporated.  The changes have raised more questions than there are answers for plan administrators.  The primary question is whether there is a legal requirement to take ESG into account or must the administrator simply consider whether, or not, to incorporate ESG?

Ontario is not the only jurisdiction to introduce ESG into the SIPP equation. In 2005, Manitoba indicated that fiduciaries could consider ESG factors provided administrators otherwise complied with statutory fiduciary duties.  Not taking ESG factors into account is not a breach of any statutory law (at least not yet), but Ontario’s recent move has certainly added to the not-so-old debate:  Is a failure to consider ESG factors in your pension plan’s SIPP a breach of fiduciary duty?

On a basic level, it is the fiduciary’s role as plan administrator to be responsible for investing the pension fund in accordance with the administrator’s standard of care, in a prudent manner and always in the best interest of plan beneficiaries. Pursuant to section 22 of the Ontario PBA, prudent investing entails understanding, monitoring and investigating risk.  The administrator is responsible for determining what prudence requires within the context of the plan in question.

North American investors have in general been slow to incorporate ESG factors into their investment research, analysis and decision making, whereas European investors have been doing so for many years.

Canada’s large public sector pension funds, including CPP, Ontario Teachers’, HOOPP, OMERS, bcIMC and others, have now incorporated ESG into their investment policies. CPP Investment Board has stated:

“We believe that organizations that manage Environmental, Social and Governance (ESG) factors effectively are more likely to create sustainable value over the long term than those that do not. As we work to fulfill our mandate, we consider and integrate ESG risks and opportunities into our investment decisions.”

The link between ESG issues and bottom line profits and share prices was illustrated late in 2015 when BHP Billiton and Vale’s horrific mine disaster in Brazil resulted in the deaths of 17 people as well as hundreds of individuals losing their homes due to a massive dam burst. In February 2016, BHP recognized a US$1.12 billion provision related to the disaster.

The questions for administrators include:

  • How should you balance your primary objective to achieve optimal rates of return within an acceptable level of risk?
  • Should an investment target company’s ESG record take precedence over its increase in share price?

Administrators face significant hurdles in gathering relevant non-financial (or extra-financial) data if they wish to take ESG factors into account. Independent ESG research and analysis firms are available to help pension fund administrators gather materially relevant information on potential investments and their respective corporate ESG performance as well as information on external managers, many of whom are already integrating ESG factors into their investment processes.

Bottom line for administrators, if ESG factors are determined to be of importance in their investment policies and procedures, their first step is to separate the identifiable legal implications that will arise from incorporating ESG information into their SIPP and how their governance committee is expected to assess ESG analytics into their overall risk management policies. Does ESG act as a tie breaker when other financial considerations appear equal?  How should administrators communicate (and document) their ESG factors and decision-making processes to the plan beneficiaries?

Plan administrators should seek legal advice to ensure their fiduciary duties are fulfilled if (and more likely when) they begin to embark on considering ESG factors into their investment decision-making process.

 

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