capital markets and sustainability: investing in a sustainable future

7/31/2019 Capital Markets and Sustainability: Investing in a sustainable future

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S t a t e o f t h e D e b a t e


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National Round Table on the Environmentand the Economy, 2007

All rights reserved. No part of this work covered bythe copyright herein may be reproduced or used inany form or by any means graphic, electronic ormechanical, including photocopying, recording,

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Library and Archives Canada Cataloguing in Publication

Capital markets and sustainability : Investing in asustainable future. (State of the debate report)

Issued also in French under title: Les marchs financierset la durabilit.

ISBN 978-1-894737-13-5

1. InvestmentsCanadaDecision making. 2. Socialresponsibility of businessCanada. 3. Capital marketCanada. 4. Sustainable developmentCanada. 5.Disclosure of informationCanada. I. National RoundTable on the Environment and the Economy (Canada)II. Series: State of the debate (National Round Table onthe Environment and the Economy (Canada))

HC120.E5C37 2007 658.4080971 C2006-906883-6

This book is printed on Environmental Choice papercontaining 20 percent post-consumer fibre, usingvegetable inks.

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Other publications available from the NationalRound Table State of the Debate on the Environmentand the Economy Series:

1. State of the Debate on the Environmentand the Economy: Water and WastewaterServices in Canada

2. State of the Debate on the Environment andthe Economy: Private Woodlot Managementin the Maritimes

3. State of the Debate on the Environmentand the Economy: The Road to SustainableTransportation in Canada

4. State of the Debate on the Environment and theEconomy: Greening Canadas Brownfield Sites

5. State of the Debate on the Environmentand the Economy: Managing Potentially

Toxic Substances in Canada

6. State of the Debate on the Environmentand the Economy: Aboriginal Communitiesand Non-renewable Resource Development

7. State of the Debate on the Environment andthe Economy: Environment and SustainableDevelopment Indicators for Canada

8. State of the Debate on the Environment and theEconomy: Environmental Quality in CanadianCities: the Federal Role

9. State of the Debate on the Environment andthe Economy: Securing Canadas NaturalCapital: A Vision for Nature Conservation inthe 21st Century

10. State of the Debate on the Environment and theEconomy: Economic Instruments for Long-termReductions in Energy-based Carbon Emissions

11. State of the Debate on the Environment andthe Economy: Boreal Futures: Governance,Conservation and Development in CanadasBoreal

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D e b a t e R e p o r t

February 2007


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State of the Debate Report

About Us

The National Round Table on the Environmentand the Economy (NRTEE) is dedicated to explor-ing new opportunities to integrate environmentalconservation and economic development, in orderto sustain Canadas prosperity and secure its future.

Drawing on the wealth of insight and experiencerepresented by our diverse membership, our mis-sion is to generate and promote innovative waysto advance Canadas environmental and economicinterests in combination, rather than in isolation.In this capacity, it examines the environmental andeconomic implications of priority issues and offersadvice on how best to reconcile the sometimescompeting interests of economic prosperity andenvironmental conservation.

The NRTEE was created by the government inOctober 1988. Its independent role and mandatewere enshrined in the National Round Table onthe Environment and Economy Act, which waspassed by the House of Commons in May 1993.Appointed by Governor in Council, our membersare distinguished leaders in business and labour,universities, environmental organizations,Aboriginal communities and municipalities.

How We Work

The NRTEE is structured as a round table inorder to facilitate the unfettered exchange ofideas. By offering our members a safe haven fordiscussion, the NRTEE helps reconcile positionsthat have traditionally been at odds.

The NRTEE is also a coalition builder, reachingout to organizations that share our vision for sus-tainable development. We believe that affiliationwith like-minded partners will spark creativityand generate the momentum needed for success.

And finally, the NRTEE acts as an advocatefor positive change, raising awareness amongCanadians and their governments about thechallenges of sustainable development andpromoting viable solutions.

We also maintain a secretariat, which commissionsand analyses the research required by our membersin their work. The secretariat also furnishes admin-istrative, promotional and communications supportto the NRTEE.

The NRTEEs State of the Debatereports synthesizethe results of stakeholder consultations on potentialopportunities for sustainable development. Theysummarize the extent of consensus and reasonsfor disagreements, review the consequences ofaction or inaction, and recommend steps specific

stakeholders can take to promote sustainability.

Mandate


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ChairGlen MurrayToronto, Ontario

Vice-ChairEdythe A. MarcouxGibsons, British Columbia

Elyse AllanPresident & CEO, GE Canada, Toronto, Ontario

David V.J. BellProfessor Emeritus, Senior Scholar and Former DeanFaculty of Environmental Studies, York UniversityToronto, Ontario

Janet L.R. BenjaminNorth Vancouver, British Columbia

Katherine M. BergmanDean, Faculty of Science, University of ReginaRegina, Saskatchewan

William J. BorlandDirector, Environmental Affairs, JD Irving LimitedSaint John, New Brunswick

Honourable Pauline Browes, P.C.Toronto, Ontario

Wendy L. Carter

Vancouver, British ColumbiaDavid ChernushenkoOwner, Green & Gold Inc., Ottawa, Ontario

Richard DrouinCorporate Director, Montreal, Quebec

Timothy R. HaigPresident and CEO, BIOX Corporation,Oakville, Ontario

Linda Louella InkpenSt. Phillips, Newfoundland and Labrador

Mark JaccardProfessor, School of Resource and EnvironmentalManagement, Vancouver, British Columbia

Stephen KakfwiYellowknife, Northwest Territories

David KerrCorporate Director,Toronto, Ontario

Manon LaportePresident & CEO, Enviro-Access, Sherbrooke, Quebec

Audrey McLaughlin

Whitehorse, YukonAlfred PilonPrsident directeur gnral, Qubec-Amriques pourla jeunesse, Montreal, Quebec

Darren Allan RiggsMarketing and Sales Manager, Superior SanitationServices Ltd., Charlottetown, Prince Edward Island

Keith StoodleySenior Vice-President, Marketing, ProvincialAerospace Group Ltd., St. Johns, Newfoundland

and LabradorSheila Watt-CloutierOutgoing Chair, Inuit Circumpolar ConferenceIqaluit, Nunavut

Steve WilliamsExecutive Vice-President, Oil Sands SuncorEnergy Inc., Fort McMurray, Alberta

Acting President & CEOAlexander Wood

National Round Table on the Environmentand the Economy Members


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Co-ChairsPatricia McCunn-MillerExecutive Vice-President,Corporate Responsibility, Synenco Energy Inc.

John WiebePresident & CEO, Globe Foundation of Canada

MembersIan BrucePresident & CEO, Peters & Co. Ltd

Charles CoffeyExecutive Vice-President, Government Affairs &Business Development, RBC Financial Group

Sean Harrigan *Commissioner and President, Los Angeles Fire and

Police Pension Board; Vice-President, CaliforniaState Personnel Board (Former President of the Boardof Administration, California Public EmployeesRetirement System [CalPERS])

Michael JantziPresident & CEO, Jantzi Research Inc.

David KerrCorporate Director(Former Chairman,Falconbridge Limited)

Richard Legault

President & Chief Operating Officer, BrookfieldPower Corporation (formerly Brascan PowerCorporation)

Ernst LigteringenChief Executive, The Global Reporting Initiative

Ken OgilvieExecutive Director, Pollution Probe

Bill SwirskyVice-President, Knowledge Development,Canadian Institute of Chartered Accountants

Bill TharpChief Executive Officer, The Quantum LeapCompany, Ltd

David WheelerDean of Management, Dalhousie University(Former Erivan K. Haub Professor of Businessand Sustainability, Schulich School of Business,

York University)Diane Wood *International Vice-President, National Union ofPublic and General Employees (NUPGE)

Ex-officio MembersSuzanne HurtubiseDeputy Minister, Public Safety and EmergencyPreparedness Canada (Former Deputy Minister,Industry Canada)

Barry Stemshorn

Research Fellow, School of Management,University of Ottawa (Former Assistant DeputyMinister, Environmental Protection Service,Environment Canada)

NRTEE Policy AdvisorDavid Myers

Members of the Task Force onCapital Markets & Sustainability

Note: Although there is broad agreement on the main report, the two Task Force members whose names are marked with an asterisk (*)

above wish to express their disagreement with the inclusion of the Foreword. Disclosing this is in keeping with the National Round Table

on the Environment and the Economys state of the debate process, with its tradition of embracing and acknowledging the importance

of both consensus and divergent views in its reports.

Meetings held inOttawa, February 16, 2005Toronto, June 17, 2005Toronto, October 3, 2005


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Mandate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iii

A Message from the Co-Chairs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Foreword . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

1) Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

2) Premise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

3) Capital Markets & Sustainability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

4) Sustainable Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

5) Sustainable Pension Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

6) Fiduciary Duty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

7) Materiality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

8) Short-termism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

9) A Final Word . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38

Appendix A: Summary of Research Papers Commissioned . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40

Appendix B: National Consultation Participants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53

Endnotes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62

Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68

Contents


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We are very proud to present the final report ofthe Capital Markets and Sustainability Task Force.

The work of the Task Force has greatly enhancedour understanding of how sustainable developmentissues interact with the activities of the businessworld and how they affect long-term competitive-

ness not only of the individual enterprise, but ofthe economy as a whole.

Our work was greatly enhanced by the insights ofsome of Canadas leading thinkers who helped usexplore the links between corporate responsibilityand business competitiveness. This has allowed usto define win-win opportunities in the capitalmarkets that can benefit society as a whole.

Canadian companies have begun to recognizethe importance of social drivers for change including, among others, stakeholder expectations

and the publics perceptions of an enterprisescommitment to the environment and to broadersocial and community values.

It became clear to us that the other side of thecapital market the providers of capital arelistening to what the marketplace is saying. Theyunderstand the importance of integrating environ-mental, social and governance factors into theirshareholder counsel and their investment decisions.Their voices are having a major impact in redefin-ing how the capital markets work.

One example is the Carbon Disclosure Project(CDP), which now encompasses over US$31 trillionin managed funds around the world. Participants inthe CDP make explicit the fact that climate riskawareness and responsible corporate managementare key factors in investment decision making.

Another example is the Global Reporting Initiative(GRI). Companies that adhere to the reporting stan-dards of the GRI globally comprise approximately26 percent of the S&P 100 Index and approximately24 percent of the S&P 1200 Index (2006).

In developing this report we were able to identifyand explain many of the market barriers thatuntil now have clouded the analysis of how environ-mental, social and governance factors influence theworld of capital investment. We have articulatedthese barriers, including short-termism, as they relateto the application of fiduciary duty and materiality,and have provided several recommendations thatwill help to provide greater transparency anddisclosure in the corporate sector.

We share the view of our Foreword authorsthat innovation and productivity are enhancedthrough Canadian corporations and capital marketstaking leadership over environmental, social andgovernance issues. Our overarching goal was toenhance the understanding of the factors thatlink the world of business with the broader socialdimensions of the nation, thereby equipping capi-

tal market issuers and providers with better toolsin the formulation of their investment decisions.

A Message from the Co-Chairs


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Capital Markets and SustainabilityInvesting in a sustainable future

We would like to thank the Task Force, theNRTEE, as well as all those in business, govern-ment, academia who gave unstintingly of their timeand energy to assist us in developing this report. It

was a tremendous learning experience, one whichwe hope will assist in shaping the strategic choicesto be made in defining Canadas competitive future.

Patricia McCunn-Miller

Executive Vice-President, Corporate Responsibility,Synenco Energy Inc.Co-Chair, Capital Markets & Sustainability Task Force

John Wiebe

President & CEO, GLOBE Foundation of CanadaCo-Chair, Capital Markets & Sustainability Task Force

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We see no necessary contradiction between acompetitive and innovation-driven Canadianeconomy and the desirability of enhancing thesustainability of Canadian firms.i Nor do weneed to be convinced of the potential salienceof environmental, social, ethical, and governance

risks to the reputation of Canadian firms, and

the relevance of such risks to both domestic andinternational investors.ii However, in pursuingwin-win scenarios in this area, we do not see theneed for increased regulation, increased taxation,or increased interference in the normal value-creating activities of Canadian businesses.

In our deliberations on the issues raised by thework of the Capital Markets and SustainabilityTask Force of the National Round Table on theEnvironment and the Economy, three principalthemes emerged as central to achieving optimal

outcomes for the economic competitiveness ofCanadian industry, the sustainable developmentpolicies of all levels of Canadian government, andthe values of Canadians. These were (a) the needfor regulatory efficiency of financial services in particular, the need to remove perceived andactual barriers to capital flows represented by

jurisdictional complexity; (b) the need to improvethe fiscal environment so as to foster corporateinvestment in technology and efficiency, as wellas for enterprise growth; and (c) the importanceof enhanced disclosure and transparency on what

is becoming recognized by legal, accounting, andregulatory authorities, as well as by the capitalmarkets, as sources of novel risk, including social

and environmental issues, to corporations andtheir investors.

Special factors for Canada

We have taken several contextual factors specific

to the Canadian situation into account in framingour commentary for this Foreword. They are thefollowing:

Canadian stock exchanges are heavily weighted

toward natural resources and financial indus-tries. Canadian exchanges are a world-leadingdestination for investments in resources and are,therefore, uniquely exposed to public policy andpublic sentiment on extractive industries and

issues such as climate change.iii Meanwhile, ourfinancial services sector has experienced its fairshare of exposure to recent governance scandals.

Canadian systems for financial regulation including the pension fund, securities, banking,and insurance regulation areas are uniquelyfragmented compared to other countries

regulatory regimes.ivThe regulators havediffering rules, making it time-consumingfor companies and investors to navigate.This is particularly confusing to external(i.e., international) investors.

Canadian micro and small cap companiescomprise a disproportionately large numberof all listed companies. This factor has anumber of implications for public policy andrequires particular sensitivity in discussionsof the reporting and other resource-intensiverequirements to be expected of such companies.

A very low proportion of Canadian pensionplans are active in venture financing, especiallyin comparison to US pension plans. Indeed,there is a generally perceived low tolerancefor risk among Canadian investors bothindividual and institutional.

Foreword1

1 The views expressed in the Foreword are those of its contributors and do not necessarily reflect those of the Task Force or the

National Round Table on the Environment and the Economy.


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Canadas spending on research and development(R&D), as a proportion of GDP, is relativelylow compared to that of the other Organizationfor Economic Co-operation and Development(OECD) countries despite some of the fiscalincentives that exist in Canada for R&D.

The following discussion of our three principalthemes regulatory efficiency, improvementof fiscal incentives, and enhanced disclosure will lead to several key opportunities for Canadato explore.

Regulatory efficiency

We are convinced that the current fragmentedand confusing nature of financial regulationin Canada acts as a net cost to Canadian firmsand their investors and is thus a de facto drag onthe efficiency and, in turn, the sustainability ofthose firms. For example, it is not controversialto assert that natural resource-based companiesare important to Canadas competitiveness andproductivity and that they represent a significantsource of inward investment. We can also assertthat Canadas mining and oil and gas companiesare adopting world-leading technological innova-tions that promote both efficiency and long-term

sustainability.Consequently, it makes little sense to confuseforeign investors with competing provinciallistings and unaligned regulatory requirementsfor those firms; in effect, that will only act as adrag on capital flows. We therefore agree withBank of Canada Governor David Dodges viewthat there is no need for Canada to have differentsecurities regulation for different provinces.v

The report Blueprint for a Canadian SecuritiesCommissionvi put together by a national groupchaired by Purdy Crawford, helps to move thedebate beyond the need for a national system bymaking recommendations for actually designingand implementing a single securities regulator.

Similarly, we recognize that pension plans representa large, somewhat untapped resource for venturecapital and small- and medium-sized enterprise(SME) financing. We recognize, too, that there

are opportunities to link such financing to sustain-ability issues of interest to pension plans andtheir trustees. It is noteworthy, here, that Canadianinstitutional investors are significantly less exposedthan their US counterparts to the private equitymarket.vii This has been attributed to institutionalbarriers, both perceived (for example, due tolack of experience and memories of poor perform-ance in the 1980s) and real (for example, thecapital adequacy rules from the Office of theSuperintendent of Financial Institutions thatspecify capital set-asides that are far greater forprivate equity relative to private debt). Institutionalinvestors should not be discouraged from engagingin the private equity market.

We note the researchers identification in a

study conducted by York University (Canada)and Kingston University (U.K.) on the compara-tive virtues of UK and Canadian public policyregarding pension plans and transparency onsustainability questions of one of the keybarriers to reform as being the fragmentednature of pension regulation in Canada.viiiAgain,this finding demonstrates how the interests ofinvestors with respect to both transparency andsustainability may be hindered, or even negated,by regulatory inefficiency.

It is worth pointing out that Canada is internation-ally unique in not streamlining its financial servicesregulation. Clearly, this represents a significantand, potentially, a growing and very material imped-iment to our countrys economic competitivenessand sustainability. We are in grave danger of beingnon-strategic and parochial in a world that requiresa much more strategic policy formation.ix

Improving fiscal incentives

Canada is a highly competitive and relativelyrich country in global terms indeed, the secondmost prosperous after the U.S.x However, thegap between US and Canadian prosperity persists.Indeed, the prosperity gap, which stood at $3,200in per capita GDP in 1981, grew to $8,700 inper capita GDP in 2004.xi This jump has beenattributed mostly to lower productivity and partly

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to matters related to capital markets. We acknowl-edge that there is no general shortage of capitalin Canada. But Canadas cost of capital has, attimes, been high, and its availability has failed

to stimulate large-scale enterprise growth.

xii

Compared to the U.S., Canadas marginaleffective tax rates for both capital and labour arealmost twice as high. Thus there is a particulardisincentive for capital investment by Canadianfirms, meaning that companies are more likelyto purchase more labour than to invest innew machinery or equipment.xiiiWe agreewith David Emerson, Minister of InternationalTrade and Minister for the Pacific Gatewayand the Vancouver-Whistler Olympics, who,in September 2005, drew attention to theuncompetitive nature of Canadas corporatetax system. One way to address this challengewould be to lower the fiscal penalties applied tocapital investment specifically, to ensure thatcorporate and capital taxation, including capitalgains tax, remains competitivexiv and, especially,to encourage the growth of innovative young firmsand competitive transitions for traditional firmswith respect to the U.S.xv

Enhanced disclosure

Research commissioned by the Task Force fromthe Canadian Institute of Chartered Accountants(CICA) identified the Managements Discussionand Analysis (MD&A) section of annual reportsas the most appropriate vehicle for identifying andhighlighting sources of novel risk to firms and theirinvestors, including those risks related to social andenvironmental issues.xviWe note, too, that theCICA recommended a range of policy options thatmight promote changes in corporate disclosure. Inour view, however, what is needed for firms and

their investors is a clearer and better disclosure ofnovel risks, not more. Empirical evidence existsthat firm valuation can be affected by social andenvironmental performance;xvii investors arealso explicitly factoring in these risks in theirinvestment portfolios.xviii So the real questionis how to ensure that the information on which

these phenomena are based is both accurate andmaterial. There may be awareness and outreachopportunities for both analysts and their clientsin recognizing and responding effectively to novel

sources of risk. This could enhance the efficientfunctioning of markets and, indeed, would notcontradict the existing duty of financial advisorsto advise clients on factors that may affect theirportfolios.

We do understand that there is evidence that whenindividual investors begin to take a greater interestin personal investments and the management oftheir portfolios, they also take a greater interest inthe nature of the companies in which they invest.We suggest, however, that enhancing the flow ofsalient information about the sources of novel risksand opportunities represented by Canadian invest-ments may have an intrinsically positive impact onthe availability of capital to more sustainable firmsin the future.

Key opportunities

We believe that the main point of connectionbetween the competitiveness of the Canadianeconomy, today and in the future, and the issuesof sustainability relates to innovation. We refer,

here, to innovation with respect to efficiencyand productivity, as well as to the best use oftechnology and capital investment.

Many of Canadas leading companies are alreadyactive in the realm of efficiency and best practicesthat lead to positive economic, social, and environ-mental outcomes. These companies are featuredin a variety of stock market and other rankingsthat recognize high performance in sustainabilityand economic value-added terms. But this is along-term agenda that is also about creating the

conditions that would allow for the emergenceof tomorrows products and services. Happily,some of our very best companies today are activelyexploring the sustainable enterprise opportunitiesof the future, including alternative energy tech-nologies, biotechnology, or nanotechnology.



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There is a special category of industrial activitythat also needs to be nurtured and facilitated byCanadian capital markets. We refer to the start-ups,new ventures, and high-technology sustainableenterprises of the future. One of Canadas biggestchallenges is to ensure that the growth of thisthird category is not undermined because ofthe structural impediments identified earlier inthis Foreword.

We believe that initiatives in the following keyopportunity areas would help to promote thecompetitiveness, innovativeness, and sustainabilityof the Canadian economy and Canadian firms:

1) For regulatory efficiency

We suggest the streamlining of financial servicesregulation across Canada into a single marketconduct regulator and a single prudential regulator.This would enhance the efficiency of Canadiancapital markets generally and, therefore, theeconomic sustainability of Canadian firms.

2) For improved fiscal incentives

We suggest improved tax incentives for investment,especially with regard to the targeting of enterprisegrowth, but also in the areas of research anddevelopment, information technology, and humancapital for all businesses. This would include thereduction of corporate tax and capital tax, fasterdepreciation on capital investments to enhancecompetitiveness, as well as an increase in thelikelihood of investments in environmentallyand socially beneficial technologies and skills.

3) For enhanced disclosure

We would suggest a requirement for clearer andbetter disclosure of novel risks in the MD&Asection of annual reports, which might, in turn,

facilitate greater transparency regarding social andenvironmental issues with respect to individualinvestors, and more effective disclosure of sustain-ability issues management by pension plans andother institutional investors.

4) For future research

More research on the detailed effects of all ourrecommendations would be welcome. We wouldalso suggest that further research be conductedinto the impacts of legitimate market-enhancinginterventions by government. For example, is therea role for government procurement policy in thisarea? As well, there is a need to better understandhow capital markets respond to new sources ofinformation on novel risk so that information canbe factored into stock prices.

Contributors:

David Brown,past Chair, Ontario SecuritiesCommittee

Steve Foerster,MBA Program Director,Professor of Finance, Richard Ivey School ofBusiness, University of Western Ontario

Roger Martin, Dean, Rotman School of Business,University of Toronto; Director, AIC Centre forCorporate Citizenship

Senator Hugh Segal, Senior Fellow, School ofPolicy Studies, Queens University

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For some time now, Canadian corporations havebeen responding to calls from various stakeholdersfor improved performance and greater transparencyon issues related to environmental sustainability,social justice, and rigorous and ethical corporategovernance. While the trend to better performance

and greater accountability is well underway, ithas in no way become the norm. Whereas somecompanies have begun to engage stakeholders,implement recognized international norms andstandards, and improve their public disclosure,the majority of large publicly traded Canadiancorporations have notyet integrated sustainabilitypolicies, programs, standards, indicators, or auditedreporting into their normal operating procedures,although an increasing number of FT500 corpora-tions are doing just that.

There are significant risks associated with notrecognizing, measuring, or managing these issuesfor individual companies, and for industry sectorsas a whole, including questions of shorter-termcompetitiveness and longer-term viability. Indeed,the remaining gaps are significant. We musttherefore ask ourselves: What is missing?

Although progress in responsible investment onthe business front versus that of the investorshould not be exaggerated, it is clear that, inthe second instance, the missing element isinstitutional investors able to handle sustainability

in a manner equivalent to that of the corporatesector. While some companies have begun to seethe benefits of sustainability, institutional investorscan still make short-term returns the old-fashionedway. To the extent that investors are not rewarding

companies for integrating environmental, social,and governance (ESG) issues into their businessdecisions, they effectively discourage companiesfrom going any further. This cycle is extendedwhen certain institutional investors are or feelprecluded from even taking into account ESG

factors in their assessment process. Ultimately,who will pay? Perhaps the sustainability ofCanadas future economy.

Meanwhile, economic and social forces are mount-ing, with the mainstreaming of socially responsibleinvestment and consumer activism being goodexamples. They have not yet overcome, however,the existing inertia and countervailing forces.

Despite the recent legal clarification that wasprovided in a 2005 study by the large andwell-known City of London law firm Freshfields

Bruckhaus Deringer,1 many fiduciaries in Canadacontinue to be advised by counsel that considera-tion of ESG factors is in general conflict withtheir fiduciary duty. Clearly, pension fund trusteesmust be made aware perhaps via regulatorsissuing guidelines or, where appropriate, enactingregulations and/or legal changes by government that considering ESG factors in capital allocationdecisions is not in conflictwith established fiduci-ary duties and that, in fact, not considering themmay actually be a potential breach of such duty.Beyond this, we need a broad political and

societal consensus for increasing the transparencyof pension fund investment, as well as a voluntaryor regulatory framework that ensures the inclusionof ESG factors in capital allocation decisionspertaining to pension plans and proxy voting.

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1 Executive Summary


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Recent work by the Canadian Institute ofChartered Accountants (CICA) helps to providesome direction on corporate disclosure of ESGfactors in Canada. The CICAs October 2005

Discussion Brief,MD&A Disclosure about theFinancial Impact of Climate Change and OtherEnvironmental Issues, pointed out that certainenvironmental (and social) disclosures are alreadyrequired by securities regulators rules2 and,therefore, are, in fact, mandatory where likelyto be material to investors.3 The CICAs MD&AGuidance reinforces this principle.4 Relevant secu-rities regulators mandatory disclosure requirementsare also discussed in the CICAs November 2004paper for the NRTEE,5which presented a rangeof policy options for consideration by the NRTEE

Task Force to improve MD&A disclosure aboutESG issues material to investors.

Without development of further rigorous guidance,the definition and consideration of materiality ofESG issues amongst capital providers could wellbe given a wide berth. But investors, particularlypension plans, need to understand the currentand future risks associated with ESG issues. Aswell, such investors should agree on a commonframework for disclosure of ESG factors; in short,they need to be able to measure the extent to

which material issues are being identified andaddressed. It is also important that disclosure ofsuch material information (at least as presentlydefined) be enforced by securities regulators.

Finally, in order to temper investors obsessionwith short-termism, which can run counter tothe consideration and rewarding of sound ESGperformance, signals must be created in todayscapital markets to permit and encourage long-termsustainability considerations. Accounting, actuarial,and regulatory practices including reporting need to be changed to address the obsession withshort-term earnings performance and valuation. Andimproved incentives should be instituted for corporateand investor management of long-term cash flow.

Overcoming these challenges will require not onlyadopting proven international standards andpractices, but also going beyond them. Creating

a competitive advantage will mean taking a leader-ship role at the investor, corporate, and politicallevels. It will mean providing current and futureinvestors as well as business people with the

information and professional skills they need tointegrate ESG factors into their decisions, nowand in the future. Undoubtedly, sustaining oureconomic prosperity in a rapidly evolving globaleconomy, one in which declining natural resourcesand growing population levels are the reality, willrequire innovation.

Canada is a recognized world leader in the capitalmarkets for the financing and developing of globalnatural resources. Canadian corporations and capitalmarkets can either continue in this leadership role,or let the international markets govern the termswith which we must ultimately comply. Indeed,current environmental, social, and governance issuesare dividing leaders and followers alike.

The Task Force has made recommendationsthat it believes will encourage the integration ofESG factors into capital allocation decisions andcontribute to a new and strengthened vision forinvesting in Canadas sustainable future. Therecommendations of the Task Force are set outbelow and also at the end of the relevant chapters.

Recommendation 1.1

That the federal, provincial, and territorialgovernments adopt, in their respective jurisdic-tions, regulations that require pension plans:

a) to disclose on a recurring basis, at a minimumannually, the extent to which environmental,social, and governance considerations are takeninto account in the selection, retention, andrealization of investments; and

b) to disclose the extent to which environmental,social, and governance considerations are

taken into account in proxy voting andcorporate governance engagement activities,and to require pension plans to disclose theirproxy voting activity.



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Recommendation 1.2

That all fiduciaries, including institutionalinvestors, money managers, and fund trustees,adopt voluntary practices to disclose (a) ESGconsiderations and (b) investment policy, andthat they be encouraged to sign on to the UN-sponsored Principles for Responsible Investment.

Recommendation 2

That federal, provincial, and territorial govern-ments or regulators enact guidelines or, whereappropriate, regulations to clarify that the fiduciaryobligation of the trustee includes the considerationof ESG issues that are financially material toinvestment decisions.

Recommendation 3

That the federal government lead by exampleand actively integrate ESG factors in

a) federal funding of grants and projects relatedto capital markets; and

b) federal pension plans.

Recommendation 4

That ESG issues be integrated into the educationrequirements of academic and professional institu-tions and programs

a) granting MBA degrees and CFA accreditation;b) offering director education courses and

certification; andc) offering trustee education courses and

certification.

Recommendation 5.1

That the Canadian Institute of CharteredAccountants (CICA) and the Canadian SecuritiesAdministrators, in consultation with the federaland provincial governments, establish an outreach

and education program for capital issuers so asto increase understanding of the material ESGissues that should form part of the ManagementDiscussion and Analysis (MD&A) section ofannual reports.

Recommendation 5.2

That institutional investors, money managers,and trustees engage capital issuers (companies) onthe potential materiality of ESG issues, adopt apolicy regarding ways of addressing ESG factorsin the decision-making process, and encourage therefinement and use of standardized ESG reporting.

Recommendation 5.3

That the Canadian Securities Administratorsencourage the disclosure of financially materialESG issues through publication of a guidanceor interpretation statement and encourageCanadian firms to be guided by establishedreporting frameworks such as the GlobalReporting Initiative (GRI).

Recommendation 5.4

That securities regulators support the existingMD&A disclosure requirements as they relate toESG considerations and, when required, enforcethe ESG disclosure requirement.

Recommendation 6

That federal and provincial laws and regulationsas well as the standards set out by professionalbodies such as the Canadian Institute of CharteredAccountants (CICA) and the Canadian Instituteof Actuaries (CIA) regarding accounting, actuarialvaluation, and pension fund governance be assessedfor their impact on sustainability and amendedwhere necessary to address the needs of sustainablecapital allocation.

Recommendation 7

That institutional investors assess the impact onsustainability of their investment policies andpractices, paying particular attention to the quality

of the investment research and the alignmentof fund manager compensation practices withlong-term performance.

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Information is important to the proper functioningof capital markets. The quality of the decisionto allocate capital whether to invest or divest depends on the quality and availability of theinformation relevant to the decision at hand.Choices between investment options rely to a

large extent, too, on the comparability of theinformation. Given the short- and long-termconsequences of these decisions to the capitalprovider and issuer as well as to the individualdecision-maker the question of motivation alsobecomes paramount. What, then, are the incentivesor penalties associated with these decisions? Whatare the core criteria for making these decisions?Are they short- or long-term factors? Are theyfinancial? And do they take into account thesocial or environmental risk factors or values?

Financial stewardshipPrivate and public institutional investors, ingeneral, and pension plans, in particular, investlarge pools of capital on behalf of shareholdersand employee beneficiaries. Their decisions andthe criteria upon which the decisions are based canhave broad economic, social, and environmentalconsequences. For publicly held corporations, pen-sion plans often represent the single-largest shareownership positions. For those individuals relyingon pension plans for their retirement income, theways in which the plans are managed can alsohave serious personal impacts. In fact, the natureand prospects of the Canadian economy andcompetitiveness depend to a large extent on thechoices made by the managers of these plans.The managers, for their part, ultimately make their

choices based on established criteria, regulations,and traditional practices. All of this is driven bythe expectations of pension fund stakeholders,including policy-makers and the public at large.And in the end, we Canadians get the financialstewardship we deserve.

Risks and rewards

For an economy such as Canadas one thatrelies so heavily on natural resources and exportmarkets it is crucial to be keenly aware ofboth the sustainability issues here at home and

the competitive innovations abroad. Other regionssuch as Europe and Japan, less blessed with naturalresources, have invested more effort and money inenvironmentally sustainable business and invest-ment practices. In much the same way, investorsand companies that do business in those placesand are faced with the difficult social consequencesrelated to economic decisions particularly indeveloping countries have learned how to inte-grate such factors as human and labour rights intotheir decision-making processes. In Canada, we arefaced with similar challenges, particularly now that

we realize more clearly that our resources are finite,that the carrying capacity of many of the planetsecosystems may be less than previously thought,and that the growing internationalization of tradehas deep social consequences.6

2 Premise

We get the financialstewardship we deserve.


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The ultimate question for this report, then, is:What can Canada do to encourage capital marketsso that we not only catch up with our Europeanand other counterparts in integrating environmen-tal, social, and governance (ESG) factors (orsustainability factors) into economic decisions,but also gain a sustainable competitive advantage?

Sustainable advantage

It is becoming clear to Canadian corporateexecutives, members of boards of directors,investment trustees, employees, pensioners,

customers, activists, and voters that Canadascollective future depends on the extent to whichwe are able to leverage our advantages in human,capital, and natural resources to serve present and

future generations. Ignoring issues such as humanrights or climate change within new internationalregulatory regimes is no longer an option. Actingas if our resources are unlimited will not makethem so. Pretending that we do not rely on foreignfinancial and consumer markets will not make usany the less dependent. If we ignore the globaltrend to include non-financial risk factors ininvestment decision-making, we do so at our peril.

We must now ask ourselves the following ques-tions: Are we gaining a sustainable advantage ordisadvantage in the way we invest the resourcesat our disposal? What is working in our favour?What is holding us back? And what can we doabout the situation?

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What is working? What isholding us back?


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Drawing on the diversity of its members wealthof insight and experience, the NRTEE seeks togenerate and promote innovative ways to advanceCanadas environmental and economic interests co-operatively rather than in isolation. In thiscapacity, it examines the implications of priority

issues and offers advice on how best to reconcilethe sometimes competing interests of economicprosperity and environmental conservation.

Capital Markets and Sustainability Program

With the Capital Markets and SustainabilityProgram, the NRTEE undertook to explore therelationship between capital markets, financialperformance, and sustainability in Canada.

Over a period of two years, the members appointedto guide the Task Force on Capital Markets and

Sustainability and its program met with approxi-mately 200 participants from the private, public,and civil society sectors. A series of five regionaland multi-stakeholder meetings were conductedacross the country, during which the parametersof the project were scoped-out. Six backgroundpapers7were subsequently commissioned, fourof which were used in ten further consultationmeetings held across Canada. At each session,participants were asked to consider the extent towhich sustainability factors are being incorporatedinto capital allocation decisions by both providers

(investors) and issuers (companies).

The goal was to determine the nature and scope ofthe associated barriers and to identify opportunitiesfor Canadians to get ahead of the curve. While theformat was designed to capture a range of ideas andexperiences related to this question, the overarching

objective was to distill the findings into a set ofactionable recommendations for policy-makersand capital market participants.

The consideration of commissioned research andthe deliberations of the Task Force on CapitalMarkets and Sustainability a body composed

of prominent executives or representatives drawnfrom business, labour, government, academia, andother multi-stakeholder backgrounds from Canadaand abroad, and assisted day-to-day by its policyadvisor8 led to the development of this researchprocess. A further dimension to the multi-stake-holder process was the participation of the TaskForces co-chairs and policy advisor in the ExpertsMeetings of the UNs Principals of ResponsibleInvestment initiative, a project convened bythe UN Secretary General Kofi Annan andimplemented by the UN Environment ProgrammeFinance Initiative, as well as the UN GlobalCompact. The first Experts Meeting was sponsoredin April 2005 in Paris by the French GovernmentsCaisse des dpts et consignations; a follow-upmeeting was co-sponsored by the NRTEE and

the Toronto Stock Exchange (TSX) in September2005. The meetings of the Experts9 on thePrinciples for Responsible Investment, held inParis and Toronto, worked in an iterative manner(during the second half of 2005) with a group ofinvestment professionals in London and New York

3 Capital Markets & Sustainability

Progress to date has not beendue to the pull of investors.


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City representing 20 large institutional investorsin 12 countries. The outcome of this work, the

Principles for Responsible Investment,10was releasedin final form at a ceremony at the New YorkStock Exchange April 27, 2006 (for NorthAmerica) and at the old Paris Bourse onMay 2, 2006 (for Europe).

Addressing two key questions

By both facilitating a strong, neutral, independentmulti-stakeholder debate on responsible investmentand corporate responsibility and exploring the linksbetween sustainability (comprising environmentaland social issues) and financial performance inCanada, the Round Table strove to address twokey questions:

Is there a financial return to business in pursuingcorporate responsibility (CR) policies?

Is the pursuit of such policies rewarded through theinvestment allocation decisions of fund managersin the capital markets?

With regard to the first question, the Task Forceheard anecdotally that pursuing good CR policiesis not rewarded by the market, but that, by thesame token, a company that ignores the pursuit ofgood CR policies is often punished by the market.Thus in a sense, the market places a premium on

good CR, although not in the manner initiallysupposed; that is, it punishes companies with poorCR performance and only indirectly, in relativeterms, rewards companies with good CR perform-ance. The Task Force also heard that one of thereasons for the disconnect between good CR andno (apparent) returns was that the metrics werenot yet sufficiently developed. However, a modestcontribution to establishing the links betweensustainable development (SD) disclosure andreturn was subsequently provided by a reportcommissioned by the NRTEE.11 The reportprovides a pilot framework that comprises tenworked examples of the conversion of sustainabledevelopment disclosures of f ive major Canadianmining companies,12 using standard valuation

techniques,13 into financial values. It is hopedthat this work will provide examples to mainstreamfinancial analysts as to how they might beginapplying sustainable development disclosures in

their daily analytical work for investment advice.At the same time, the Task Force noted theexistence of anecdotal soundings taken from themainstream business community. It also heardabout substantial academic investigations, as wellas reviews of groups of studies showing medium(and stronger) correlations between good CRand financial performance. The Task Force notesthat, setting aside the question of the link betweendisclosure and financial returns, there are nowmore than 80 empirical investigations examiningthe link between corporate social (and environmen-tal) performance and financial performance.14

With regard to the second question, the TaskForce heard that the pursuit of good CR policiesis not rewarded via the investment allocationdecisions of fund managers in the capital markets.However, evidence does show that this situationis beginning to change with, for example, thedevelopment, in 2005, by a huge domestic capitalprovider, the Canada Pension Plan InvestmentBoard, of a Policy on Responsible Investment,and its pursuit of this policy beginning in 2006.

Additionally, the board of British ColumbiaInvestment Management Corp (BCIMC), oneof the largest pension funds in Western Canadaand a recognized leader in global infrastructureinvestments, has introduced the early-stage notionof using triple bottom-line investment guidelinesin the consideration of investments. As well, theCaisse de dpt et placement du Qubec pursuesCR policies in investee corporations via engage-ment practices.

As the Task Forces work progressed, however, the

two initial, key questions of the report (and theiranswers) were eventually used only as guidelinesfor the fuller development of the Task Forcespublic consultations and deliberations.

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Besides presenting the programs key findingsand providing policy recommendations to thefederal government, this State of the Debate (SoD)

report is intended to shine a light on issues thatgo to the heart of Canadas future economic pros-perity, competitiveness, environmental protection,and social justice. For this reason, it is less of anend point and more of a point of departure fora broader societal dialogue about how to createsustainable value.

As such, the Task Force report discusses variousbarriers and addresses several key areas withregard to incorporating environmental, social,and governance issues into the investment process.The general themes and intended recommenda-tions fall under the broad categories offiduciaryduty, materiality, and short-termism.

The State of the Debatereport begins with a briefsummary of the state of corporate sustainabilityin Canada. It looks at the key drivers for change,including protection of reputations and accessto resources, consequences related to disclosure,stakeholder engagement, and the application ofinternational standards. Notably, most of theprogress to date in Canada has stemmed fromthe push of consumers and retail investors,

rather than from the pull of institutionalinvestors seeking a change in behaviour.

Recognizing this lack of engagement by institu-tional investors, the SoDreport probes both thecauses and significance of this lack. For the mostpart, the report focuses its attention on capitalproviders in general, and on pension plans morespecifically; these institutions hold the reins ofinvestment capital, and by their action or inactionhave considerable impact on how the Canadianeconomy evolves to meet the needs of current and

future generations. In fact, it was only recentlythat institutional investors paid attention to theenvironmental and social risk factors that affectfinancial performance. Witness such initiatives asthe Carbon Disclosure Project,15 a US$31-trillioninvestor-led coalition involving 225 institutionalinvestors, and the United Nations Environment

Program Finance Initiative (UNEP FI), a globalpartnership with the financial sector. Finally, inwhat is essentially the last third of the report(chapters 7, 8, and 9), we consider several key

barriers to, and desired outcomes for, increasedcorporate sustainability in Canada.

Actions for a sustainable future

It became clear during the round table discussionsthat there are many ways to encourage capitalmarkets to further integrate environmental andsocial factors into decisions related to capitalallocation, or at least to remove some of thebarriers to doing so. Some of these ways relateto promoting incremental improvements, suchas the disclosure of sustainability factors in the

Management Discussion and Analysis (MD&A)sections of annual reports to shareholders, asdiscussed in the 2004 paper prepared by theCanadian Institute of Chartered Accountantsfor the NRTEE, Financial Reporting Disclosuresabout Social, Environmental and Ethical (SEE)Issues.16 It should be noted that while there is nostatutory or regulatory requirement for companiesto prepare annual reports to shareholders, theMD&A is a regulatory filing that is typicallyincluded in companies annual reports. Other waysrelate to developments that occurred during theround table process itself, such as the publicationof the report on trustee law17 by the City ofLondon-based law firm, Freshfields BruckhausDeringer, which, when it was submitted to UNEPFI, finally cleared the air on whether fiduciaries,including pension fund trustees, may legallyconsider certain factors. It also became increasinglyclear during the round table discussions that nar-row recommendations that apply to incrementalimprovements, while beneficial, will not have thedeep impacts required in the face of Canadas

broad, global competitive challenges.For all these reasons, the Task Force decided topresent a series of high-level, long-term recommen-dations that would inspire not only further debate,but immediate action. These recommendations arepresented in the final chapters of the report.



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Economist Milton Friedmans famous 1970squip that a businesss social responsibility isto increase its profits18 has been a truism forprivate enterprise since at least the beginning ofthe Industrial Revolution. As recently as the 1940s,companies expectations were as limited as the

number and type of stakeholders. For example,getting good financial results was generally moreimportant than worrying about how the resultswere achieved. Workplace health and safety was aninexact science. Dumping waste was as commonas treating it. Community investment19was aboutsupplying softball uniforms. Certainly no onetalked about responsibility for future generations.Last but not least, shareholders were king.

A number of factors have changed these rules. Aseries of environmental disasters, various breachesof ethics, human rights abuses, the evolution ofsustainable development and corporate responsibil-ity, the development of instant access to informationvia the Internet and 24-hour newscasts, and the rise

of stakeholder engagement have all had a part toplay. Non-governmental organizations (NGOs) inevery industry and every domain (environmental,labour, human rights, etc.) now hold the highground in terms of public credibility. In fact, today,long-time activist investors such as the New YorkCity Office of the Comptroller and the US-basedInterfaith Center on Corporate Responsibility(which coordinates religious investors with assets

of $110 billion) have been joined by an increasingnumber of mainstream investors. At the same time,the reputations of corporations have generallysuffered, with poll after poll in recent yearsshowing that trust in corporations and CEOs isat an all-time low. Indeed, according to the public,

if you are not part of the solution, you are partof the problem.

And so calls for action continued to grow.Today, the forces that gathered over these pastthree decades have culminated in the expectationthat corporate performance and well-being cannotbe separated from the larger social and environ-mental context. For any business to establishitself to grow, prosper, and sustain itself various long-term (if not eternal) inputs, suchas human, financial, and natural resources,including material and energy, are required.

Corporate responsibility and sustainability

While perhaps self-evident, the goal of organiza-tions is to ensure their own, long-term viabilityby maintaining continual access to, natural,human, social, and investment capital. Thisrequires that organizations clearly define theirroles and responsibilities vis--vis society and a

wide range of stakeholders (not just shareholders)with whom they share mutual interests. Not onlymust they understand stakeholder expectations,they must also know what is at stake. In the recent

6

4 Sustainable Corporations

If you are not part of thesolution, you are part ofthe problem.

The early business case:this hurts, lets fix it.


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past, many companies began to embrace the princi-ples of corporate responsibility and sustainability asa reaction to negative forces (i.e., consumer boy-cotts). These corporate efforts, often driven by a

perceived need to protect a brand, were usuallysuperficial or short-term initiatives that tended tofocus on image rather than substantive change, andthey persisted until (and unless) a clear gap arosebetween the companys promise and its practices one that threatened the companys core business.What might initially have been viewed as acommunications problem had now become astrategic management issue.

The following drivers are among those mostoften identified by corporate social responsibilityadvocates attempting to make the businesscase for sustainability: reducing business risk;improving a corporations reputation (which, inturn, enhances the corporations social licence tooperate or grow, and includes improving relationswith regulators); and, linked to that last driver,enhancing brand image.

As well, or so the argument goes, pursuingcorporate sustainability policies can also, in someinstances, increase the productivity and efficiencythat lead to innovation. It can lead to cost savingsand an improved bottom line. It can attract and

retain skilled employees and customers throughincreased employee morale. It can also attractcapital, thanks to an improved reputation withinvestors, bond agencies, and banks, and facilitateaccess to new markets.

But actually measuring these outcomes is a morecomplicated matter. In the extractive sectors, inwhich protection of the societal licence to operatecuts to the core of the business model, the case forinvesting in environmental protection was quiteeasy to make. That same phenomenon of vulnera-

bility applied to avoiding the not in my backyardsyndrome, in which major projects get delayed orrefused. Suddenly, community consultations andinvestment made good business sense.

Other corporations with well-known consumerbrands quickly figured out that increasingly sophisti-cated and well-informed citizen activists could cause

significant impacts on market share. The businesscase became essentially: this hurts, lets fix it.

More and more, then, companies began torealize that there is a link between good corporate

citizenship and good, or even better, financialperformance. Much like the initially expensive

investments in quality control, many operatorssoon realized that good corporate citizenship paidoff in increased efficiency, lower costs, and greatermarket share. Those committed to establishedinternational principles, policies, and measurablecorporate responsibility programs learned thattheir operations benefit from better employeerelations, recruiting, and retention (throughreputation); lower costs (through eco-efficiency);innovative products (through Design forEnvironment, or Life Cycle Analysis); andincreased market share (through green productsor labour-rights monitoring).

Most recently, true stakeholder engagement

(especially with former adversaries) has led tobetter facility management especially incases where the NGOs know whats happening inthe factories even before the CEOs do. Companieshave begun conducting stakeholder research andconsultations well in advance of seeking projectapprovals. Multi-stakeholder coalitions are increas-ingly prevalent, well-known examples being theForest Stewardship Council (bringing together theWorld Wildlife Fund, trade unions, and corpora-tions), the Global Reporting Initiative, and theCarbon Disclosure Project. First Nations accordsand joint ventures are now common in the energysector, while multi-stakeholder associations aremore and more the norm in corporate life (e.g., theCoalition for Economically Responsible Economics[Ceres]20). Today, companies that were initiallyscreened out by socially responsible and ethicalinvestors are now responding to questionnaires to


Ethical performance is a proxyfor good management.


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facilitate their inclusion in key indexes; they areentering into constructive dialogues as a result ofshareholder resolutions. For their part, interna-tional NGOs such as Greenpeace and the SierraClub are moving toward collaborative models basedon strategies that differentiate corporate behaviour.

But the cause and effect relationship betweenaction/inaction and benefits/penalties remainshard to prove. At the very least, good ethicalperformance is a proxy for good management as witnessed by the Institute of Business Ethicswhen it found that companies with a publiccommitment to ethics perform better, on threeof four measures, than those without such acommitment. As well, leaders tend to outperformtheir laggard competitors in terms of financial

results, as seen by the performance of the DowJones Sustainability Index and the Jantzi SocialIndex. Or take the ethical, or socially responsible,investors who have long used screening to decidewhich sectors to invest in (i.e., not tobacco) andengagement to address concerns about companiesin their portfolios. Still more recently, an increasingnumber of large, mainstream institutional investorcounterparts have added engagement strategies toinfluence corporate behaviour. These take the formof public communication with other shareholders

(i.e., through the formation of investor coalitionson issues such as HIV/Aids and climate change)as well as the use of social and environmentalevaluation criteria. Interestingly, most mainstreamcapital providers (such as the Canada PensionPlan Investment Board [CPPIB] in its Policyon Responsible Investing21) who reject positiveand negative screening as suitable investmentstrategies22 have now turned to publishing variouspolicies dealing with corporate responsibility andto developing systems that model the associatedrisks and volatility, which, if managed properly,

can mean profit. It seems that consideration ofESG issues is leading more and more corporationsto modify their relationships with investors,not to mention their operational decisions andpublic disclosures.

Public disclosure

The efficient functioning of capital marketsrequires a full and timely disclosure of material

information, particularly as it relates to investmentrisk. When it comes to identifying and evaluatingnon-financial risks, which are often loaded withexternalities (as are environmental issues), theresult can be an asymmetrical market. Indeed,some companies are not rewarded appropriatelyfor sound environmental performance, even assome poor performers are penalized. Publiclytraded companies in Canada have long beenrequired to report material information via avariety of vehicles, including the ManagementDiscussion and Analysis (MD&A) section ofannual reports, the Annual Information Form(AIF) and, in short form, the Prospectus. Yeteven with all this, the disclosure of environmentaland social risk factors is not widespread.

In March 2004, the Canadian SecuritiesAdministrators (CSA) put into force NationalInstrument 51-102. This was a set of new rulesthat amended financial reporting requirementsand affected financial statements, MD&As, andAIFs. These changes served to harmonize continu-ous disclosure requirements across Canada. To

some extent, the coming into force of NI 51-102also enhanced social and environmental disclosurerequirements. The new rules required social andenvironmental policies of the reporting issuers tobe described in the issuers description of theirbusiness if such policies were fundamental to theissuers operations.23 However, this represented anenhancement of social and environmental disclo-sure rather than an innovation, as the AIF, longbefore 2004, had called for specific disclosuresregarding environmental and social policies andvarious risks.

Meanwhile, work continued on various fronts withrespect to expanding the role of the ManagementsDiscussion and Analysis in highlighting social andenvironmental risks. While the MD&A appears inthe annual report of a company listed on the stockexchange, the corporate annual report (as such) isnot in itself a required disclosure. Rather it is the

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financial statements, the MD&A, and the AIFthat constitute the disclosures required by the CSAto be filed, annually and quarterly, and distributedto shareholders upon request.

In the new post-Enron environment, companydirectors must ensure that their organizationshave well thought-out and articulated financial andnon-financial risk management policies in place.24

But while the conventional corporate governancemodel seeks to ensure long-term shareholder value,there ought to be a new approach to incorporatingsocial and environmental risks and impacts.Potentially, this could be developed at a later date totake into account the realities of director liability.

A key trend in US and international capital markets

is greater disclosure. For instance, the AmericanSarbanes-Oxley Act of 2002seeks to enhance investorconfidence through greater disclosure and increaseddirector liability apropos insufficient corporatedisclosure. In effect, US chief executives and chieffinancial officers now have to sign-off personallyon their companys financial statements. There issome corollary to this in Canada. While the CSAs2004 National Instrument 51-102 on continuousdisclosure obligations does not cover CEO and CFOcertification, the CSAs Multi-national Instrument52-109 does require a sign-off covering not only

the financial statements but also the MD&As andAIFs, thereby potentially containing disclosure ofenvironmental and social policy. However, in fact,the certification speaks more to the reliability andtimeliness of the disclosures than to the actualnature of what is disclosed. In Great Britain, allpension plans must disclose the extent to whichsocial, environmental, or ethical considerations havebeen taken into account in the selection, retention,and realization of investments. In France, firms arerequired to report on social and environmentalissues in their financial reports. As for South Africa,companies listed on the Johannesburg StockExchange must comply with the King II Report,which includes references to issuing sustainabilityreports based on the Global Reporting Initiative(GRI) guidelines.25With respect to financialreporting and auditing, these include regulations forCEO and CFO certification of financial statements,as well as rules concerning the role of audit commit-tees and auditor accountability.

Here in Canada, Canadian corporate disclosureof ESG factors is on the rise, with the number ofCanadian companies that report according to GRIPrinciples having grown from just 6 companies in

2004, to 23 in 2005 (representing about one-thirdof the TSX Composite Index in 2005), and to35 in 2006.26 The take-up of the GRI approachamong large capital issuers in the United States hasalso shown growth. For example, the number ofS&P 100 index companies that report using GRIprinciples grew from 26 (or 26%) in 2005 to 31(or 31%) in 2006. As for the S&P 1200 index, thepercentage of GRI-reporting companies grew from21 percent (or 256 of 1200) in 2005 to 24 percent(or 292 of 1200) in 2006.27

The investor case

Corporate actions in support of CR have beenundertaken primarily in the face of operationaland reputational challenges and without anymotivating, substantive, positive incentives fromthe financial community. Although the idea ofsocially responsible investors (SRI) continues togain acceptance, it is intended more as a vehiclefor aligning investors values and their investmentpractices, or for social change using negativepressure, than as a way of identifying investmentsthat will outperform the market. Indeed, vehiclessuch as the Equator Principles limit access toproject financing unless certain social and environ-mental factors are addressed. For most Canadiancompanies, however, this has little relevance.

Clearly, although some leading companies andmainstream investors have begun to evaluatethe financial risks associated with issues suchas climate change, corporate behaviour is stilllargely driven by incentives. In effect, corporationscontinue to inquire how, beyond avoiding punish-

ment from their stakeholders and investors, theycan be rewarded for decisions that incorporateenvironmental and social factors into their deci-sion-making. How, they ask, can we ensurethat investors are aware of these issues, understandour actions, and are able to evaluate our progressand competitive positioning?



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Some Canadian corporations, much like theirmajor international counterparts, have begun tosee the benefits of incorporating environmental,social, and governance factors into their decision-making. Many are working to increase shareholdervalue by better managing risks, protecting and

accessing markets, developing new products,ensuring access to critical human and naturalresources, and anticipating or mitigating theimpact of regulations. Many have also committedthemselves to contributing to the sustainable devel-opment of the economies in which they operate.

Finance industry players such as chartered banksand insurance companies now have systemsin place to consider environmental, social, andgovernance factors in lending and insurancedecisions, as well as mechanisms to improve trans-parency (i.e., public accountability statements),which may include adoption of Global ReportingInitiative (GRI) standards. As well, signatories tothe Equator Principles, for example, require the

integration of ESG factors in project-financingdecisions. However, the coordinated, consistent,and pervasive evaluation of environmental, social,and governance factors by Canadas other main-stream institutional investors has yet to happen.There is, though, an international collaborationbetween asset owners and asset managers, theEnhanced Analytics Initiative (EAI), which isaimed at encouraging better investment research

through an innovative approach to promotingbetter ESG disclosure. Although based primarilyin Europe, the EAI has also been making headwayin its approach in Canada by building links withCanadian pension plans.

Capital allocation decisions by trustees of pension

plans continue to be driven primarily by narrow,short-term financial criteria. While ESG factorsmay get indirectly factored in if, for example,a boycott is hurting sales corporations thattake the lead in this area are sometimes leftwondering how they will be rewarded by investors.As for those who continue to ignore or avoidintegrating ESG factors into their operations yet still receive investment capital they areoften left pondering what the fuss is all about. Forthe Canadian public, then, the question remains:What has to happen to ensure that these factorsare leveraged to increase Canadas long-termproductivity and competitiveness?

Pension plans

Pension funds, by their very nature, should beoriented to generating real financial returns overthe long term in order to ensure pension payouts.Indeed, pension plan profiles evince a naturalfit with sustainability considerations, which arealso oriented to the long term. In fact, given

the long-term nature of their liabilities, pensionfunds should be and often are the long-term investorspar excellence. As David Dodge,the Governor of the Bank of Canada, indicatedin a speech delivered to the Association of MBAsin Montreal, pension plans are important to theeconomic and financial efficiency of the country,and play a key role as long-term investors:

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5 Sustainable Pension Plans

Pension plans are currentlydriven by narrow, short-term

financial criteria.


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Pension plans generate important benefits in termsof economic efficiency. By transferring risk fromindividuals to collectives, pension plans help achievea more efficient allocation of savings. Pension

plans particularly the very large ones tend tohave sophisticated asset managers. These large planshave the incentive and the ability to invest pools ofcontributions across appropriately varied asset classes.Further, they invest over very long time horizons, sothey can finance large investment projects at competi-tive rates of return. All of this contributes significantlyto economic efficiency by transferring risk to thoseinvestors that are best able to bear it 28

The Governor of the Bank of Canadas commentsmake the point that the very fact of being long-term investors allows pension plans to be efficientinvestors. The comments, incidentally, helpto draw some of the links between taking thelong-term view, obtaining more efficient returns,and achieving sustainability.

The three largest pools of capital in Canadaspension system are (i) the Canada Pension Plan(CPP) and the Quebec Pension Plan (QPP);(ii) the private pension plans; and (iii) theemployer-sponsored pension plans. Across theCanadian pension system, more than 13,800registered pension plans are in place. There has

also been considerable growth in dollar terms ininstitutional investments over the past 20 years,with similar growth anticipated over the next20 years. Indeed, the Organization for EconomicCo-operation and Development (OECD), whichtracks this growth worldwide, notes that Canadianpension plans as a subset of institutional invest-ments increased more than 800 percent between1980 and 2000.29

The current size of the Canadian pension systemsis considerable. Estimates for 2004 assess total

assets held by employer-sponsored pensions atabout $594 billion.30 The figures, while large inthemselves, also show substantial growth. For exam-ple, the figures for total assets under administrationof the CPPIB in recent years are $70.5 billion (for2004), $81.3 billion (2005), and $98.0 billion(2006).31 Similarly, for the Quebec Pension Plan,available recent equivalent figures for assets underadministration are $175.5 billion (for 2004) and

$216.1 billion (2005).32 These plans, whichtogether form one of the largest pools of invest-ment capital in Canada, in recent years ownedabout 20 percent of the stock of Canadas

big-name, publicly traded companies.In addition to their role as a significant participantin capital markets, pension plans are key drivers ofchange. Pension plans are also dependent on theCanadian economy and are, themselves, significanteconomic players. For example, as whole-economyinvestors, these plans must concern themselveswith more than the business case for sustainabilityon a corporation-by-corporation basis. Certainly,pension plans are long-term investors, but their sizeand global diversification also make them universalowners,33 a term which implies that what is anexternality at the level of one firm can end upas an internality and a material factor in termsof their global portfolios. Both the long-termissues and the universal investor implicationsallude to the fact that the best interests of theplan members and the beneficiaries the testof fiduciary duty are best served when ESGfactors are taken into account.

Public plans

No pension plans are as dependent on the eco-nomic prosperity of Canada as are the Canadaand Quebec Pension plans.34 In both cases, littlein the way of pension benefits will be comingout of the reserves in the near future; most payoutswill emanate directly from the contributionsof active workers. For example, at the time ofwriting (October 2006) the Canada Pension PlanInvestment Board website reports that incomefrom the money that we invest today will be usedby the Canada Pension Plan to help pay pensionsbeginning in 2022.35As for the Quebec Pension

Plan, the last triennial actuarial report (datedDecember 31, 2003)36 indicated that 100 percentof pension benefits would emanate from the activeworkers contributions until 2015 when invest-ment income from the reserve will be used to fundthe expected cash outflows, after all contributionincome has been applied.37 For the QPP, ifone projects forward to nearly mid-century, the



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actuarial projection is that investment income willbe used to bridge the gap between income fromcontributions and cash outflows until 2042,38

and that from 2043 withdrawals from the reserve[will] accelerate the narrowing of the ratio betweenthe reserve and cash outflows.39 Clearly, thesepublic plans are highly susceptible to the perform-ance of the economy, most notably the employmentand productivity levels. Because sustainability issuesare critical for Canada, perhaps the case could bemade that these public plans should be mostproactive in promoting sustainability.

Initially, numerous large pension plans, as well asinvestors such as the California Public EmployeesRetirement System (CalPERS) among others,demonstrated an interest in screening investments;

more recently, they have shown an interest in morecomprehensive, responsible investment engagementstrategies. Another case in point is the Fonds desolidarit FTQ, which, although not a pensionplan, acts as an investment fund controlled by theQuebec Federation of Labour and invests venturecapital with social objectives in Quebecs small andmedium enterprises (SMEs). Some major Canadiancapital providers, however, are beginning to preferengagement techniques (with companies) ratherthan screening techniques. As for the Quebec

Pension Plan, the Caisse de dpt et placementdu Qubec, in January 2005, introduced a new,responsible investing policy that advocates activeengagement as part of its tools to promote goodCR. An extract from a press release by one of theCaisses affiliates concerning the new policy onsocially responsible investment illustrates theinterest of the Caisse in engagement techniques:

The Caisse intends to maximize its influence inthe area of socially responsible investment. For thisreason it favours an interventionist approach througha specific policy guiding it in exercising its proxyvoting rights and by preferring to engage in dialoguewith the companies in which it invests.40

Interestingly, on October 13, 2005, the CPPInvestment Board introduced a Policy onResponsible Investing41 that is generally alignedwith the key findings in this SoD report, includingits preference for engagement. Moreover, threemajor institutions in Canada have now signedon to the Principles for Responsible Investment(PRI) the Caisse and the CPP InvestmentBoard, both as asset owners; and the BCInvestment Management Corporation (BCIM),as investment managers42 in a sense, leadingthe way for Canadas other major fiduciaries.

Barriers to change

The Task Force identified three key barriers tointegrating ESG factors into the capital allocation

decisions of pension plans. These barriers consti-tute the basis for the Task Forces recommendationson guiding capital markets and policy makers.The three barriers and their attendant questionsare as follows:

Fiduciary duty:Are there perceptions andpractices among pension fund trustees vis--vistheir fiduciary duty that limit the inclusion ofESG factors in investment decisions? If so, howcan they be overcome?

Materiality: Is there alignment or disagreement

between what capital providers and companiesdeem to be material? If so, what does this meanto the nature and scope of information sought,provided, and integrated?

Short-termism: Are there short-term behavioursthat go against the inclusion of longer-terminvestment criteria? What can be done tochange them?

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The traditional approach of fiduciaries inCanada incorporates two main views: (a) thatthe consideration of ESG or non-financial factorsin conjunction with capital allocation decision-making is in general conflict with the fiduciaryduty of these groups or individuals; and (b) that

although their duty requires maximizing financialreturns, fiduciaries duties are actually more aboutexercising prudence.

This approach may reveal an overly rigidinterpretation of fiduciary duty or a lack ofclarity as to legal limits. It may also belie thelack of appreciation for the highly materialnature of many ESG issues, such as diminishingecological services, decreasing natural resources,and increasing social unrest, among others. Infact, doing away with the ambiguity of whetheror not a consideration of ESG issues falls withinthe scope of fiduciary duty may actually turn thetables to such a degree that not considering ESGissues becomes perceived as a potential breach of

fiduciary responsibility. For example, lead advocatesof the Carbon Disclosure Project are now activelyparticipating in the growing camp that supportsmaking hard market evidence of higher returnsdemonstrably available and, thus, the lack ofconsideration of ESG issues (such as carbonrisk) a real, not just a perceived, breach offiduciary responsibility.

Legal limits

The overview of a recent study by the large andwell-known City of London law firm FreshfieldsBruckhaus Deringer (which reviewed the legalparameters defining fiduciary duty in nine differentinternational jurisdictions including the U.S.

and Canada) has essentially put this question torest at least from a legal perspective. The centralfinding of this UN FI-sponsored r

capital markets and sustainability: investing in a sustainable future

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