Environment, Social, and Governance (ESG) continues to gain importance in the eyes of corporate Canada, becoming a necessity for investors and garnering more attention in M&A transactions.
However, it is often difficult to quantify or characterize ESG criteria, and a lack of standardization has made reporting and evaluating a challenge. While this remains an issue, lawyers are seeing progress.
“The lack of standardization is definitely one of the biggest challenges around ESG,” says Vanessa Coiteux, a partner at Stikeman Elliott LLP who practises in securities, public and private M&A, and corporate finance. “It makes it really difficult for investors and stakeholders to compare corporations.”
There are many ESG-reporting frameworks and metrics available in the market, says Radha Curpen, Vancouver managing partner and national leader for ESG strategy and solutions at Bennett Jones LLP. Yet she says each was created with a specific audience or focus. “It’s not always clear that you’re comparing apples to apples.”
This disparity means that organizations can have a high rating in one measure and a low rating in another, which reduces the value of ESG disclosure for investors, says Coiteux.
Even when comparing companies that have reported ESG information using the same frameworks, there will still be “significant variations,” says Curpen, because most frameworks and metrics are voluntary. Companies can choose to report on some factors but not on others.
“Some good news is that we’re apparently moving toward better standardization and consistency with respect to some of the key frameworks and metrics,” she says.
On ESG’s environmental prong, there are two frameworks toward which governments, regulators, consultants, shareholders, and companies are increasingly gravitating, says Carol Hansell, the founder and senior partner of Hansell LLP. The first is the Task Force on Climate-related Financial Disclosures (TFCD), which sets a framework for climate-change risk. The other is the Sustainability Accounting Standards Board (SASB), which provides metrics. She says these two tools are becoming more broadly accepted, allowing for more comparability.
In October 2021, the British Columbia Securities Commission sent out a request for comment on its proposed national instrument 51-107, which was based on the recommendations of the TCFD. The proposed instrument will help create consistency in climate-related disclosures, says Coiteux. “And I think it will help set parameters around governance, strategy, risk management, metrics, and targets,” she says.
In the same vein, south of the border, the Securities and Exchange Commission is likely to adopt ESG-related disclosure requirements sometime in 2022, says Coiteux. Last year, the SEC put out a request for comment on whether current disclosures properly inform investors on ESG-related issues. “They’re expected to cover corporate-board diversity, climate change, human capital management, and cybersecurity risk-governance,” she says.
The Canadian Securities Administrators published guidance for investment funds on ESG disclosure practices this January. The CSA wants to help funds and fund managers ensure their communication around the products they are selling is not misleading, says Coiteux. As demand grows in the investment fund industry for funds incorporating ESG, there is more potential for greenwashing, said the CSA’s announcement.
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ESG is also playing an increasingly important role in M&A transactions, says Curpen. It is not just companies searching for low-carbon or clean-energy businesses for purchase, though that plays a part. Acquirers are also applying an ESG lens to the entire M&A process, using ESG factors and metrics as part of the overall assessment of the transaction, she says.
This ESG lens is partly due to the growing body of research that demonstrates a link between ESG and financial performance, says Curpen. Purchasers also want to see how the target’s ESG pursuance lines up with their own. These considerations include transition and physical risk from climate change, workplace diversity, relationships with Indigenous communities, supply chain issues, business ethics, and anti-corruption.
“These are just some of the issues that may be relevant when assessing M&A transactions through that ESG lens,” she says. “And many of these have not been part of traditional M&A due diligence. They may have been considered in a limited and siloed way, but not in a holistic and strategic manner.”
While increasing standardization is a positive trend, Curpen says it is essential that the relevant ESG information be effectively obtained, assessed, and understood, especially in M&A, despite the difficulties in quantification and measurement. Acquirers need to ask questions and insist on answers. They also cannot stop at the ESG reports. In each ESG area, in addition to the data, the parties must consider the procedures and processes that support the management of those issues, she says.
Acquirers should look at board oversight, the scope of internal and external reporting, the materiality assessments the target has applied to itself, the potential gaps in and vulnerabilities of the ESG information, and the potential reputational impact for both parties, she says.
“What we’re seeing is just the tip of the iceberg on ESG in M&A. I expect that the importance of ESG on M&A will continue to grow significantly. We have yet to see the full impact of it. It’s just the beginning.”
Aligning corporate practices with ESG considerations provides many opportunities, says Coiteux. A “substantial body of research” shows ESG contributes to value creation. Sustainable products attract customers. Companies enjoy cost reductions from lower energy or water consumption. ESG also assists with reputational capital and license to operate. And it provides access to financing that is not otherwise available, she says, as funds are increasingly deployed with ESG in mind.
Canadian institutional investors are taking ESG seriously in asset allocation decisions, says Coiteux. Most use ESG factors as part of their investment approach and decision-making. More and more, a committed engagement on ESG is necessary to obtain capital.
“Pension funds play a leadership role in the investment community on ESG,” she says.
In February, the Canada Pension Plan committed to a goal of net-zero emissions by 2050, in line with the Paris Climate Agreement. The Caisse de dépôt et placement du Québec, Ontario Teachers’ Pension Plan, OMERS, and Investment Management Corporation of Ontario have announced similar net-zero pledges.
Coiteux also points to innovative ESG initiatives such as Climate Engagement Canada, which brings together 27 institutional investors that collectively manage over $3 trillion in assets. The campaign aims to drive Canadian business toward net-zero emissions by engaging with 40 of Canada’s highest-emitting companies to encourage best practices. The Oil Sands Pathway to Net Zero also involves Canadian Natural, Cenovus Energy, ConocoPhillips, Imperial, MEG Energy, and Suncor Energy. These companies are responsible for 95 percent of Canada’s oil-sands production. They intend to work together with the Alberta and federal governments to meet the Paris Agreement’s climate goals of net-zero emissions by 2050.
In the last year, climate change has taken centre stage in the environmental aspect of ESG, says Hansell. People have bought into, understand, and are seeing the evidence of what the changing climate – including hurricanes, tornados, forest fires, and earthquakes – will mean for business.
Shareholders are exerting more pressure on companies to provide detailed information on climate-change risks and how the companies are handling social issues. She says this pressure has increased the quality and scope of ESG reporting.
“Companies are getting ahead of the issue now and are being more proactive, partly because they think it’s the right thing to do, and partly because they know they’re going to have to deal with the shareholders at some point.”
Hansell says COVID-19 has also led to more emphasis on employee well-being and the “social aspects of work.”
Mental health and wellness are a growing component of the ESG rubric, says Ravipal Bains, Vancouver partner in capital markets and securities at McMillan LLP. The E in ESG has traditionally garnered much of the focus. Still, the social aspect, including employee wellness, customer satisfaction, and impact on communities, is being factored more prominently into investor considerations, he says.
Companies are collecting data on employee well-being and how they can improve it, year over year, to demonstrate performance in this respect as part of their overall ESG strategy. The COVID-19 pandemic also contributed to the rise of mental-health-and-wellness considerations, says Bains.
“People are recognizing or have recognized now that mental health is a key component of overall wellness [and the] ability to contribute,” says Hansell, “and that from a workplace-environment perspective, protecting and promoting the mental health of your employees is critical to achieving success as an organization.”