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After Larry Fink demanded companies in BlackRock’s portfolio to provide climate-focused disclosures, other major investors and regulators are making similar demands

Eric Wetlaufer, Managing Partner with Twin River Capital, on Dec 1.Fred Lum/The Globe and Mail

Larry Fink, BlackRock Inc.’s chief executive, has shaken up the corporate world. The head of the world’s largest asset manager has demanded companies in its portfolios prove they have a plan to deal with a global economy headed to net-zero carbon emissions.

“We are asking you to disclose how this plan is incorporated into your long-term strategy and reviewed by your board of directors,” Mr. Fink wrote in his letter to CEOs early this year. And he warned that those that lag on that front face potential proxy fights against management or even divestment by his giant firm, which now manages US$9.5-trillion.

Other major investors, as well as regulators, are following suit by demanding answers from executives – and increasingly, directors – on a wide array of environmental, social and governance risks. The more stringent stance has not only forced companies in all industries to adopt new ways of managing them, but has transformed the way boards operate.

There is growing pressure on directors to speak knowledgeably on climate, in addition to the other ESG metrics that The Globe and Mail has now tracked for 20 years in its annual Board Games ranking of Canadian companies. The Globe collaborates with the David and Sharon Johnston Centre for Corporate Governance Innovation at the University of Toronto for the annual report.

“Increasingly, investors have been wanting to speak to directors about matters that are under our purview – in particular, board composition, compensation and now we are getting questions about ESG,” says Sheila Murray, chair of miner Teck Resources Ltd. and a director of BCE Inc. and CI Financial Corp. “BlackRock, if they happen to be an investor in your company, have a whole ESG team, and they want to hear from directors.”

The questions, often directed at board committee chairs, are pointed, Ms. Murray says. For example, investors want data on compensation incentives that are in place for management to meet ESG targets. “That’s a relatively new trend in my experience, but it is absolutely trending.”

ESG was already a concern for corporate boards before the COVID-19 pandemic hit. But the world’s reaction to the outbreak helped expose vulnerabilities throughout society, from health and safety, to gender and racial equality, and to climate change.

Concern about the latter was only heightened this year as a severe heat wave, wildfires, droughts and then catastrophic flooding brought the impact home to Canadians. Beyond environmental concerns, the killing of George Floyd in Minneapolis in May, 2020 amplified racial inequalities throughout society and in workplaces.

The COP26 summit in Glasgow this year put the spotlight on the the corporate world and showed how major investors are demanding detail on climate risks.Dan Kitwood/Getty Images

Still, climate change has emerged as the top ESG issue for many boards. The COP26 summit in Glasgow put the spotlight on the corporate world and showed how major investors are demanding detail on climate risks, says Helle Bank Jorgensen, CEO and founder of Competent Boards, a firm that provides ESG advisory services and professional development courses to a global list of clients.

Directors, while not handling day-to-day company management, oversee climate strategy and must speak credibly about metrics that are becoming as important as financial results and targets. They have to know the “ABCs of ESG,” Ms. Bank Jorgensen says.

“They must understand that ESG-related issues can build value in their organization as well as destroy it,” she says. “It’s not just saying, ‘Oh, you know, by 2030 or 2050 we want to be carbon neutral.’ [Investors] want to know what kind of discussions you have had in the boardroom about this. What the transition plan looks like. Who is accountable? How much will it cost? What will it cost if you don’t do it?”

Indeed, these issues are beginning to affect a company’s cost of capital, and its attractiveness to major investors, so the director’s role as a fiduciary has only expanded.

“We’ve hit a tipping point with respect to competition between companies, where you can’t afford to be seen as the laggard in the fight for customers, the fight for talent and in areas of regulatory risk. If you are seen as behind on ESG matters, not paying attention to them, that’s to your detriment,” said Eric Wetlaufer, managing partner at Toronto-based impact investment firm TwinRiver Capital and a director at four companies, including TMX Group.

“A keen understanding of the material factors, the ESG factors that are material, is a board responsibility.”

A sustainability survey of 100 global companies by the Harvard Law School’s forum on corporate governance found that ESG-related knowledge at the board level has increased since last year, but that corporate governance policy on such issues “too often remains vague and lacklustre.”

“Simplistic and general stipulations like ‘oversee sustainability issues’ or ‘govern ESG factors’ should not and cannot provide stakeholders confidence that relevant issues are being monitored and adequately addressed,” the authors wrote.

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Canada’s Institute of Corporate Directors, which provides a wide range of education courses, introduced a series of classes on board oversight of climate risk last year. The first session for 40 participants in November sold out, as has the upcoming February session with another 40 seats. The 40-person module scheduled for May is filling quickly.

Certainly, boards have long since moved past the era when one or two directors dealt with ESG issues alongside other duties, says Ms. Murray from Teck Resources. Instead, responsibility is spread across nearly all committees.

“Now, that’s really expanded and I think, depending on the industry, you’ll see a different way to approach ESG. But there’s no question it’s on the board’s agenda in a much broader way than just governance.”

A little over a year ago, companies could still say they were in wait-and-see mode regarding climate risk and disclosure, because there were a number of competing disclosure regimes for ESG matters and climate risk. That meant the quality of disclosure by companies who did bother to report on these issues varied widely, and wasn’t comparable from one to another.

Things have moved quickly since then, however. Major investors, such as large Canadian pension plans and the Canadian Coalition for Good Governance (CCGG), have backed a set of climate standards from the international Financial Stability Board’s Task Force on Climate-Related Financial Disclosures, or TCFD. And the International Integrated Reporting Council and the Sustainability Accounting Standards Board announced they will merge into a new organization, the Value Reporting Foundation, to set international sustainability standards for companies, including standards on climate disclosure.

In Canada, the umbrella group for provincial securities regulators, the Canadian Securities Administrators, put out a draft of climate disclosure guidance that largely embraces the TCFD principles. Based on the current timeline, Canada’s largest companies will begin reporting on their climate risks in the spring of 2024, for their financial years ending in late 2023.

'We’ve hit a tipping point with respect to competition between companies, where you can’t afford to be seen as the laggard in the fight for customers, the fight for talent and in areas of regulatory risk,' said Wetlaufer.Fred Lum/The Globe and Mail

Many companies are working on disclosure, even if what they produce may not yet adhere to the upcoming standards. Millani, a Montreal-based ESG consulting company, said that as of Aug. 31, 71 per cent of companies listed on the S&P/TSX Composite Index released a report dedicated to some sort of disclosure of ESG topics, compared with 58 per cent in the previous year.

Catherine McCall, executive director of the CCGG, which represents major institutional investors and speaks regularly with boards on governance issues, says climate “is now part of our engagement discussions on a regular basis, and it will be included when we’re talking to independent directors.”

“We don’t go in and say, let’s see your TCFD compliance,” she says. “It’s more a matter of ensuring that for the directors, it’s on their radar screen and that they’re aware of the issues of identifying the climate change risks and opportunities that impact their company, and that they’re on top of management managing those risks and opportunities ... We are happy to see that they’ve started down that path.”

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Large Canadian companies that seek capital globally are more likely to move faster, however, and more will be expected of them, particularly if they have a net-zero goal of completely offsetting their carbon emissions, says Sarah Keyes, CEO of Toronto’s ESG Global Advisors and the leader of the ICD training program for directors.

“The institutional investor pressure on companies who stated that they are going to achieve net zero Is becoming massive for boards,” Ms. Keyes says. If a company has a net-zero plan in place, investors are demanding interim targets for cutting emissions and a transition plan overseen by the board.

“Many investors have now gone on the record saying, ‘If we engage with you and we ask you to have board oversight and to publish a transition plan, and you don’t, we will use the power of our voting to oust directors as required,’” she says.

This is already happening. Early this year, Exxon Mobil Corp. found itself in the crosshairs of a then little-known activist fund that criticized the U.S. oil major’s approach to climate-related risk. The fund, called Engine No. 1, succeeded in replacing three directors with its own nominees despite CEO Darren Woods’s campaign against the offensive. Mr. Woods said Exxon was already diversifying beyond fossil fuels, but warned moving faster would jeopardize profits.

The fund won over major institutional shareholders with its message that Exxon Mobil has failed to adequately prepare for the energy transition. It said companies that have done so were being rewarded by the market, while Exxon’s cost of capital was increasing.

British billionaire hedge fund manager Christopher Hohn started a movement called “say-on-climate” through his TCI Fund Management Ltd., which is a shareholder in Canadian National Railway and Canadian Pacific Railway. TCI wants companies to conduct an annual say-on-climate votes, modelled after say-on-pay resolutions in which shareholders give non-binding affirmation to a company’s approach to executive compensation.

After talks with TCI, CN submitted its Climate Action Plan to shareholders this spring for a vote, becoming the first Canadian company to do so. CN’s plan noted the international standards it complies with in climate reporting, explained how the board oversees the issue, and described CN’s history and goals in reducing carbon emissions from its locomotive fleet. CP says it will put its climate strategy to shareholders at its 2022 meeting.

Say-on-pay took a number of years to catch on. Say-on-climate may be embraced more quickly, says Kelly Gorman of Kingsdale Advisors. Kingsdale represented Mr. Hohn’s firm this year in a broader struggle against CN’s management, and it was retained by CP for proxy work in 2021.

“I would anticipate that this will be faster, just with how important this issue is becoming for everyone and how directors are turning their minds to this,” Ms. Gorman says.

One of the next key battlegrounds for investors will be the push to have ESG principles more deeply embedded into executive compensation plans.

So far, companies outside the natural resources industries are only at the very beginning of implementing such policies. When companies do use ESG in setting management’s pay, the measures tend to be included among criteria that do not have clearly defined targets that must be met. That’s in contrast to most of the financial criteria in bonus formulas, based on concrete measures such as gains in revenue, earnings and cash flow.

But as disclosure standards tighten, and there’s a growing consensus on the important metrics, shareholders can expect that to change eventually.

“I think as the data evolves, it’s going to be a long process as what is relevant and what is material becomes clearer – because it changes,” CCGG’s Ms. McCall says. “The science is constantly changing as well. So I think it’s going to be a while before we get to quantitative metrics for [linking] climate change and compensation.”

Editor’s note: Kelly Gorman's last name has been corrected in the online version of this story.

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