Ed Waitzer is a professor and the Jarislowsky Dimma Mooney Chair in Corporate Governance at Osgoode Hall Law School and the Schulich School of Business in Toronto. Kevin Thomas is chief executive officer of the Shareholder Association for Research & Education (SHARE).
Canadian securities regulators struggled this summer when they decided to issue new guidance on climate change-related disclosures for issuers. The regulators were clearly searching for a way to provide investors with useful information on an unprecedented systemic risk while still working within our existing continuous disclosure framework.
Sadly, the results of that struggle came up short, largely because regulators shied away from actually regulating. Instead, they chose to merely “clarify” existing regulatory requirements, trapping themselves (and all of us) in a framework for disclosure that is simply not fit for purpose.
Securities regulation is the product of a simpler world, in which the role of encouraging investment while protecting investors was limited by fairly consistent technologies and a more predictable economic system and environment. Within that world, the concept of “materiality,” which underpins our current system of corporate disclosure requirements, made sense for both investors and corporate issuers. Simply put, if a reasonable investor’s decision on whether to buy, sell or hold securities in a particular issuer would likely be influenced by the corporate information, it should be reported in a timely manner.
Over time, the concept of materiality has become more complex. New technologies and investment vehicles, a multitude of means for providing information to investors, and a growing appreciation for the significance of system-wide risks and externalities undermine the value of corporate disclosure focused solely on the financially material risks borne by any single corporation.
The challenge that an issue such as the climate crisis presents for securities regulation is exactly that – it is systemic. The whole is not the sum of its parts. For an investor – whom the securities regulators are seeking to protect – the financial effects of climate change are felt at the portfolio level as well as with respect to any particular issuer.
For any single company, the value of its own shares may not be negatively affected in the short term by a failure to curb its own greenhouse gas emissions, as it is in effect externalizing the bulk of those costs to others.
But information on those emissions and other sustainability matters are real and should be disclosed. Earlier this year, the Bank of Canada voiced concern about the significant risks climate change poses for both the economy and the financial system. A company’s outsized contribution to climate change may have an impact on those systems, and on other assets in an investor’s portfolio – real estate, farmland, mortgage lenders or insurance companies, for example – for whom the physical and financial effects of extreme weather may be catastrophic. Ultimately, for a long-term or passive investor, the chickens will come home to roost at the company level as well.
Should the law not require that investors be warned of those effects, and the company’s contribution to them? Could it not, for the reasonable investor, affect the decision of whether to invest in that company?
Most major companies provide some relevant disclosure – in sustainability reports, in their proxy disclosure or elsewhere – but using a wide variety of inconsistent standards. That is exactly why securities regulators, with a view to serving all capital market participants, should play an active role in setting new rules, to help promote the integrity, utility and comparability of such disclosures.
Mandatory disclosure standards will help companies better understand their own exposures and opportunities. More broadly, it should inform innovation and increase competitiveness, enhancing shareholder value. This suggests an imperative that goes beyond the materiality analysis.
There is ample precedent for such disclosure requirements. Consider requirements to disclose executive (and board) compensation, or the Ontario Securities Commission’s more recent move to require annual disclosure on gender diversity in the boardroom and senior executive ranks. The OSC didn’t ask the company to first determine whether the presence or lack of diversity was material to the company. Such disclosures have been invaluable to investors and have been helping to change governance practices for the better.
If participants in Canadian capital markets are going to be able to make reasonable decisions about their portfolios (and managing their businesses) in the context of systemic risks, common standards will be necessary.
Regulators have shown restraint as understanding of the risks, how to measure them and what to disclose has developed, but we now need their leadership. Voluntary reporting is no longer enough. The time has come for regulators to step up to that challenge.
Your time is valuable. Have the Top Business Headlines newsletter conveniently delivered to your inbox in the morning or evening. Sign up today.