As interest in sustainable investing grows rapidly, advisors should welcome new disclosure rules. Still, there are concerns that Canada is lagging in the push among global regulators to stamp out “greenwashing,” which could undermine confidence in the industry.
Regulators have placed a greater priority on ensuring informed decisions about investments that incorporate environmental, social and governance (ESG) factors, while preventing fund companies from misleading investors through disclosures or marketing material.
Greater disclosure among fund companies helps advisors who invest in these products on behalf of their clients. Yet, a light-touch approach here could become an Achilles heel for Canadian fund managers.
“As a whole, the sector is inconsistent,” says Murray Gold, partner at Koskie Minsky LLP in Toronto, which advises institutional investors. “There are going to be more cases in which fund managers are accused of selling one thing and doing another.”
The Canadian Securities Administrators (CSA) issued guidance for investment fund companies early this year on their ESG disclosure, which call for consistency between a fund’s name and investment objectives, better disclosure of the strategies used to achieve investment objectives, and clear language around how ESG factors are evaluated and monitored.
Some critics say that funds still remain open to allegations of misrepresenting or inflating their ESG credentials. They argue that the CSA’s guidance is insufficient considering the more stringent disclosure rules that will come into force in the European Union (EU) and U.S. as soon as next year.
“Everything is kind of a best-practice suggestion. It’s helpful, but compared to other jurisdictions, it’s like speaking softly and carrying a small stick,” says Alexander Dyck, finance professor at the University of Toronto’s Rotman School of Management. “I think there’s every reason to expect that we won’t be as careful in following these guidelines as in other markets where there’s more of a big stick.”
One risk is that Canadian money managers could see fund flows diverted to better regulated investments elsewhere.
Advisors also need to keep in mind that the CSA guidance doesn’t define what constitutes ESG or require measurable outcomes. That leaves the door open for funds to label themselves as ESG-compliant even when they don’t further ESG objectives materially, Mr. Gold says.
“It puzzles me that our securities regulators are not taking a more coherent and effective position,” he says.
Fund managers seek ways to boost credibility
Billions of dollars have flowed into Canadian ESG funds this year. As of this past May, assets under management in such investments were up 24 per cent compared to a year earlier, according to Thomson Reuters data. Globally, assets in such funds totalled US$3.3-trillion.
Advisors have no choice but to learn about and incorporate ESG into client portfolios. Investment fund companies are increasingly creating mutual funds and exchange-traded funds that will help Canadians invest in a more responsible manner. Those companies say they’re heeding what the CSA put forward, and are taking steps proactively to spell out more clearly how they’re achieving ESG objectives.
“We’re taking very seriously what the regulators are telling us,” says Vivian Hsu, director of product innovation at Fidelity Investments Canada ULC.
In addition, Fidelity uses third-party ratings agencies like Morningstar Inc.’s Sustainalytics or MSCI ESG Research to screen what goes into portfolios. That’s one method for money managers to establish their fund’s credibility with investors.
“They can privately signal to the market, and that’s what’s going on right now,” Mr. Dyck says.
Ms. Hsu says regulators and the financial services industry are both grappling with how best to unify ESG standards.
“This is an iterative process. It will take us some time as an industry and as fund companies to align ourselves, and have more consistent terminology and disclosures. But I think any step forward helps,” she says.
With U.S. and EU securities regulators set to enact new laws, further Canadian regulations that hew more closely to those standards are likely coming. New requirements will be phased in not just for ESG funds but for the entire investment industry, says Diane-Laure Arjalies, associate professor of management and sustainability at the Western University’s Ivey Business School.
She says sustainability considerations will integrate with traditional fundamental analysis of companies and sectors.
“What the industry is facing is a total change of paradigm. Investment managers and financial advisors will have to grasp what that means,” Ms. Arjalies says.
A more robust regulatory framework will be beneficial for the industry, Mr. Dyck says, pointing to evidence of higher market capitalization for firms and greater fund flows in which well-established governance standards exist.
“If you can have a credible regulatory regime that makes sure material ESG-related disclosures are made – and enforced – that’s going to be good for the firms and for capital markets,” he says.