On January 19, 2022, the Canadian Securities Administrators (the CSA) released Staff Notice 81-334 ESG-Related Investment Fund Disclosure (the Notice) to provide guidance on the disclosure practices of investment funds as they relate to environmental, social and governance (ESG) considerations. The issuance of this Notice follows a considerable increase in interest in ESG investing in Canada for both retail and institutional investors.
CSA staff (Staff) emphasize that the guidance provided in the Notice is based on existing securities regulatory requirements and does not create any new legal requirements or modify existing ones. Rather, the Notice clarifies and explains how the current securities regulatory requirements apply to ESG-related investment fund disclosure, with the view of enhancing and bringing greater clarity to ESG-related disclosure and sales communications to enable investors to make more informed investment decisions.
This article highlights certain key developments in the ESG-related space and summarizes the guidance provided by the CSA for investment funds. For complete details, please refer to the Notice.
An increase in ESG interest among investors as well as the potential for “greenwashing”, whereby a fund’s disclosure or marketing intentionally or inadvertently misleads investors about ESG-related aspects of the fund, are cited in the Notice as having led securities regulators and international organizations to directly address issues relating to ESG investing. Notably, the International Organization of Securities Commissions published a final report in November 2021, setting out recommendations for securities regulators and policymakers to improve sustainability-related practices, policies, procedures and disclosure in the asset management industry. In the same month, the CFA Institute published their Global ESG Disclosure Standards for Investment Products with the aim of providing greater transparency and comparability to investors by facilitating clear communication of ESG-related features of investment products from asset managers.
In Canada, Staff have conducted continuous disclosure reviews of regulatory disclosure documents and sales communications of ESG-related funds. The findings of these reviews are summarized within the Notice. Although Staff consider current disclosure requirements to be broad enough in scope to address ESG-related disclosure, in Staff’s view, additional guidance was needed to clarify how the current disclosure requirements apply to improve the quality of ESG-related disclosure and sales communications.
The Notice sets out guidance on how existing securities regulatory requirements apply to investment funds as they relate to ESG considerations in the following areas:
Under securities laws, an investment fund (in its prospectus) is required to disclose the fundamental investment objectives of the fund, as well as information that describes the fundamental distinguishing features of the fund. To prevent greenwashing, a fund’s name and investment objectives should accurately reflect the extent to which the fund is focused on ESG and, where applicable, the particular ESG-related aspects the fund is focused on. To ensure consistency, where a fund’s name references ESG, the fundamental investment objectives of the fund are required to reference the ESG-related aspect included in the name. The following figure provides further direction in this respect.
Non-ETF mutual funds are required to identify the type of mutual fund that the fund is best characterized as in its prospectus. In Staff’s view, where a fund does not include ESG considerations in its investment objectives, it should not characterize itself as a fund focused on ESG, and conversely, where ESG considerations are so included, a fund may characterize itself as a fund focused on ESG.
The Notice sets out guidance in relation to investment strategies disclosure applicable to all funds and specific guidance applicable only to funds that use any of the following: (a) proxy voting or shareholder engagement as an ESG strategy; (b) multiple ESG strategies; and (c) ESG ratings, scores, indices or benchmarks.
An investment fund is required to provide full, true and plain disclosure of all material facts in its prospectus. To enable investors to understand the ways in which a fund will meet its ESG-related investment objectives, where applicable, and make investments, full, true and plain ESG-related investment strategies disclosure must be made. ESG strategies, if used, either principally or as part of its investment selection process, requires disclosure of the ESG-related aspects of the fund’s investment selection process and strategies. Description of these strategies must be written using plain language.
Further, Staff take the view that investment strategies disclosure should identify the ESG factors used and explain their respective meanings, as well as how they are evaluated and monitored.
Funds that use proxy voting or shareholder engagement as a strategy to select investments are required to disclose how they are used by the fund. In Staff’s view, disclosure should include the criteria used by the strategy, the goal of the strategy, and the extent of the monitoring process used to evaluate progress towards such goal.
If multiple ESG strategies are used, disclosure explaining how the different strategies are applied during the investment selection process is required. In addition, if the strategies are not applied simultaneously, disclosure must include the order in which they are applied.
In Staff’s view, where an ESG-related fund uses ESG ratings, scores, indices or benchmarks as part of its principal investment strategies or investment selection process, disclosure in relation to how these ratings, scores, indices or benchmarks are used should be provided.
An investment fund that uses proxy voting as an ESG investment strategy must include a summary of the ESG aspects of the fund’s proxy voting policies and procedures in the fund’s prospectus or annual information form, as applicable. Such inclusion can provide clarity about how voting rights will be used to further the fund’s ESG-related investment objectives.
Further, Staff encourage investment funds that use shareholder engagement as an ESG strategy to make their shareholder engagement policies and procedures publicly available to achieve greater transparency for investors.
In keeping with the requirement for a fund to disclose any material risks associated with an investment in the fund, Staff encourage all investment funds to consider whether any material ESG-related risk factors are relevant to the fund and to disclose such risk factors, if applicable.
As mentioned above, a fund’s name and investment objectives should accurately reflect the extent to which the fund is focused on ESG. Similarly, Staff highlight that brief statements of a fund’s suitability for particular investors should also accurately reflect the extent of the fund’s focus on ESG and any particular aspects of ESG that the fund is focused on.
Funds that have ESG-related investment objectives can help prevent greenwashing by providing useful continuous disclosure that allows investors to monitor and evaluate the fund’s ESG performance. ESG-related funds are required to disclose how the composition of the investment portfolio relates to the fund’s ESG-related investment objectives or strategies, as applicable, in its management reports of fund performance. Further, Staff encourage funds with a measurable ESG outcome to report whether the outcome is being achieved in the same reports. Investment fund managers are also encouraged to regularly assess, measure and monitor the ESG performance of the funds they manage to ensure that useful disclosure is provided.
If a fund uses proxy voting as an ESG strategy to meet its ESG-related investment objectives, the fund is encouraged to include disclosure of all of the fund’s annual proxy voting records on their websites, despite the current requirement that only the most recent annual proxy voting record be made available. Staff take the view that such disclosure would provide greater transparency into how the fund has historically made use of proxy voting to meet its ESG considerations. For the same reason, funds that use shareholder engagement as an ESG strategy are also encouraged to provide disclosure of past shareholder engagement activities.
Sales communications containing ESG considerations must not be misleading or untrue and should be consistent with a fund’s regulatory offering documents so as to not intentionally or inadvertently mislead investors about ESG-related aspects of the fund.
The extent to which a fund is focused on ESG should be accurately reflected in any sales communication pertaining to an investment fund. Further, Staff believe that a fund should not indicate that it is focused on ESG in its sales communications unless ESG is referenced in its investment objectives.
A fund must not include misleading statements about ESG performance of the fund in its sales communications.
Similarly, sales communications that include fund-level ESG ratings, scores or rankings must not be misleading. In the Notice, Staff provide specific guidance on how to avoid issues such as: (a) conflicts of interest involving the provider of the ESG rating, score or ranking; (b) cherry-picking ESG ratings, scores or rankings; (c) selecting ESG ratings, scores or rankings that are not representative of the ESG characteristics or performance of the fund; and (d) omission of necessary or appropriate explanations, qualifications or limitations.
To the extent that any references to ESG are added or removed from the fundamental investment objectives of a fund, that fund will be subject to the requirement that approval of its security holders be obtained prior to the making of any change to the fund’s fundamental investment objectives. If an investment fund changes its name to add or remove a reference to ESG, as mentioned above, similar consideration should be given to changing the fund’s fundamental investment objectives.
A fund’s prospectus should provide a clear explanation of any ESG-related terms that are not commonly understood.
If investment fund managers are signatories to certain international or regional ESG-related initiatives and publicly disclose this information, Staff highlight the importance of clarifying that commitments to these initiatives are at the entity-level, rather than at the fund-level.
If you have any questions about the guidance contained in the Notice, how to set up an ESG-related investment fund, or investment funds in general, please contact Michael C. DeCosimo.
We wish to thank Cindy Qi, articling student in Toronto, for her assistance with this summary.