Canada: Findings And Tips From Canada's First Survey Of Fund Managers On ESG (Podcast)

Kathryn Fuller

So today on The Legal Listen, your host, Kathryn Fuller, that's me, and Lynn McGrade from BLG's Investment Management Group will explore the key findings from a first-in-Canada survey by BLG on the ESG perceptions and practices of Canadian fund managers. Using this information, you'll be able to benchmark your practices against those of your peers and take away some practical tips on what to do about some of the more challenging areas of ESG.

Of course, to talk about your specific situation, you can reach out to us or any of your usual BLG contacts. Links to our contact information are available in the show notes.

This podcast is part of BLG's Future of Law series, which captures the perspectives of industry leaders on the biggest issues facing law and business in honor of BLG's 200^th anniversary. Check out the show notes for the link to the full series.

So Lynn, let's start with a quick recap of the main findings from our ESG survey. What do you think, for the people that haven't looked at it yet, are the things they should know?

Lynn McGrade

Well, thanks Kathryn. I think there were some interesting findings when we got the survey results. For example, the extent to which ESG is an important issue for the asset management industry. I mean our survey showed us that more than six in ten of our survey respondents, Canadian fund managers, consider ESG factors in their investment process. So it's impacting a lot of the industry.

Secondly, we also saw the extent of the review by the regulators in this area and how interested the regulators are, because of those that are involved in ESG, six of ten also were involved in an OSC sweep. So, I think that really the regulatory agenda in this area is quite strong and you and I know that for sure because that kept us quite busy this year.

And the final thing that we saw in the survey, is just the extent to which that regulatory guidance and the guidance from the sweeps is causing confusion and the notice that came out is confusing for people and people are really grappling with how to implement it and deal with it in practice. So, we did see that, for example, fewer than one in four felt like it was just something that was clear already. They did really feel like it was something new, a new regulatory requirement that they hadn't had to deal with before.

Kathryn Fuller

I definitely heard a lot of grumblings from clients about that staff notice and I think that we know that this is a complex area and I think the regulators maybe didn't appreciate how complex it was when they came out with that first staff notice and I think we're hopeful from their experience through the comment process and prospectuses and through the sweeps that they've done that maybe they've become a little bit more aware of the complexities in the area. I know I'm certainly looking forward to seeing what their rewrite of that staff notice is going to look like, because I do think that people are going to be looking for it with great interest.

Lynn McGrade

I agree. It's going to be a lot of interest coming out of that and it is really too bad that it's just going to be guidance again and not something we'll be able to comment on. Do you know when that might be coming out? What are your predictions on that, because we have seen a few mixed messages on this.

Kathryn Fuller

I agree. I think we should put a bet on it Lynn.

Lynn McGrade

[Laughing]

Kathryn Fuller

My best bet. I'm going to go with March and I say that mostly because I know the OSC's year end is the end of March and I think it's one of their priorities that the staff want to be able to say "done." Ticked the box.

Lynn McGrade

I won't take that bet. [Laughing]

Kathryn Fuller

So things are moving fast and beyond the challenges of the staff notice itself, I know our clients are just grappling with the pace of change in the ESG area in general. So, what have you been seeing Lynn in terms of how fund managers are actually responding to all of this?

Lynn McGrade

Well, certainly there's a lot of focus on disclosure. Disclosure at many levels. Disclosure in the prospectus documents. Disclosure in the continuous disclosure materials. So, for example, we did see in our survey that a majority of our respondents did have to make changes or chose to make changes. Chose to take another look, in light of the guidance, what they were saying in public disclosure and offering documents. We also saw in the survey results that clients are spending a lot more time considering their marketing materials and ensuring that they are aligned. Let's just say at least aligned with the offering documents. Almost half of the survey respondents have changed their sales communications or marketing materials because of either the notice or the sweep or a combination of both.

Kathryn Fuller

And I think really we can't talk about the survey without talking just about compliance as a whole. So, I know that almost half of all the survey respondents believe that their compliance-related costs for ESG were going to go up in the next five years, and I think I'm not surprised by that. I think that we all expect that we just need to devote a lot more time and attention to this area because it is new.

What I thought was interesting was that a lot of managers are using very manual controls to try to deal with this compliance issue and I think it was because ESG in its nature is not easily programmed. You can't code, "don't own more than 10 per cent of this issuer in the fund." Like that's not the same way that you can do for some kinds of concentration restrictions. I think that there are a lot of nuances on why a particular issuer might be held in the portfolio and what the rationale might be for how it fits within your particular ESG approach. I think that requires a lot of documentation and nuanced conversations. And so, if I'm in the compliance group, I think it's hard to figure out how to best demonstrate that you are compliant and ensure you are compliant.

Lynn McGrade

Yeah, I agree and it's also very different from issuer to issuer and also on a time basis, like a time horizon basis, it can change over time in terms of what the priorities are. But it is important to have those compliance objectives. Obviously, the OSC and the regulators are looking for that but there is also a lot of risk in the area outside of just the regulatory reviews. Things like, we've seen class action litigation going on. Obviously in the U.S., in particular, we have seen all the activities of securities regulators south of the border. And finally, we've seen activity by the Competition Bureau in Canada. So, obviously, the compliance costs are essential in this area for sure as you mention.

Kathryn Fuller

So, I think you mentioned three different areas of risk to worry about. What should fund managers be doing to deal with that? What controls seem to be working?

Lynn McGrade

Well, I mean, I think the industry is doing a great job so far managing those controls and compliance issues but obviously, looking at the offering documents, that's something we see.

Obviously, examining sales communications and marketing material. Thinking about this whole—we haven't really spoken about a lot—but characterization of funds. What kind of ESG funds? Are they ESG objective-forward funds? Are they more integration type funds if we use the definitional terms that have just come out from the CFA and others in the industry report.

So, I think looking at how you're categorizing your funds internally and making sure everything is aligning with that. Continuous disclosure materials like the MRFPs and client reporting.

How are you going to show, if you an impact fund, what kind of impacts you've made, etc. And then having, of course, as we talked about, the compliance policies and procedures to support all of that.

Kathryn Fuller

Definitely. I mean one of the biggest challenges is how do you demonstrate compliance with what you've said you're doing in those disclosure documents? Because, you know, how do you figure out how can you demonstrate it? Can you automate it? Are there ways to be able to test or are we still back in a very manual kind of process that the compliance department is doing. Or are you stuck with just getting certifications from your portfolio managers that everything in the portfolio is complying with the objectives. My personal view is that you probably need a more robust demonstration of compliance than you would for other areas that you've been thinking about. I think it's just such a tricky area to be able to answer questions from a regulator or in a litigation context to show that you've complied.

Lynn McGrade

Right and I think because of all the risks, another big area to think about is governance, like top-down governance. How is the board going to be satisfied that you've dealt properly with the risks associated with these new products and the types of investment processes you're using and how you're communicating those processes to the public. So, I think, thinking about governance as well from a larger perspective is really important.

Kathryn Fuller

It's that tone from the top.

Lynn McGrade

Tone from the top, that's it.

Kathryn Fuller

And I think the other part is training. So, you know, you can have all the guidance coming from the top of the house but you need the people doing the day‑to‑day on the ground really understanding this is the risk they should be looking out for. These are the procedures and policies you've put in place and then trying to make sure that everything you're doing is consistent with that. I know some of the rules around what you can say in marketing materials seem really granular, but if you haven't got a marketing team that understands what the risk is and what the concern is, then you're going to set yourself up for a challenge, I think, from a compliance perspective.

Lynn McGrade

And one last area that has to be taken into account and I'm not sure we've seen all the final evolution of how this one's going to play out but's it proxy voting and when your proxy voting is going to be considered to be a pure ESG strategy or when ESG is going to just follow along with other financial metrics, etc., as part of your proxy voting. And also, we've seen a number of comments in the sweeps around stewardship and if you say something about your ESG stewardship in your marketing materials, you have to have disclosure in your prospectus. Well that's new because that word stewardship never even appears in 81-101 right now or the form requirements. So, trying to figure out how disclosure, proxy voting and stewardship is going to be aligned in all the materials as well, I think is a challenge and something that the industry and the regulators in Canada are still working out. Maybe we'll get some thoughts on that in the next iteration of the notice.

Kathryn Fuller

For sure and I think it's interesting because you could have a decision to invest in something that doesn't seem at all ESG compliant or vote in favor of something that doesn't intuitively seem to work with what your stated goals are. So, I think that the next wave of what's going to happen is that the regulators are going to start to look at what the fund is actually holding. They were focused on this disclosure piece about what are you saying. But now they're going to look at the next level, which is what are you actually doing.

Lynn McGrade

Yes, which is tricky because ESG means different things to different people in some cases.

Kathryn Fuller

Exactly. So, I think for me there's a lot of rapidly evolving issues in this area and I think that there's more challenges to come. So, I wanted to say thank you so much for talking about the ESG survey findings from our fund managers and what they can do to reduce their ESG risk, Lynn.

Lynn McGrade

Well you're welcome, Kathryn. Very nice to do our first podcast together and for those who listened, thank you very much and just a reminder that you can find the link to the full survey in the show notes.

Kathryn Fuller

And reach out to Lynn or I if you have any specific issues that you want advice on. We're happy to help talk to you about your particular issues and help you navigate this rapidly evolving environment.