Companies can be exposed to climate risks that range from the physical to the reputational.Nastco
Tougher rules from regulators in Canada and around the world on how companies report on climate risks will have implications on how investment advisers approach their relationships with clients and invest their money.
Late last year, the Canadian Securities Administrators (CSA) proposed a standardized reporting framework on climate risks greenhouse gas (GHG) emissions for Canadian-listed stocks and bonds.
“It will enable a level playing field when it comes to disclosures,” says Jean-François Gagnon, co-leader of sustainable finance at EY Canada in Montreal. “When you look at the different ESG rating agencies, there is a lack of convergence. Part of it is due to the fact that disclosures are hard to come about, so this should normalize things and support better decision-making.”
The CSA isn’t alone in taking these measures. The International Sustainability Standards Board is planning for global sustainability or non-financial disclosures for corporations or issuers, such as implementing minimum requirements for reporting GHG emissions. The U.S. Securities and Exchange Commission and European Union are also developing new standards around environmental, social and governance (ESG) disclosures.
These proposals share the common goals of increasing transparency on ESG risks and making it easier for advisers to compare companies from a risk perspective.
That’s especially important as investor interest in sustainable funds continues to rise. Morningstar Canada reported that assets invested in these funds doubled to $34.5-billion in 2021 from the year prior. To add an extra layer of protection for investors and increase transparency, the CSA has introduced guidelines on disclosure practices for funds that consider sustainability or ESG in their objectives or strategies.
“Advisors should start to see more disclosure in terms of how an investment manager or portfolio manager is taking some of the material factors into consideration in their investment decisions, and whether they engage in shareholder activism,” says Fate Saghir, head of sustainability at Mackenzie Investments in Toronto.
Standard disclosures are like financial statements
Climate risks can be physical (damage to assets and operations), reputational (if a company is seen as hindering the transition to a low-carbon economy), market-related (shifts in demand for certain products/services), legal and regulatory (costs of compliance or exposure to legal action), technological (displacing old tech and investing in new alternatives), and more.
While climate risks are becoming even more prevalent, they can be hard to assess as a risk category. That’s why disclosing material climate-related risks is vital for advisers and investors in order for them to make more informed investment decisions.
Standardized disclosure rules on ESG-related risks will help in the analysis of companies for asset managers, somewhat akin to comparing financial statements, says Mr. Gagnon. Ultimately, that will make it easier to build ESG-friendly investment funds without sacrificing returns.
“ESG is an additional dimension in which you can enrich your risk/return profile as you build your client’s portfolio,” he says.
While Canada and the U.S. are more aligned on the ESG-reporting front, the divergences begin to widen on a global scale. Europe is generally viewed as stricter and Asia as less so.
In 2018, the European Commission (EC) introduced the Sustainable Finance Action Plan to promote sustainable investments across the bloc, combat greenwashing (misleading claims about a product’s ESG credentials) and change how funds are classified. Although the EC’s plan is approaching the end of its five-year implementation, some more complex changes have been given a longer timeline before they take effect.
“It will be easier for advisers or portfolio managers to understand how a company’s activities or revenue are aligned to sustainability,” Ms. Saghir says.
For international securities that might not have enough ESG disclosures, she says advisers should take the time to engage with the company.
“If you’re investing directly in a company and not going through an investment fund, it’s actually a great opportunity for portfolio managers or advisers to better understand how they’re thinking about sustainability and managing their climate risks,” she says.
There are also other tools advisers can use to help compare climate risks. Ms. Saghir says MSCI Inc. is starting to make more of its company disclosures and rating publicly available. Data from Morningstar Inc. and ESG-focused research firms, such as Morningstar subsidiary Sustainalytics, can also provide an overview of regulatory or geopolitical challenges that fund managers should be looking at, she says.
“If you’re going to go through a third-party ESG-reporting route, it’s important to understand the methodologies because they’re all different,” Ms. Saghir says. “So, spend the time on the methodology if you’re going to invest in the securities directly. Otherwise, get that aggregate disclosure and get a feel for how that portfolio manager thinks about sustainability in their investment process.”