Jan 5, 2023

What’s on the Horizon for Responsible Investing in the Year Ahead?

It was certainly a year to remember in the environmental, social and governance (ESG) space in 2022 — a new record for the number of environmental and social related shareholder proposals on the ballot during proxy voting season, multiple consultations on disclosure frameworks and global actions discussed at COP27 in Sharm el-Sheikh to address the urgency of climate change.

Here are ESG developments that AIMCo’s Responsible Investment team is keeping an eye on as we look ahead to 2023.

Biodiversity Takes Centre Stage

In December 2022, governments from around the world came together at the United Nations Biodiversity Conference in Montreal, also known as the Conference of the Parties (COP15), to strike a landmark agreement to guide global action through 2030 to halt and reverse nature loss.

Biodiversity refers to the variety of life on Earth and the natural patterns it forms. COP15 marked a crucial inflection point as human activity is pushing one million species of plants and animals towards extinction — the largest extinction event since the dinosaurs.¹ The health of the planet matters to all of us as it underpins people’s health and wellbeing. Human existence relies on the clean air, food, energy, medicine, materials, and other benefits provided by the natural world. Nature is also critical to meeting the UN Sustainable Development Goals and limiting global warming to 1.5 degrees.

Earth’s ecosystems have massive value. Despite the value being difficult to calculate, we know that natural capital is a precursor to resilient economies. More than half of the world’s economic output — USD 44 trillion of economic value creation — is moderately or highly dependent on nature.² We can look no further than our own backyard to see how urgent acting on biodiversity really is. Canada has a large natural balance sheet, which means that nature loss can materially impact the financial performance of companies we are invested in on behalf of our clients, especially companies involved in the extraction of natural resources, and pose long-term risks.

A new way of taking nature into account is capturing the attention of investors. The Task Force on Nature-related Financial Disclosures (TNFD), modelled on the existing Task Force on Climate-related Financial Disclosures (TCFD), is a market-led, science based framework that will enable companies and financial institutions to integrate nature into decision-making. The third beta version of its framework was released in November 2022 and is being piloted by 130 organizations, with the goal of having the final framework ready by September 2023. The TNFD expects a number of companies and financial investors commit to adopting the TNFD in 2024.

Institutional investors at COP15 also announced the Nature Action 100 initiative, which will formally launch in spring 2023. The initiative will focus on mapping sector pathways and identifying 100 focus companies for investor engagement, with companies’ progress tracked against key indicators.

In 2023, AIMCo will closely monitor the rollout of the TNFD’s final framework and the activities of Nature Action 100 as we begin our own journey of identifying and assessing our impact on nature.

From Consultation to Implementation

Last year, preparers, investors, assurers and other capital market stakeholders around the world welcomed the news that the International Sustainability Standards Board (ISSB) would form to deliver a comprehensive global baseline of sustainability-related disclosure standards. This global baseline is important because it gives a strong foundation for regulators to build off while pushing for more consistent and comparable information to help form investment decisions.

In 2022, AIMCo and its institutional investor peers responded to consultations from the ISSB, U.S. Securities and Exchange Commission (SEC) and the Canadian Securities Administrators (CSA) on their proposed climate-related disclosure frameworks. The proposals all generally align with the Task Force on Climate-related Financial Disclosures (TCFD) framework; however, differences between the proposals exist such as the stringency of reporting on upstream and downstream GHG emissions (Scope 3) and whether reporting on scenario analysis is required. To address these differences, the CSA is revisiting the feedback received on its proposal in addition to Canadian stakeholder feedback submitted directly to the SEC and ISSB.

The ISSB plans to issue final standards as early as possible in 2023. An ISSB Partnership Framework with more than 20 partner organizations was formed to help jurisdictions prepare for its implementation.

AIMCo is following implementation of these standards through our involvement in various investor initiatives. We will keep clients and our internal teams informed on how it may impact on our own reporting efforts and that of our investee companies.

Regulation Will Help Address Greenwashing

According to the Responsible Investment Association, concerns around greenwashing were identified as the most significant deterrent to growth in responsible investment in 2022. Concerns and mistrust have been driven by political backlash in the U.S., inconsistencies in ESG data and a lack of regulation.

The SEC, which created its Climate and ESG Task Force last year, brought at least three enforcement cases to action in 2022. Closer to home, the November 2022 CSA biennial report called out overly promotional disclosure pertaining to ESG matters as a key area for improvement in issuers’ continuous disclosure. The CSA noted that it observes many issuers making potentially misleading, unsubstantiated or otherwise incomplete claims about ESG and sustainability-related aspects.

Issuers that don’t back up their sustainability claims with factual and balanced evidence are at increasing risk of enforcement activity and litigation, with Bloomberg Law stating that the three cases brought forward in 2022 are likely just the beginning. The ISSB standards and potential regulation, as mentioned in the previous section, should help to alleviate greenwashing concerns through consistent and verifiable ESG reporting.

A Tailored Approach to Engagement

In AIMCo’s 2022 Stewardship Report, we highlighted that engagement individually or through collaborative initiatives on behalf of our clients with investee companies on key ESG issues is a pillar of the RI program at AIMCo, demonstrating active management and our “voice over exit” philosophy.

In 2023, AIMCo and other investors will continue to engage with investee companies on material ESG issues such as climate change, human rights, diversity, equity and inclusion, and executive compensation. However, our engagement approaches will evolve to consider a sector- or subsector-based context and leverage technology to better track the desired engagement outcomes that create sustainable value for our clients.

Common material themes can exist across multiple sectors, such as governance issues like executive compensation; however, incorporating materiality assessments from third-party data providers can give an additional layer of insight on the best practice ESG outcomes investors should seek action on to drive sustainable value through ongoing, constructive dialogue with company management. Take the energy sector, for example. Instead of engaging broadly on the topic of climate change, decarbonization strategies (energy transition risk) and clean tech opportunities were identified through a sector-based analysis as material ESG issues. An engagement plan can now be built based on this analysis to discuss these material topics and develop associated outcomes, such as the company explicitly committing to aligning capital expenditure plans with its long-term GHG target and issuing a decarbonization strategy that explains how it intends to meet its long and medium-term GHG reduction targets.

Recognizing that engagement outcomes may take months or even years for investee companies to achieve, the tracking of milestones in an engagement database every step of the way will be critical for investors to demonstrate accountability and evaluate any further actions or escalations.

AIMCo developed a new outcomes-based and sector-informed engagement framework in 2022 and will focus on the implementation of this framework, along with the onboarding of a new engagement database in 2023.

¹UN Environment Programme, 2022

²Taskforce on Nature-related Financial Disclosures, 2022