There are over 16,000 registered pension plans in Canada, stewarding $2.2 trillion in assets on behalf of 6.7 million Canadians.  How pension trustees interpret and apply fiduciary concepts is fundamental to informing their view of risk and value. In a 2023 decision, the Supreme Court of Canada found that ‘climate change poses an existential threat.’¹ As such, the duty of prudence (Latin-prudentia, meaning foresight) underscores the importance of conducting forward-looking scenario analysis; while the duty of loyalty highlights the need to consider climate risk across generations and investment time horizons. Meanwhile, the year 2050, the line in the sand scientists have given us to get to net-zero (NZ) emissions to keep global warming in check, looms closer.²

From a physical risk perspective, 2023 was the warmest year on record, with 18.5 million hectares burned in Canada alone, causing $3b in uninsured losses.³ Scientific research points to major climate tipping points in danger of being breached (Potsdam Institute).  From a transition risk perspective, the insurable universe is shrinking, as large insurers including Allstate and State Farm pull out of riskier markets such as California.  Many countries, including Canada, have adopted carbon pricing and policy mechanisms to align with their NZ commitments. Two major shifts are underway- an economy-wide transformation as industries decarbonize, and an energy transition, spurred on by a combination of governmental policies, emerging technologies, and ‘green’ finance options.  The USA’s US$370b Inflation Reduction Act with its full suite of tax credits, grants and preferential loans encourages clean energy solutions. The race to NZ emissions will require an annual global investment in the energy sector ranging from US$5 T to US$7 T p.a.—yet less than US$2 trillion is invested on a yearly basis.⁴

As such, the sustainable investing landscape is moving from a focus on integration of material ESG factors in investment process to one honed in on climate risk and opportunity as a strategic imperative. Although the Government of Canada leads on some fronts, such as adopting carbon pricing, proposing methane regulations, and issuing Canada’s first Green Bond worth $5b in 2023, several proposed climate related regulations and initiatives remain on hold. These include National Instrument 51-107 (2021) which requires issuer disclosure on climate matters, Canada’s Sustainability Taxonomy, (proposed in its Taxonomy Roadmap in 2023), which sets parameters for ‘green’ and ‘transition’ investing, and methane regulations (2023). Indeed, Canada risks falling behind, as our ‘implementation gap,’ or difference between stated climate commitments and enacted policies is assessed at 27%, the highest of all G20 countries.⁵

Trustees should not be lulled into complacency. Randy Bauslaugh states: ‘Pension fund fiduciaries ignore at their peril, the financial risks climate change poses to the investments they have a duty to manage,’ and finds they may be personally liable for lack of oversight.⁶ Indeed, climate litigation is growing.  There are over 2,000 climate related lawsuits registered globally in climate lawsuit databases⁷, with 80% of these emanating from the US.  Pension plan members are calling for action to protect their retirement savings. By contrast, in some ‘ESG backlash’ cases, members are concerned the plan may be compromising returns by pursuing ‘green’ strategies. Trustees should prepare themselves accordingly. 

Carol Hansell, in her legal opinion ‘Putting Climate Change Risk on the Boardroom Table,’ ⁸ finds board members are legally obligated to address climate change risk and opportunities.  Janis Sarra finds that board members must go ‘beyond passive receipt of information…” and establish a robust process to verify the fund’s progress on climate risk and opportunity.⁹

So, what are and should pension plan fiduciaries be doing to ensure they are appropriately addressing climate risk and opportunities within their investment portfolios?

Effecting meaningful change at a pension fund begins with governance.  Board members should seek training, so they feel equipped to deal with climate risk. Board oversight of climate should occur not only at the board level, but also at governance, audit and risk committees. The Task Force for Climate-related Financial Disclosures Framework (now subsumed by ISSB) is instructive.  Entities should address climate across categories (governance, strategy, risk, metrics and targets) that are interdependent. The board should expect management to embed climate into investment process, provide a full accounting of financed emissions by sector and asset class, and conduct forward looking analysis to identify climate risk under various warming scenarios. 

Asset owners convey their investment goals and expectations in their statement of investment policy (SIP.)  Yet an on-line search of publicly available Canadian pension plan SIPs finds most do not even mention climate, or simply mention it as a factor to be considered in the investment process. This level of hesitancy is puzzling- do pension plans not find climate to be a material, fundamental risk and corresponding investment opportunity? By contrast, BC’s Municipal Pension (MPP) Plan’s SIP  specifically instructs BCI, its investment manager, to seek climate related investment opportunities, including investment in up to $5b in sustainable bonds by 2025.  

Climate should feature in fund investment beliefs and strategy. For example, does the fund wish to divest of more carbon intense assets, or ‘go to where the emissions are’ and engage with co2 intense assets to help them decarbonize?  The International Energy Agency postulates that by 2030 the target ratio should be to invest 6:1 on clean energy supply versus fossil fuels with a concomitant focus on transformation of critical but carbon-intensive industries, such as cement and steel, to more sustainable business models.¹⁰ Leading investors are adopting climate action plans (ICAPs) with strategies for climate mitigation, adaptation and resilience to enable the fund’s transition to a NZ economy.  The ICAP can serve to reassure beneficiaries and stakeholders that the fund is focused on maximizing risk adjusted returns over the long term. 

Carbon Tracker recently warned that investors may be over-reliant on economic models that underprice climate risk. However, a leading date provider, Oxford Economics has updated its damage assessment and finds global warming of just 2.2 degrees Celsius, barely over the goal of the Paris Agreement, could reduce global GDP by up to 20%.  Their reassessment underscores the need to revisit loss assumptions and conduct value at risk assessment to stress test the portfolio. 

The flip side of risk is opportunity. Ultimately pension fiduciaries must ask themselves whether they are adequately positioned from a diversification, risk and return perspective for the economy as it is evolving. Investors may need to revisit risk tolerances, exposures to emerging markets and new technologies such as carbon capture to get sufficient upside returns.  Fiduciaries should ask themselves whether the fund is sufficiently invested in the 'levers' of the emerging global economy, such as eco-efficiencies, alternative energy, battery technology, grid upgrades, EV charging stations, circular economy and regenerative agriculture. The International Panel on Climate Change advises 80% of global energy supply must be renewable by 2050 to keep global warming in check.¹¹

The Office of the Superintendent of Financial Institution’s (OSFI) expects climate risks to intensify over time and result in financial risks, such as credit, market, insurance and liquidity risks, leading to strategic, operational and reputational risks. The OFSI B-15 Guideline requires 350 federally regulated financial institutions (FRFI’s) to disclose how they factor climate into their governance, investment strategy and risk management processes.  All pension plans should take heed, as this level of reporting may eventually be expected as commonplace. 

So how are Canadian funds rated on climate?

In February, Shift Action12 released its evaluation of 11 of Canada’s largest pension funds, representing $2T AuM. While CDPQ and UPP fared well, with overall B+ scores, SHIFT ascribed 7 of the funds lacklustre C to D scores. Shift’s criteria seem prescriptive. It penalizes funds for not divesting of fossil fuels.  Yet this ignores the real economy and the transition imperative, to stay invested in carbon intense firms that commit to pivoting to a more eco-efficient business model.  

  Indeed, Canada should be considered a global leader on climate- focused engagement. Climate Engagement Canada (CEC)13 is the first national affiliate of Climate Action 100+, which encourages carbon intensive companies to decarbonize in alignment with NZ by 2050.  Over 45 Canadian investors and 41 issuers participate in CEC and CA 100+.  Collectively investors represent greater ownership and thus influence on the company. Benchmarking issuers progress tends to improve engagement outcomes aligned with a ‘grey to green’ trajectory.  

So, what are the key takeaways?

Canadian pension funds can do more to ensure they are taking climate risk into account and should re-examine their assumptions.  Climate change is not an incidental risk to be passively added to the list of risks to be factored into investment process, but a fundamental and pressing one. Questioning their investment managers on climate strategy may reveal new insights into unrecognized risks and investment opportunities over time. 

Fiduciaries should communicate with their beneficiaries on the steps they are taking to address climate risk and opportunity across the fund. While Canadian fiduciaries can advocate for approval of climate related regulations and the taxonomy, they should not wait for regulations to take climate in account, in keeping with a prudential approach. 

Footnotes

1 Supreme Court of Canada Reference re GHG Pollution Pricing Act https://scc-csc.lexum.com/scc-csc/scc-csc/en/item/18781/index.do

2 IPCC ipcc.ch/sr15/

3 Environment and Climate Change Canada 2023 Progress Report on the 2030 Emissions Reduction Plan

4 Deloitte, Financing the Green Energy Transition, November 2023

5 International Energy Agency https://www.iea.org/reports/financing-clean-energy-transitions-in-emerging-and-developing-economies/executive-summary

6 ‘Climate Change-legal Implications for Canadian Pension Plan Fiduciaries and Policy Makers’ McCarthy Tretault, 2021

7Sabin Centre for Climate Change Law https://climatecasechart.com/

8 Carol Hansell, ‘Putting Climate Change on the Boardroom Table,” https://www.hanselladvisory.com/content/uploads/Hansell-Climate-Change-Opinion.pdf

9 Janis Sarra, ‘Enhancing Effecting ESG and Climate Governance in Pension Oversight’ 2022 https://ccli.ubc.ca/enhancing-effective-esg-and-climate-governance-in-pension-fund-oversight/ 

10  World Energy Investment 2023, International Energy Agency 

11 International Panel on Climate Change Sixth Assessment Report (AR6) 2023

12 SHIFT Action 2023 Canadian Pension Climate Report Card, accessible at www.shiftaction.ca

13 Climate Engagement Canada, accessible at www.climatengagement.ca

Alison Schneider MBA, ICD.D, Encompass ESG Corporation 

Formerly Vice-President of Responsible Investment (RI) at AIMCo (2011-22), Alison Schneider is currently a Senior Fellow for GRESB, Canadian Representative for Ceres Investor Network, Director with Emerging Markets Investor Alliance and a sustainability consultant. Alison is a co-founder of GRESB Infrastructure (2015), the world’s first infrastructure sustainability benchmarking tool, and of Climate Engagement Canada (2022).  Alison teaches a climate risk micro-certificate for Canada Climate Law Initiative and a sustainable finance course for the University of Alberta's MBA program. She is an author/co-author of The New Frontiers of Sovereign Investment (2017) and ICGN’s Guidance on Fiduciary Duty (2018). Alison was awarded Canada’s Clean50 award (2021, 2020), & the University of Alberta Alumni Honour Award (2022) for contributions to the field of RI.