At the time of writing, updated Canadian Association of Pension Supervisory Authorities (CAPSA) Risk Management Guidelines¹ were due to be finalised in the first quarter of 2024. The draft guidelines require Canadian pension plans to consider whether environmental, social and governance (ESG) information may be relevant to the investment performance of funds and to take appropriate action based on that determination. Given that the nature of pension obligations is typically long-term, the consideration of material sustainability-related information, including climate risks, would be relevant to long-term investment performance and should be considered in managing the long duration of members’ pension assets. 

February also saw an important development in the UK, with the release of the Financial Markets Law Committee (FMLC) paper on Pension Fund Trustees and Fiduciary Duties. This paper examined the legal uncertainties surrounding the inclusion of sustainability and climate change when making decisions as pension fund trustees with fiduciary duties and concluded that “stewardship of an investment once made may be material to achieving (…) the balance of financial risk and return”.² 

The key question then is: what should an appropriate stewardship program look like for pension plan sponsors and administrators? As part of that program development, it is helpful to consider the relative strengths of divestment and corporate engagement strategies as mechanisms to align long-term performance with pension obligations.

Divestment has always been an important part of NEI’s approach to investing responsibly, as a tool to avoid taking excess risk in portfolios. Whether there are material sustainability related risks or financial risks that cannot be mitigated, investors can use divestment to protect portfolio value by removing those that are not adequately compensated by the market.

An example can be found within fossil fuel investments. It is valid for investors to consider the uncertainty facing this industry in a low carbon economy to be a material business risk for companies exposed to this sector. If a company is unable to show how it will align with a net zero path and generate sustainable future cash flows, a risk averse investor with a long time horizon may well consider divestment as the cost of capital remains uncertain. 

However, there are some limitations to the benefits that divestment can achieve for long-term investors. Removing a company from the portfolio does not impact the demand for holding companies by other investors – in fact, by reducing the voice of ‘responsible’ investors a company could become even more focused on the short-term profit seeking behaviour that can lead to undesirable practices and outcomes in the first place. Reducing real world carbon emissions requires the engagement of all participants in an industry; divesting investors lose their ability to influence business practices or capital allocation by companies (for example, into transition assets or employee upskilling). Additionally, a blanket divestment program can mean that leaders are treated the same as laggards, which, if anything, undermines the motivation for a company to be a leader. Leaders are important to drive industry action on issues. 

NEI has long argued the benefits of active engagement through the exercise of shareholder rights (corporate dialogue and proxy voting) to influence change at a strategic level within companies. This can be a more effective strategy to protect shareholder value and comply with fiduciary duties in instances where sustainability risks are potentially mitigatable. Leveraging shareholders’ rights retains a seat at the table and means companies are more likely to listen and change their activities. 

Alerting companies to the environmental, social, and governance risks they face, and influencing their decisions in a spirit of collaboration, can tangibly improve their performance to achieve long-term sustainability, which includes positive investment outcomes for shareholders. This can be a lengthy process; change doesn’t happen overnight, and it can take multiple years to achieve desired outcomes. 

Canadian investors have generally been among the first to embrace engagement as a preferred tool for change. More recently, there has been heightened public emphasis on engagement and as a result we are seeing increasing sophistication now in corporate dialogues. For smaller Canadian pension plans, engagement is often outsourced to external fund managers who have large pools of funds to leverage influence with Boards, and dedicated resources focusing on sustainability issues. Larger schemes, by contrast, often have additional exposure through direct holding and may have more resources to engage directly with companies. 

In terms of the efficacy of this approach, it remains challenging to evidence to a quantitative investment world the impact of this qualitative and nuanced approach. However, it would be a mistake to conflate perfection and progress. If we can open a dialogue with a company that has not yet identified its material climate-related risks, to have it acknowledge the future risks to its business and operating model, that is a significant achievement. Progress may not show up on a quarterly basis in neat KPIs, but it has happened, nonetheless. 

An example of this change in action is the use of net zero targets. There is much cynicism as to whether company net zero targets are realistic, achievable, and capable of driving society towards broader decarbonization targets. These concerns are fair, and we still have a long journey ahead to limit the worse climate outcomes currently facing us. Yet, taking a step back, with the benefit of perspective we can also see how far we have come. As close as 10 years ago, we weren’t even having the net zero conversation, let alone having it with CEOs or other investors. Now the topics of conversation include aligning capital expenditures with emission reduction targets and including climate risks in assurance engagements.

Today, with the investment industry largely bought into the value of sustainability and embracing engagement as a core stewardship process, we are facing a new set of challenges. The loudest of these is the anti-ESG movement, which has been exaggerated by a period of exceptional political polarization. Past investor behaviour which applied strict divestment policies for select industries has also become something of a self-fulfilling reality where fruitful dialogue with certain companies can be more challenging today. This includes some members of the fossil fuel industry, an industry on which our whole economy depends and will continue to do so for the foreseeable future. Finding a way to work with these companies to pivot into sustainable investments remains of paramount importance to our goals as investors.

A worrying development arose at the start of this year. Activist investors Follow This and Arjuna Capital issued a shareholder proposal to ExxonMobil that requested disclosure on the company’s greenhouse gas emissions and its plans to reduce them. In response, Exxon filed a lawsuit against the shareholders to block the proposal from advancing. At the time of writing, Exxon had succeeded in forcing the investors to withdraw the proposal but was continuing to pursue the countersuit. 

Regardless of Exxon’s intent, this unprecedented action has the potential to reduce future shareholder debate on issues of disagreement. Successful or not, the case may have a chilling effect on minority shareholders who do not have the resources to fight large conglomerates. The case therefore has strong implications for diversified shareholders like pension funds which have a longer-term mandate to meet their pension obligations and are dependent on the sustained health of the common systems on which our economy relies. 

The question is, are we too late? We don’t think so. Despite the noise from the anti-ESG movement, and more disturbing instances such as the Exxon case, most companies continue to engage, and few investors have stepped back from integrating sustainability considerations in practice - even though they may be retreating from collaborations and public statements. It feels like a good time to inject a meaningful and respectful approach into the dialogue and look to engage in the first instant. 

Constructive engagement is critical to supporting the transition to a low carbon economy, which includes finding solutions to global emissions reduction and ensuring a just transition. The complexity and scale of the real-world challenge should not be underestimated; it is not enough for a single company to reduce its emissions. An effective engagement strategy needs to be developed over time to build trust with companies across all industries and to maximise the influence of investors. Track record in this space counts.

In the absence of the ability to engage meaningfully, though, the prudent fiduciary may be forced as a last resort to reconsider divestment to address investment risks. Trustees, sponsors and administrators looking to discharge their duties will increasingly need to think about the approaches their asset managers are taking to stewardship on behalf of their members. These managers need to have robust investment processes and, in the instances where corporate engagement fails, be willing to take decisive action.

1 NEI provided feedback on the CAPSA guidelines during the 2023 consulting phase.

2 Pension Fund Trustees and Fiduciary Duties: Decision-making in the context of Sustainability and the subject of Climate Change. 6 February 2024, Financial Markets Law Committee

This material is for informational and educational purposes and it is not intended to provide specific advice including, without limitation, investment, financial, tax or similar matters. The views expressed herein are subject to change without notice as markets change over time. Information herein is believed to be reliable but NEI does not warrant its completeness or accuracy. Views expressed regarding a particular security, industry or market sector should not be considered an indication of trading intent of any funds managed by NEI Investments. Forward-looking statements are not guaranteed of future performance and risks and uncertainties often cause actual results to differ materially from forward-looking information or expectations. Do not place undue reliance on forward-looking information.

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Jenny Banks, Director Responsible Investing Advisory

Jenny Banks, Director of Responsible Investing Advisory, joined NEI Investments in 2023 as a product specialist representing the Responsible Investing team. Prior to this she worked as a consultant to First Nations communities in West Canada. Until 2020, Jenny worked in financial services in London, UK, where she had various roles at Wellington Management, Santander Asset Management (UK) and KPMG UK.

Jamie Bonham, Head of Stewardship

Jamie Bonham heads up NEI Investment’s Stewardship program and has over 20 years of experience engaging with companies on environmental, social and governance (ESG) issues. He is recognized industry wide for his depth of engagement experience and participates in numerous investor group initiatives on behalf of NEI. Jamie is currently a member of the Initiative for Responsible Mining Assurance (IRMA) board. 

Adelaide Chiu, Head of Responsible Investing   

Adelaide Chiu joined NEI Investments in 2022 as Head of Responsible Investing. She is a registered portfolio manager with over 24 years of responsible investing and investment management experience. Adelaide previously held portfolio management roles at the Ontario Municipal Employees Retirement System and Mackenzie Investments. She also worked in investment banking at BMO Nesbitt Burns, and PwC. Adelaide is a board member of the Canadian Sustainability Standards Board and the Responsible Investment Association.