ESG Regulatory Reform, Canadian Corporation Governance and Securities Law

Environmental, social, and governance (“ESG”) has been a popular topic in capital markets discussions. Governance—or the “G” in “ESG”—is the outlier from environmental and sustainability concerns.[1] Although they are cast together, it is often thought that there is no strong conceptual tie between governance and environmental or sustainability concerns.[2] What broadly ties ESG together are the aspirational moral aims such as environmental ethics, intergenerational justice, and equality of opportunity.[3] The legal framework around ESG attempt to guide companies towards these aims through various incentives.[4] Many approaches to ESG analysis focus solely on the putative value it brings to a company, such as attracting new investors; less focus has been put on the internal incentives, such as moral considerations or the views of current shareholders on ESG policy.

Corporate governance can have a role in incentivising management to develop and implement an ESG strategy.[5] The duties of directors are one way to influence the decisions of the directors, which is important since directors regulate a company’s strategy, operations, and performance.[6] There is a move towards directors (and officers) having a broader moral duty flowing from their fiduciary duty, or “looking beyond legality, to what is fair, given all of the interests at play” to address what is “wrongful even if it is not actually unlawful.”[7] This move in Canadian jurisprudence towards expanding the fiduciary duty can capture the moral dimensions of ESG while also incentivising ESG compliance. I argue that an expansion of a director’s fiduciary duty can buttress the current reforms to the ESG disclosure regulatory regime. Corporate governance laws can be a fruitful avenue for operationalizing ESG beyond mere disclosure and towards corporations being more morally conscious.

In part 1, I provide an overview of Canadian securities laws as it relates to ESG, and some of the standard market practices and attitudes towards ESG. I take a closer look at the disclosure regime and current discussions around market practices. This leads to a look at some potential weaknesses around the proposed reform with respect to corporate incentives. In part 2, I propose that a closer look at a director’s fiduciary duty can lead us to a more robust ESG regime. I begin by contextualizing fiduciary duty within the framework of current Canadian corporate governance law. I then suggest that the aims of ESG disclosure reform overlap with a director’s fiduciary duty and explore some potential problems with this view. In part 3, I expand on the relationship between corporate governance and securities disclosure laws. I look at the aims of each framework and how they go about incentivizing these aims. I then look at some speculative solutions and explore how other jurisdictions have approached these issues.

1. The Legal Framework Around ESG in Canada

I want to begin by contextualizing this discussion with some background on ESG and the current views surrounding it. The purpose of this section is to provide a basic background of the laws around Canadian capital markets and corporate governance; to this end, I highlight only what is necessary for understanding the relevant legal aspects of ESG. Additionally, I provide further context around ESG market practices and how they relate to the legal framework. In essence, laws and market practices track incentives, particularly around increasing value and avoiding loss, and this results in some problematic outcomes.

1. Securities law, disclosure, and ESG

            To start, it is necessary to briefly outline the legal framework in Canada’s capital markets. The current securities regulations in Canada reflect its federalist commitments. Each of the provinces and territories regulate their capital markets: in the words of the Supreme Court of Canada (“SCC”), “It is open to the federal government and the provinces to exercise their respective powers over securities harmoniously, in the spirit of cooperative federalism.”[8] Thus, there are 13 securities regulators accountable to 13 governments, and each regulator is supposed to reflect the different strategic priorities for their jurisdiction. There are partially harmonized securities national instruments as well as guiding national policies,[9] and the Canadian Securities Administrators (“CSA”) provides some national cooperation. Despite substantial attempts to completely harmonize the capital markets regime in Canada, there is currently no fully national body for securities accountability. Notably, in response to attempts at harmonization, the SCC noted that the Federal Parliament and each province may exercise their combined powers to collaboratively create a national cooperative capital markets regulatory system.[10] In 2020, Ontario’s Capital Markets Modernization Taskforce (“taskforce”) recommended to implement a single piece of legislation to apply across Canada.[11]

            To take a closer look at the securities disclosure framework, let us narrow the focus to the province of Ontario as a case study. A prospectus is required for public issuers and must be filed with the Ontario Securities Commission. A prospectus must provide “full, true and plain disclosure of all material facts relating to the securities issued.”[12] The prospectus must include a description of risk factors in the issuer and its business. Procedurally, any new material changes must be disclosed in a news release and a “Material Change Report” must be filed on the System for Electronic Document Analysis and Retrieval (“SEDAR”).[13] As a reporting issuer—namely, one who has obtained a receipt for a perspective from their respective regulator—there is also an obligation to continuously disclose information to investors. A corporation’s AIF must disclose any information that will influence a reasonable investor’s decision on the issuer’s securities. However, this is not the test for materiality in Canadian securities law; rather, the materiality of information depends on what would be reasonably expected to have a significant effect on the market price of securities.[14]

Material information relating to ESG can be a part of a number of securities disclosure forms. Some material risks might be disclosed in an issuer’s MD&A, especially as it relates to consumer preferences, supply chain management, or carbon allowances.[15] Material risks can also be a part of an issuer’s AIF, especially as environmental and social policies can affect operations and influence an investor’s decision to purchase securities.[16] It also includes elements of environmental protection requirements and disclosures of risks which can affect the price of securities. It is important for investors to have accurate, accessible, timely and up-to-date information which may have significant impact on the prices of securities. Nevertheless, in terms of ESG, boards often only make vague representations about managing risks, corporate culture, and internal policies.

The CSA has provided some guidance on what environmental information is material for disclosure. Currently, the existing ESG disclosure framework is outlined in CSA Staff Notice 51-333 (Environmental Reporting Guidance)[17] and CSA Staff Notice 51-358 (Reporting Climate Change-related Risks)[18] whereby factors of materiality are highly context sensitive. The CSA noted there is no bright-line test or quantitative threshold for materiality; rather, both quantitative and qualitative factors are considered in light of contextual information.[19] The CSA further notes that that environmental disclosure is only required insofar as it relates to material risks.[20] Current factors for material risk include probability, timing, context, and magnitude of the risk. This gives companies a high amount of discretion and little guidance insofar as what is material enough to be disclosed.[21]

            There are consequences for failing to disclose or misrepresenting information. [22] Institutional penalties take the form of criminal, quasi-criminal, and administrative enforcement. Yet, in theory, civil liability can be the costliest and the most incentivising for companies. Misrepresentation flows from securities statutes and mainly focuses on representations made by the prospectus and the offering memorandum.[23] In the primary market, purchasers may bring a cause of action if they purchased a security during the period of distribution.[24] In the secondary market, misrepresentations can flow from documents related to the prospectus (e.g., annual information forms, annual financial statements, interim financial reports, MD&A) or public oral statements (e.g., press releases, websites, roadshow presentations). The remedy can be damages or recission; when damages are awarded, they are calculated with respect to the real value of the purchases at the time of purchase and the depreciation of the security price.[25] Civil liability is a strong incentive for companies to make full, true and plain disclosure.

The taskforce’s final report recommends mandatory ESG disclosure for all non-investment fund issuers which is consistent with the recommendations of the Task Force on Climate Change-Related Financial Disclosure.[26] The CSA proposed National Instrument 51-107: Disclosure of Climate-related Matters[27] whereby reporting issuers would be required to disclose their governance around climate risks and opportunities in the management information circular (alternatively in the AIF or MD&A); additionally, reporting issuers must disclose the impacts of climate-related risks on the company’s business and financial planning, how the company would manage such risks, and the metrics and targets for managing risks.[28] The disclosure requirements would apply to all reporting issuers and entail “governance, strategy and risk management” as well as varying “scopes”[29] of green house emissions on a “comply-or-explain” basis. The task force also called on the CSA to impose similar standards across Canada.[30]

By and large, the ESG disclosure regime remains problematic in Canada. The CSA reported that, despite the guidance provided in NI 51-333, 22% of sampled issuers made no climate-related disclosure at all and 22% included only boilerplate disclosure.[31] There are a number of conclusions one might draw from this. First, clarity in the disclosure procedures is not the issue when it comes to voluntary disclosure; rather, it may be a problem of incentive. Second, this may indicate that mandatory disclosure is necessary for detailed climate-related disclosure and issuers need to be incentivised by stricter regulations. Third, if firms are not voluntarily disclosing climate-related disclosure, then the value it brings to the company or its role in attracting new investors might be minimal or at least lower than the costs of the disclosure. While there still is no explicit requirement for disclosing ESG in Canadian securities laws, some material aspects of disclosure may fall under the purview of ESG; nevertheless, it is becoming a common practice among firms to voluntarily disclose detailed ESG information.

• Market practice

Market practices are intimately linked to laws and changes in laws can have profound impacts on market practices; conversely, market forces can also impact legal reform and it is important to keep in mind the reciprocity of this relationship. Market practices have led to a trend towards increased voluntary disclosure and the causes of these trends are variegated. There is a strong case for attributing the rise in companies’ voluntary ESG disclosure to selfish motives of attracting investors, bolstering public relations, and strategically addressing climate risk. More idealistically, we might view this practice as corporations becoming better moral citizens and that there is an evolution in the morality of companies, investors, and stakeholders. On the other end, cynical views understand the trend as corporations acting in self-interest and view ESG as a mere mode for maximizing profit. Some remain skeptical about the underlying financial value that ESG can really bring and explain recent trends as a temporary response to market forces.[32]

            More attenuated optimistic views towards the value creation of ESG explain recent trends towards ESG in terms of a welcomed alignment between the financial benefits of ESG with moral considerations.[33] For example, a firm that cares about environmental ethics may be more attractive to shareholders and therefore ESG can become financially advantageous. It is important to disentangle these two motivations as they tend to be conflated. Claims that ESG can both contribute to moral ends while also maximizing returns should be approached with some skepticism.[34] It is difficult to convincingly argue that corporations are being altruistic in their voluntary disclosure of ESG. The more likely explanation is that companies are trying to attract investors and largely concerned about their public perception.

There is some talk about ESG being a fad.[35] The significance of whether ESG is a fad or not is partly due to the idea that ESG creates permanent value for companies. The veracity of this idea is important because if ESG is only creating perceived value on the market without contributing any intrinsic value for the company, then ESG would cease to provide any value when market sentiments shift.[36] In 2020, there were an estimated 300 ESG funds that claimed to build wealth while also contributing to ethical practices.[37] With the prevalence of profitable companies contributing to environmental disasters, human rights violations, and deplorable conditions for their employees, the promise of ESG is that investing can also contribute to positive ethical practices while simultaneously providing increased risk-adjusted returns.[38] Recently, since the COVID-19 pandemic, the trends indicate that investors are incorporating ESG as a premium in their valuing of companies.[39] Whether investors are becoming more morally conscious in their investing decisions or perceive ESG as a mere means for more returns remains to be seen. In any case, companies have been responding to this trend as pledging to be climate-neutral have doubled since the pandemic.[40]

There is a lot of money in ESG. There are many prominent ESG rating agencies which attempt to provide a standardized ESG rating similar to credit rating agencies.[41]  What is notable about these private firms is their pecuniary interest is tied to the propagation of ESG.[42] Such interests and motivations for ESG are suspect. While it is idealistic to expect firms to have purely altruistic motivations in connection with ESG, one should be wary of whether such motivations can conflict—for instance, maximizing ESG may be inconsistent with maximizing economic gain.[43] The lesson here is that readers ought to be sensitive to pecuniary interests associated with ESG and try to disentangle the morality in ESG from the money in ESG.[44]

There are a number of studies outlining the efficacy of ESG for financial performance. Some have shown that increased corporate transparency on ESG information has positive correlations with corporate efficiency, and one meta-study noted that 88% of sources find that companies with robust sustainability practice have increased operational performance translating into cashflows.[45] Some finance experts are skeptical towards the value ESG really adds.[46] Nevertheless, others argue that ESG does very little for increasing the permanent value of a company. At best, the goodness of ESG can penalize bad companies so investors do not buy their shares, but it is more difficult to establish a lasting positive benefit of ESG.[47]

To tie this all together, market practices and laws around ESG need to be understood holistically. Without clear laws, the markets will be left to its own devices and companies will only chase financial incentives. The ESG trend conveniently brings financial incentives, but it is entirely possible that this is temporary and dependent on market sentiment instead of intrinsic value. At this point, it appears that companies cannot be left to pursue moral ends without financial incentives, and this leaves ESG in a precarious situation.

• Incentives and issues with the current ESG framework 

Reforming the regulations around the ESG disclosure regime may not be the most effective way at incentivising companies to be good, especially since this partly relies on the assumption that ESG will bring short-term returns to a company. In other words, if the fad disappears and ESG no longer brings short-term returns, then companies will no longer attend to ESG.[48] Absent any altruistic motivations, companies may need some other incentive. Rules and penalties are the obvious choice from the perspective of securities regulators. However, detailed prescriptive rules can be too restrictive, inflexible, and inefficient. Moreover, if companies are amoral and indifferently maximize profits, companies may try to gamify such rules.[49] For instance, a company might deem it is less costly to take on the risks of regulatory penalties than comply with expensive ESG changes and disclosure. While this is a cynical view of companies, it is important to address this possibility when reforming the ESG framework.

Another issue with the current ESG disclosure framework is investor protection.[50] Due to their lack of sophistications, retail investors are susceptible to misinformation, manipulation, and misdirection, and their vulnerability needs to be protected;[51] although sufficient disclosure can satisfy legal requirements, it is often not practical enough to protect retail investors.[52] Notably, without consulting exact details and poring over disclosure documents, retail investors may buy into corporate virtue signalling.[53] Virtue signalling is the act of portraying a good moral character to others. This can be problematic if one does not genuinely hold such moral beliefs and acts disingenuously.[54] We can see how this applies to ESG: companies may signal that they are allies of ESG to lure investors with their perceived moral character yet fail to operationalize any principles of ESG in their company. ESG virtue signalling can take the form of promising both morality and money, and, while this in itself is not problematic or illegal, it can start to become harmful if their promises are anything less than the truth and deceive investors. ESG virtue signalling may partly explain how ESG became a fad.[55] Latching onto this trend, more companies may try to signal their virtue through ESG and creep into the lines of dishonesty and deception.[56] Deceptive practices which prey on an investor’s moral sentiments, information asymmetry, and false perception of competitive advantage needs to be penalized.

Since its advent, some have been optimistic about the role of technology for enhancing risk disclosure and protecting investors.[57] Technology and access to information through the internet has had profound impacts on investing behavior.[58] The internet and other information technologies have certainly lowered information costs, and this can benefit all parties. However, the sheer amount of readily available and free information can pose a challenge for parsing out the quality of information.[59] Retail investors often act without consulting intermediaries and are frequently unequipped to filter out unreliable or biased information. A related worry with disclosure for retail investors is an “information overload.”[60] More information can counterintuitively worsen investment decisions.[61] Discussions around the density of information in prospectuses and the opaqueness of some legal or financial jargon suggest the need for simplified information for retail investors. Thus, a necessary part of disclosing information is also ensuring that it can be processed effectively. This can be achieved through clearer and more manageable disclosure that is easily searched and digested.[62]

To take stock, returning to the role of securities law intervention, the current laws around ESG disclosure targets only what is material. There is a gap in disclosing what shareholders might care about and what directors are obligated to disclose as material. Recall that the materiality threshold is based on a test of significant impact of market price and not what would affect a reasonable investor’s choice to purchase a security. There is a disconnect between what impacts market price and what impacts an investor’s decision. Market practices have picked up on this and often voluntarily disclose beyond what is legally required in order to attract new investors. Canadian regulatory reform around ESG disclosure have been largely focused on targeting companies and using stricter, more detailed rules to provide clarity and to incentivise compliance. Companies, however, have been more responsive to market forces rather than stricter rules.[63] This suggests that securities laws around ESG disclosures is not the proper incentive for companies; rather, the best incentive for enhanced ESG disclosure must track the sentiments of shareholders towards ESG.

• Expanding the ESG framework

It is important to think about the hypothetical scenario whereby the trends around ESG subside and ESG investing is no longer financially beneficial.[64] Exploring this scenario can be helpful for understanding the effectiveness of the current ESG disclosure regime and whether corporations are sufficiently incentivised to disclose detailed ESG information. In this scenario, it is possible that directors may stop caring about ESG altogether. At this point, we should think about the current shareholders. Ideally, directors would ask for input from their shareholders on ESG matters, but directors currently have no explicit duty to ask their shareholders for input on ESG.[65] Some may argue differently and try to capture ESG under one of the director’s duties to their shareholders, but this view depends on what the role of the directors ought to be.[66]

            Both fiduciary duties and a duty to disclose have the aim of encouraging companies to act in morally beneficial ways. Directors can have a duty of disclosure under securities laws, but we have seen that this is an insufficient incentive and leads to vague, boilerplate ESG disclosure. The better incentive might be achieved through corporate governance law and a director’s fiduciary duty. The relationship between morality and legal duty is vexed, but there is some indication that Canadian courts are becoming increasingly more sensitive to moral considerations in the context of corporate law.

1. Fiduciary duty and corporate governance law

Before exploring the relationship between corporate governance and ESG, I want to sketch out some key relevant laws and developments in Canada. By way of background, the CBCA[67] and OBCA outline the core duties for directors and officers:[68] the fiduciary duty; and, the duty of care, diligence and skill. [69] Courts have read in three duties flowing from the general statutory fiduciary duty: a duty to monitor management of the corporation to address risk and misconduct, a duty to treat stakeholders fairly, and a duty to act ethically.[70] First, a duty to monitor flows from the idea that it is unrealistic to expect directors to directly manage a large business. They must have acted reasonably on an informed basis and includes reasonable steps taken to evaluate ESG performance. This entails environmental and social risks relating to increased risks of litigation; more concretely, the directors and officers must have a process that is documented to verify and oversee ESG performance. This must be done within the backdrop of mitigating financial risk and performance.

            Second, a duty to treat shareholders fairly is captured broadly in Canada as shareholders are understood to be only one of many stakeholders. The SCC’s decisions in Peoples Department Stores Inc. (Trustee of) v. Wise[71] and BCE Inc. v. 1976 Debentureholders[72] marked a shift from a director’s duty to shareholder primacy to acting in the best interest of a plurality of stakeholders. Additional stakeholders include employees, retirees, creditors, consumers, the government, the environment, and the long-term interests of the corporation. One set of stakeholder interests does not override another. Many writers of pointed to the vague and potentially conflicting nature of understanding a director’s duty as owed to multiple stakeholders.[73] It is unclear how directors are expected to ensure each stakeholders’ interest is treated fairly and which circumstances are relevant in prioritizing varying interests. While this vagueness may be understood to defer to the business judgment of directors, it can weaken claims for breaches of the duty and attaining a remedy for damaged parties.

Third, a duty to act ethically implies a director should go beyond mere compliance with laws. In BCE, the SCC noted that the duty of loyalty entails a “duty to act in the best interests of the corporation, viewed as a good corporate citizen.”[74] Fiduciary duties have the broader goal of fostering trust in social institutions.[75] Interestingly, this suggests a broadening of fiduciary duties beyond the scope of legal requirements. We can understand this to mean that directors need to be sensitive to moral considerations affecting the “goodness” of corporations and its place in contributing positively to the norms of society. This final branch of the fiduciary duty has the most potential for expanding into ESG reform.

            Crucially, and consistent with the “business judgment rule,” the fiduciary standard is not about outcome but the process of rationally accounting for relevant issues and the circumstances of the information available.[76] The business judgement rule covers such decisions by the director provided they act on an informed basis, in good faith, and in the best interest of the corporation.[77] If directors breach their duty, shareholders might bring an oppression claim for a broad range of remedies.[78] One should note that decision-making is context-specific and draws on factors like “general commercial practice; the nature of the corporation; the relationship between the parties; past practice; steps the claimant could have taken to protect itself; representations and agreements; and the fair resolution of conflicting interests between corporate stakeholders.”[79] This duty is separate from corporate governance legislation and the duties which flow from them.[80]

It is important to clarify what it means to be “good” in the moral sense and “good” in the legal sense, and how they relate with respect to BCE.[81] Some have balked at the court’s liberal expansion of fiduciary duty and the use of contentious moral terms in BCE.[82] What can be confusing to understand is the separation between legal duty and moral duty. It is possible to follow legal requirements without being morally good or following a moral requirement. A clear example of this is in private law and the use of equitable doctrines in contract law.[83] Even when one has a legal right in common law, equitable doctrines step in to fix immoral or unjust transactions. Despite there being no strict equivalent of equitable doctrines for corporate governance and fiduciary duty, it is important to recognize that satisfying a legal duty like a checkbox is not sufficient. Indeed, the court draws on “concepts of fairness and equity rather than on legal rights.”[84] Directors may have a moral duty owed to the environment that goes beyond their legal duty, which is housed under their fiduciary duty.

            From the lens of securities law, the existing disclosure requirements around corporate governance is clear. However, the taskforce recommends greater corporate board diversity.[85] The governance portion of ESG relates to enhanced disclosure of corporate governance practices. This intersects with topics of board diversity, transparency, and shareholder rights.[86] Governance-related disclosure is required by securities law whereas environmental and social disclosure is not expressly required. The taskforce has specific ESG related recommendations focusing on board composition and governance.[87] The policy rationale for greater diversity is again both moral and instrumental. Morally, we aspire to have a more equitable society free of systemic discrimination and prejudice, and this needs to be reflected in our corporate boards. Instrumentally, diversity can be beneficial for the health of companies and create more value.[88]

The relationship between environmental and social disclosure with governance is significant. The board and management are in charge of overseeing, assessing, and managing environmental risks, opportunities, and related policies. They are naturally accountable for any deficiencies or misstatements in ESG disclosure, and they are responsible for moving the company towards better ESG. Expanding a director’s fiduciary duty to include ESG as a moral rather than financial consideration can be a productive way forward for ESG reform. The SCC have made suggestive indications about expanding the fiduciary duty to include moral considerations that are independent of any material financial risks. This shows that moral on its own has a role to play in the duties of a director, and protecting interests does not always mean maximizing only economic interests. Taken to its extreme, directors must be sensitive to the morality of the company, its shareholders, and other stakeholders in their decisions.

• Expanding fiduciary duty for ESG reform

Directors and officers are responsible for the interests of internal stakeholders, particularly current shareholders.[89] Shareholders can have a profound role in pushing companies to care more about ESG and incentivising directors and officers to invest more into ESG. The line between business risks and environmental risks is becoming blurred. Shareholders want companies to articulate how growth can come from ESG and how companies will address long-term risks. It is becoming increasingly important for management to demonstrate how a company can protect against issues, like a public health crisis or climate change. While this might be more obvious for companies in industries like agriculture or fossil fuel, ESG risks are affecting all industries. Indeed, as issues such as climate change become exacerbated, the business risks start to become existential.[90]

            Corporate governance incentives are a more targeted approach towards directors. It is a core principle of corporate law that corporations have a separate legal entity. While it is clear the current laws would not pierce the corporate veil,[91] we may slowly move in that direction for ESG related violations. Courts have reserved piercing the veil of separate corporate legal personality and holding directors personally liable in the most aggregious cases of fraud, criminality, or objectionable purposes.[92] We should be careful that this is not punitive rather it is for just and equitable ends.[93] A duty of care held by directors and corporations could also extend to be owed to the environment and future generations.[94] The disclosure of morality can be tied to ESG and one might argue that shareholders ought to know about the moral decisions of a company. [95] This moral dimension might be initially introduced through ESG by its relationship to increasing the value of a firm and the general health of a firm, but it may go further to the discrete claim that shareholders ought to know about the moral outcomes of the decisions of the board, as suggested in BCE.

            Directors may also have a fiduciary duty owed to their shareholders to act in the best moral interest of the shareholders. In operation, this can take the form as a duty to consult their shareholders about their moral interests. In the same vein, one aspect of the duty of loyalty is to avoid conflicts. A conflict in morality might be understood in this way.[96] Notably, directors and officers are using other people’s money to act in their best interest of what is moral.[97] A problem arises when the demands of one stakeholder conflict with the judgment of the directors (and officers). For instance, while it can be reasonably said that shareholders defer financial decisions to the expertise of the directors, it is not clear that they defer moral decisions as well, particularly the morality around ESG. BCE suggests a move away from the paradigm that corporations have the sole objective of maximizing profits. The nuances of a corporation’s purpose are reflected in a director’s fiduciary duty and the plurality of stakeholders. Directors must be sensitive to the moral considerations of the company’s stakeholders and cannot paternalistically impose their own morally questionable decisions onto stakeholders.

At this point, one might push back and argue that all this analysis is unnecessary because trends towards ESG are better explained by the moral evolution of corporations, investors, and other stakeholders.[98] These parties are already incentivised by morality and laws do not need to import the presumption from economic theory that agents all seek to rationally maximize their self-interest,[99] so the argument goes. It is certainly within the realm of possibility that ESG is not a fad driven by finances but a lasting change in moral attitudes. Perhaps laws can move to encourage reasonableness or acting with respect to the common good and political morality.[100] These claims should be met with some skepticism. The idea that investors are willing to pay a premium for morality without any added return on their investment is largely speculative and idealistic.[101]

It is also possible that corporations have no role to contribute in morality.[102] It may be more appropriate that businesses should solely focus on profit and thus directors should solely pursue this end amorally. However, we typically attribute moral attributes to corporate persons. For example, we might attribute moral responsibility to the human rights violations of Nevsun Resources Ltd.[103] Even beyond the legality and even if certain actions are technically legally permissible, we believe that there are further moral constraints on corporations in addition to legal constraints, that is, to behave in ways consistent with shared morality such as environmental ethics. Corporations should not be viewed as mindless profit maximizing machines.[104]

To be clear, even if shareholders did not care about moral considerations, they can egoistically care about avoiding long-term existential threats. Imagine if shareholders were only concerned with financial returns and did not care about ESG as a moral consideration. ESG would still be useful to them as far as ESG can combat risks of poor governance and practices which threaten the sustainability of our global capital markets. Additionally, ESG addresses broader existential threats caused by global inequality, climate change, and rights violations. This may invoke debates about weighing short-term versus long-term issues and what needs to be properly prioritized. However, we can sidestep these vexing issues and concede that there are short-term issues which ESG policies can address. There are current damages and risks in businesses related to climate change, current human rights violations in supply chains, and current inequities in corporate governance. It is odd to think of such moral claims in financial terms. While financial gain can be an incidental effect of attending to these moral claims, these moral claims should still be pursued at no financial gain or even at a short-term financial loss. These are issues in front of us that ESG can immediately address.

In sum, it is currently not clear how courts will continue to expand the fiduciary duty. Some subsequent caselaw have moved in the direction of emphasizing good corporate citizenship.[105] However, further test cases are necessary to clarify the exact relationship between this expansion of the fiduciary duty and its application to ESG matters. It is possible to move this agenda forward concurrently with ESG reform.

• ESG reform

The need for integrating a broader fiduciary duty into ESG reform comes from the worry that corporations will not be sufficiently incentivised to invest in ESG (in the case that the ESG fad dies down). The fad brings a lot of value returns from investing in ESG, but if the returns start to wean it could cause companies to devote less attention to ESG.[106] This can cause ESG to be a mere checkbox to meet regulatory requirements whereas the current voluntary scheme (combined with the current fad) results in more enthusiastic and generous diverting of resources to ESG. Incorporating broader fiduciary duties as a part of the ESG scheme would provide another source of incentives for directors to invest in ESG. More specifically, independent of the ESG fad attracting external shareholders, the current shareholders can keep directors accountable.

1. Combining fiduciary duty and disclosure duties

The aims of fiduciary duty and ESG disclosure regulation overlap in important ways. Both securities and corporate governance regulations work with incentives.[107] However, they achieve their aims through different means. One way to illustrate this is by tracking the relationship between incentive and duty. In the corporate governance context, the incentives are directly aimed at the duties of directors and their accountability to current shareholders.[108] The directors are incentivised to behave well by the potential of being ousted by shareholder actions or incurring liability through a breach of fiduciary duty.[109] In the public disclosure context, the incentives are aimed at avoiding regulatory sanction while also attracting new investors. The directors are incentivised to behave well by the potential of investors choosing another company that has higher ESG outcomes or regulators punishing them for misrepresenting their ESG disclosure. Remarkably, both fiduciary duty and ESG disclosure regulation target directors.

We can try to speculate on how corporate governance law and securities law can further merge.[110] Reform can try to target other market players that have an influence on directors and officers. Beyond directors, underwriters may be another gatekeeper for scrutiny of ESG disclosure. While directors are better positioned to obtain information about the company, underwriters have a role in seeking out and questioning all relevant material facts to the best of their knowledge, information and belief. In other words, “they are expected to exercise a high degree of care in investigation and independent verification of the company’s representations.”[111] Creditors are another stakeholder for companies and can influence a company’s decisions.[112] Creditors may be more generous with their terms if companies meet a standard of ESG.[113] Of course, creditors have to be motivated and incentivised to move companies in this direction and they need to be similarly incentivised. In some sense, it may appear that we just moved the problem of incentives backwards instead of addressing it, but it may be worth thinking about how incentives for creditors are different from that of the company.[114] Employees are also more interested in working for sustainable companies; while attracting talent is important, directors should consider current employees as a stakeholder and how employees view ESG.[115] The plurality of stakeholders to which a fiduciary duty is owed opens up a lot of creative modes to implement ESG.

            Principles-based regulation—or, aiming at high-level rules rather than more detailed prescriptions—can be an effective approach for reform.[116] Rules should be designed by market participants rather than regulators as this would be more efficient and have stronger rates of compliance. Regulator should certainly still act to protect consumers or protecting against market failure, but they should only implement prescriptive rules when there is clear evidence of harm.[117] This would assist in the growth of Canada’s capital markets and reduce limits of the speed or volume of transactions. Prescriptive regulations always lag a bit behind innovations and changes in the market, so it is important to have a more flexible approach to regulation.

            Principle-based regulation is a natural fit for ESG reform rather than the rules-based approach to regulation.[118] It recognizes the variability in businesses in terms of size, sector or industry. We can look at the success of principle-based regulation through an outcomes-based approach. For example, if ESG metrics set by regulators are not met, and there is clear evidence of harm (e.g., environmental), the regulators would need to step in for more prescriptive measures to address the harms. An onerous disclosure regime with prescriptive rules can be inefficient if market participants are already voluntarily disclosing with similar outcomes—prescriptive rules would then punish the majority for the minority of free-riders and bad players. Despite the minority of bad players, the majority will establish a norm of ESG disclosure and create a penalty of reputational risk.[119]

• Speculation on reform from other jurisdictions

Current ESG legal reform in Canada is primarily focused on securities disclosure in terms of making voluntary disclosure mandatory (rather than focusing directly on the duties of the directors). While the disclosure regime is connected to the duties of the director, implementing regulatory reform solely through the disclosure regime is an ineffective way of incentivising ESG. A further worry with stricter ESG disclosure policies is that it will add to costly over-disclosure that may obscure useful information.[120] Overcomplexity is definitely counterproductive for ESG; however, it remains that under-disclosure is currently the problem. The aim of investor protection should make disclosure as accessible as possible, but the information must first be adequately disclosed before we look at the problem of accessibility. Stricter securities regulations may undercut Canada’s competitive edge on the international stage.[121]

            Even without strict and detailed legal requirements, corporate governance practices would survive.[122] Voluntary commitments to environmental policy can be aimed at avoiding high compliance costs in the future. Firms may also try to signal that their governance is also attractive to investors—that is, directors who are transparently ethical and listen to the moral imperatives of their shareholders and other stakeholders. ESG factors can often engage the best interest of the corporation.[123] Increasing investor confidence in the capital markets is a clear policy objective that is tethered to investor sentiments and confidence in directors.[124] Some have shown that a demanding and actively enforced disclosure system with heavy civil and criminal penalties towards management promote investor confidence.[125] This line of argument is buttressed by American reform through the Sarbanes-Oxley Act and the change in investors’ confidence in financial statements after the Enron scandal.[126] Similarly, we may look to other jurisdictions for guidance on the future of ESG in Canada.

The United States fiduciary framework gives primacy to shareholders and this can open up more avenues to pursue insofar as a claim of a breach of fiduciary duty.[127] The argument is that a director or officer pursuing their own morality or benefiting a third party over shareholders is a violation of a duty of loyalty. From this perspective, the need to argue that ESG coincides with maximizing value is necessary.[128] ESG focused investing would be permissible if it benefits the shareholder by improving risk-adjusted returns and if the motives are to obtain this benefit.[129] While American corporate governance is different from the Canadian approach, we can prudently look to American reforms in securities law and ESG reform.[130]

Recently, the Biden administration announced the appointment of a “Senior Policy Advisor for Climate and ESG” for the U.S. Securities and Exchange Commission (“SEC”), and a Climate and ESG Taskforce. In May 2020, the SEC’s Investor Committee recommended that the SEC start updating reporting requirements to include ESG factors,[131] and, in December 2020,[132] the ESG Subcommittee proposed recommendations on the disclosure of ESG risks. The acting chair announced, in March 2021, a chance to comment on climate change disclosure.[133] The issues were around the disclosure of the internal governance of climate issues and risks, and whether disclosure standards should be comparable to financial disclosure requirements (e.g., audit, assessment, certifications).

Overseas, the European union began a comprehensive mandatory ESG disclosure regime.[134] The “EU Taxonomy Climate Delegated Act” introduced disclosure obligations for companies based on expert criteria on contributors of climate change.[135] The “Corporate Sustainability Reporting Directive” is supposed to act as a uniform reporting standard for sustainability disclosure. The European Union also aims at reinforcing fiduciary duties and corporate governance regulations to promote sustainability. EU securities regulators have adopted a scheme of mandatory disclosure through the “Sustainable Finance Disclosure Regulation” and called for increased oversight of ESG ratings to address “greenwashing” and other gamifying practices.[136] Others have pursued their own scheme of mandatory ESG disclosure, such as the United Kingdon[137] and New Zealand[138] which have slightly longer timelines. Australia has had some interesting developments, such as its June 2021 ASIC targeted surveillance of greenwashing.[139] Additionally, there have been several examples of litigation around climate risk disclosure, which is an important lesson for other jurisdictions.[140] These are useful datapoints that Canadian reform can draw upon.

Many hurdles remain for a unified and possibly global ESG standard. A vexing issue is compliance and combatting the gamification of ESG data and disclosure.[141] The morality of ESG should not be a strategy to cover up indifferences to ESG goals nor should it be instrumentalized, which is the central issue of greenwashing. This gamification of ESG tries to bolster ESG through massaging scores, finding biased ESG rating agencies, and relying on vague language in disclosure. The game is to maximize perceived ESG (whether it is through scores, ratings, or public image) while minimizing the resources invested into ESG. The overarching problem is the lack of standardization based on the fact that ESG risks vary by industry, business, and geography.[142]

In Ontario, nearing the end of 2021, the taskforce is working to receive comments from market participants.[143] This approach is questionable.[144] Third-party professionals offering advice might choose recommendations for political or self-motivated reasons rather than for the quality of the contribution. Similarly, the Canadian government is incentivised to promote ESG for other political motivations. Canada, through the Responsible Investment Association, is looking to lead the world charge for managing climate risks and reaffirm Canada’s place in the global capital markets through establishing the International Sustainability Standards Board in Canada.[145] Notably, this is another way of instrumentalizing ESG—that is, the aim of sustainability and equitable practices is incidental to another valuable target, which, in this case, is not money but political currency.[146] The primary worry here is that instrumentalizing ESG would lead to suboptimal outcomes and, if we believe ESG is just a fad, it may no longer be discussed or operationalized. ESG should not be used as a guise for some other end like money or political power.

• Conclusion

I have tried to offer a conceptual link between ESG disclosure in Canadian securities law and a director’s fiduciary duty being expanded into moral considerations.[147] I have provided a sketch of the legal framework for disclosure under securities law and argued that the main weakness with approaching ESG from this angle is its weak incentives. I suggested that conflating financial incentives with moral incentives can be problematic when financial incentives disappear; in other words, we cannot build a legal framework for ESG by relying on companies to act altruistically. I then outlined how Canadian corporate governance jurisprudence is expanding a director’s fiduciary duty to include moral considerations above and beyond strictly legal requirements.

I argued that ESG can be housed under these moral considerations. The upshot is that ESG disclosure in securities law can be buttressed by ESG considerations as a part of a director’s fiduciary duty in corporate governance law. My aim is to give a modest account of laws relating to ESG in Canada and demonstrate that it is at least possible to connect ESG disclosure reforms with reforms in a director’s fiduciary duty. More work is required to fully paint how a duty to disclose and a fiduciary duty can provide a coherent foundation for fully ratifying ESG into Canadian law. 

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[1] It is important to distinguish ESG from the related concept of corporate social responsibility (“CSR”). CSR arose in the United States in the 1970s by the Committee for Economic Development. ESG is distinguishable from CSR in that ESG is focused on measurable criteria applicable to specific targets, like diversity, supply chains, and climate change. CSR is aimed at general accountability of business across a wide variety of sectors with little measurability; in other words, CSR is more applicable in the context of a high-level mission statement or business commitments. While much of what this essay covers can apply to CSR, for clarity and precision, this essay will focus on ESG. 

[2] It is true that corporate governance is important for contributing to environmental and sustainability policies, but it is also tempting to cast good governance as a separate aspirational end of enhancing diversity, social equality, and general corporate accountability.

[3] The distinction between “moral” and “ethical” is not important for the purposes of this essay and are used interchangeable, unless otherwise indicated. The same applies for “duty” and “obligations” as well as “company” and “firm.”

[4] Interestingly, incentives such as penalties and punishments assume that companies are self-serving and would not pursue moral aims without regulatory intervention.

[5] As some skeptics suggest, when the ESG fad is over and the link between ESG and the perceived increased value dissolves, we will then need a stronger incentive to promote ESG aims.

[6] If ESG alone cannot get companies to act morally, and if ESG’s adding value is temporary, then we need an alternative way to enforce good behavior.

[7] BCE Inc. v. 1976 Debentureholders, 2008 SCC 69, at para 71.

[8] Reference Re Securities Act, 2011 SCC 66, at para 9.

[9] There are approximately 130 national instruments, 11 multilateral instruments, and 800 local rules.

[10] Reference re Pan-Canadian Securities Regulation, 2018 SCC 48.

[11] As of the end of 2021, it remains to be seen whether this recommendation will be realized.

[12] Securities Act, R.S.O. 1990, c. S.5, s. 56(1).

[13] Moreover, National Instrument 51-102 requires periodic disclosure of material information in its “Annual Information Form” (“AIF”), including risk factors influencing an investor’s decision to purchase securities; and, “Management Discussion and Analysis” (“MD&A”), including risks or uncertainty for the business’s future performance.

[14] Mary G. Condon, Anita I. Anand & Janis P. Sarra, Securities Law in Canada: Cases and Commentary (Toronto: Emond Montgomery, 2005)

[15] The MD&A contains a narrative of the financial performance and reflections on the likely future performance of the company. The MD&A assists current and potential shareholders evaluate the value of a company and supplement financial statements.

[16] The AIF is a detailed document disclosing material information about business operations and future prospects.

[17] Canadian Securities Administrators, Staff Notice 51-333 Environmental Reporting Guidance (October 2010) online: <https://www.osc.ca/sites/default/files/pdfs/irps/csa_20101027_51-333_environmental-reporting.pdf&gt;

[18] Canadian Securities Administrators, Staff Notice 51-358 Reporting of Climate Change-Related Risks (August 2019), online: <https://www.osc.ca/en/securities-law/instruments-rules-policies/5/51-358/csa-staff-notice-51-358-reporting-climate-change-related-risks&gt;

[19] For example, emission standards future environmental-related risks can vary a great deal depending on a company’s industry, size, or business.

[20] The CSA has given some guidance as to what environmental information could be material, but again there remains no bright-line test for materiality.

[21] The rationale behind the current framework addresses the variability in companies in terms of industry, size, and business type which inform varying factors in determining risk and materiality. However, too little guidance can have the effect of companies innocently failing to identify material risks or potentially shirking their disclosure obligations.

[22] The distinction between private and public corporations is important to address since fiduciary duty can apply in both contexts but disclosure is more important in the public context.

[23] Securities Act, R.S.O. 1990, c. S.5, s. 130.

[24] The burden is on the plaintiff to establish a misrepresentation of a material fact whereby the defendant failed to conduct a reasonable investigation. A material fact is “a fact that would reasonably be expected to have a significant effect on the market price or value of the securities.” See Securities Act, R.S.O. 1990, c. S.5.

[25] Kerr v. Danier Leather Inc., 2007 SCC 44.

[26] The final report contains 74 recommendations and is the product of consulting with over 110 stakeholders and 130 comment letters.

[27] Canadian Securities Administrators, Consultation Climate-related Disclosure Update and CSA Notice and Request for Comment Proposed National Instrument 51-107 Disclosure of Climate-related Matters (October 2021), online: <https://www.osc.ca/en/securities-law/instruments-rules-policies/5/51-107/51-107-consultation-climate-related-disclosure-update-and-csa-notice-and-request-comment-proposed&gt;

[28] The recommendation starts with the largest issuers (500 million in market capitalization) to comply within two years and smallest issuers (150 million in market capitalization) to comply within five years.

[29] Scope 1 refers to direct GHG emissions, Scope 2 refers to indirect GHG emissions from purchased energy, and Scope 3 refers to indirect GHG emissions not covered by Scope 2.

[30] More explicit and clear regulation can also assist in offsetting information costs for companies; by providing guidance, companies do not need to waste resources in trying to discern what the requirements for disclosure are, and often these requirements can be generalized through categories of industry, size, or the type of business.

[31] Canadian Securities Administrators, Staff Notice 51-358 Reporting of Climate Change-Related Risks (August 2019), online: <https://www.osc.ca/en/securities-law/instruments-rules-policies/5/51-358/csa-staff-notice-51-358-reporting-climate-change-related-risks&gt;

[32] Accordingly, the skeptic argues, as market forces die down, the financial creation will also die down; as such, tying the morality of ESG to its value creation is ultimately a fleeting and ineffective way of achieving moral policy objectives such as combatting climate change or addressing rights violations.

[33] Another appeal is ESG having the potential to solve a dilemma for investors of having to choose between money and morality.

[34] We can clarify the competing claims of morality and maximizing returns by imaging circumstances where one exists without the other. For instance, we might ask if investors or corporations would pay a premium for furthering moral aims if it had possibility of returns or even resulted in a net loss—here, it is clear that most are not purely altruistic in this sense. We can ask the opposite question: we can ask if investors or corporations further financial ends that further immoral ends—here, it is clear that egoism is rampant in corporate behavior.

[35] Witold Henisz, Tim Koller, & Robin Nuttall, Five ways that ESG creates value (November 2019), online: < https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/five-ways-that-esg-creates-value&gt;

[36] Zaghum Umar et al. “A tale of company fundamentals vs sentiment driven pricing: The case of GameStop.” (2021) 30: 100501 Journal of Behavioral and Experimental Finance.

[37] John Hale, Sustainable Fund Flows in 2019 Smash Previous Records (January 2020), online: <https://www.morningstar.com/articles/961765/sustainable-fund-flows-in-2019-smashprevious-records?

[38] Again, these claims of guilt-free investing are often exaggerated.

[39] Maura Souders, Survey Analysis: ESG Investing Pre- and Post-Pandemic (2020) online: ISS ESG Solutions <https://www.issgovernance.com/file/publications/ISS-ESG-Investing-Survey-Analysis.pdf&gt;

[40] Ecosystem Marketplace, EM Global Carbon Hub (2021) online: <https://www.ecosystemmarketplace.com/carbon-markets/&gt;

[41] Florian Berg, Julian F Kolbel, & Roberto Rigobon, “Aggregate Confusion: The Divergence of ESG Ratings” (2020), online: SSRN https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3438533.

[42] Some institutions are working on standards for ESG criteria in the investment process, such as the Sustainability Accounting Standards Board (SASB), the Global Reporting Initiative (GRI), and the UN Sustainable Development Goals.

[43] Ideally, maximizing ESG would also maximize economic gain; while there may be some correlation between the two, maximizing ESG will not maximize economic gain.

[44] As we shall see below, cynical attitudes towards ESG argue that ESG is a fad that is extremely profitable for those involved in it while failing to produce any actual good or contributing minimally to ESG’s aspirational goals.

[45] Gordon L Clark, Andres Feiner, & Michael Viehs, “From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance” (2015), online: SSRN <https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2508281&gt;

[46] Bradford Cornell & Aswath Damodaran, “Valuing ESG: Doing Good or Sounding Good?” (2020) online: SSRN <https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3557432&gt;

[47] Aswath Damodaran (Ibid) notes that increased value should be reflected through higher cash flows or a lower discount rate, but none of these are increase solely by ESG. Rather, Damodaran argues that there is a false correlation between profitability and the perceived “goodness” of ESG. Damodaran attributes the ESG and increased valuation correlation to the gamification of ESG by large companies.

[48] In other words, if the motivation to attracting investors through ESG disclosure is attached to a temporary trend, and if this temporary trend towards ESG disappears, then companies may no longer be motivated to care about ESG.

[49] Miriam A. Cherry, “The Gamification of Work” (2012) 40:4 Hofstra L Rev 851.

[50] The distinction between institutional and retail investor matters here as well. Retail investors can more guided by morality in their investment decisions whereas institutional investors hardly take morality as a factor and focus on the numbers and models. Take the example of an initial public offerings (“IPO”), or a private company’s choice to go public. Communicating an ESG strategy is important for IPOs. IPOs can be a hotbed for misleading investors, especially about ESG. It is often difficult to test the veracity of the company’s claims because private companies have a lower profile and have little history. Moreover, the story that the company spins during their roadshow can add a lot of room to massage ESG claims.

[51] Aaron A. Dhir, “Shadows and Light: Addressing Information Asymmetries through Enhanced Social Disclosure in Canadian Securities Law” (2009) 47:3 Can Bus LJ 435.

[52] While sophisticated investing decisions are often determined by incredible amounts of financial analysis and modelling, retail investors often take a more subjective and personal approach.

[53] Tyge G Payne, Curt B Moore, Greg R Bell, & Miles A Zachary, “Signaling Organizational Virtue: an Examination of Virtue Rhetoric, Country‐Level Corruption, and Performance of Foreign” (2013) 7:3 Strategic Entrepreneurship Journal 230-251.

[54] If firms know that markets are watching them, they are incentivised to act in way that seem desirable to the markets.

[55] That is, by claiming they are more moral and make more money, they have the moral high ground against their competitor companies who may only make money while committing morally repugnant acts.

[56] ESG, currently conceived, is too easy a solution to the dilemma of morality and money, and the recent fads are propagated by professionals in the ESG space profiting from this trend.

[57] Donald C. Langevoort, “Toward More Effective Risk Disclosure for Technology-Enhanced Investing” (1997) 75:2 Wash U L Q 753.

[58] Brad M Barber & Terrance Odean, “The internet and the investor” (2011) 15:1 Journal of Economic Perspectives 41-54.

[59] There are certainly sophisticated tools to assist in analysis and self-education resources available, but these are no replacement for the expertise of a professional.

[60] Troy A. Paredes, “Blinded by the Light: Information Overload and Its Consequences for Securities Regulation” (2003) 81:2 Wash U L Q 417.

[61] Imagine, for example, having to sift through a box full of diligence materials on a company within a week; now, imagine having to sift through fifty boxes full of diligence materials within a week. In the latter instance, one is more prone to be overwhelmed, confused, and unable to effectively process the information. Simply believing more information and disclosure leads to more informed investors ignores the psychological limitations.

[62] Disclosure is a means to an end of ensuring investors make informed decisions. Investors do not want information for its own sake; rather, investors want more information to make more informed investment decisions. It can also have the effect of increasing efficiency and reducing agency costs since investors will not have to devote resources to find this information. The policies structure the disclosure system to incentivise disclosure by penalizing nondisclosure.

[63] The primary market force influencing companies are potential investors. While one explanation of why these external investors pursue ESG is for profit maximization and the perception that ESG adds to the value of a company, it is possible that the relationship between ESG and increasing value is temporary. If this is true, then once ESG stops providing value, investors would stop caring about ESG. However, there may be other more permanent reasons that investors care about ESG.

[64] After all, according to some skeptics, this is the direction capital markets are headed in.

[65] We can push the scenario further. Imagine the shareholders of a company are only concerned with maximizing immediate returns and do not care about ESG or any moral contributions it makes. Now imagine the director is particularly concerned with moral causes and sincerely believes that going against the immediate interests of shareholders and investing in ESG is the best decision. We know that directors in Canada have a plurality of stakeholders beyond shareholders, but we might question whether the director violated a duty owed to shareholders. At this point, we might question whether moral decisions can be business decisions; moreover, we might question whether a stakeholder’s interests can go beyond money and whether it would be correct to defend a stakeholder’s moral interests.

[66] Stephanie Ben-Ishai, “A Team Production Theory of Canadian Corporate Law” (2006) 44:2 Alta L Rev 299.

[67] It is important to recall the May 2018 amendments to the CBCA, which were supposed to come into effect July 2021. First, some corporations are required to have discrete voting and no longer allow slate voting for elections for directors. Second, public companies are required to implement majority-voting in uncontested elections, which supersede Toronto Stock Exchange majority voting policies; additionally, shareholders can vote for or against nominees in uncontested director elections rather than withholding shares from voting.

[68] Canada Business Corporations Act, R.S.C. 1985, c. C-44 [CBCA]; Ontario Business Corporations Act, R.S.O. 1990, c. B.16 [OBCA].

[69] Canada Business Corporations Act, R.S.C. 1985, c. C-44, s. 122(1)(a) and (1.1); Ontario Business Corporations Act, R.S.O. 1990, c. B.16, s. 134(1)(a)

[70] Edward J. Waitzer & Douglas Sarro, “The Public Fiduciary: Emerging Themes in Canadian Fiduciary Law for Pension Trustees” (2012) 91:1 Can B Rev 163.

[71] Peoples Department Stores Inc. (Trustee of) v. Wise, 2004 SCC 68.

[72] BCE Inc. v. 1976 Debentureholders, 2008 SCC 69.

[73] J. Anthony Vanduzer, “BCE v. 1976 Debentureholders: The Supreme Court’s Hits and Misses in Its Most Important Corporate Law Decision since Peoples” (2010) 43:1 UBC L Rev 205.

[74] BCE Inc. v. 1976 Debentureholders, 2008 SCC 69, at para 81.

[75] Hodgkinson v. Simms, [1994] 3 SCR 377, at p. 422.

[76] The business judgment rule gives a fair bit of room for discretionary decision-making which can end up with short-term approaches instead of long-term care towards ESG. If short-term options are within a reasonable range, then in order to counter-act this we need to increase accountability and stringency through laws. Still, directors should have discretion in terms of which issues are material for a sustainability strategy as well as how to integrate ESG factors into operations. The financial market requires a critical mass of investors to invest in companies that have long-term ESG plans. This will create reputational pressures not to freeride or deviate from market norms. Market norms are a powerful tool for self-regulating among market players without the need for legal intervention. However, establishing new market norms among sophisticated parties can be challenging. Often, long-term sustainability undermines short-term returns. Arguably, the prevalent structure of corporate governance incentivises short-term returns. Management is expected to maximize returns in the short-term for investors. Compensation options for directors incentivise short-term actions and shareholders often penalize long-term strategies through their vote in board elections. There remains an issue that current incentives to create short-term returns for shareholder undermines a long-term ESG plan.

[77] See Unique Broadband Systems Inc., Re, 2014 CarswellOnt 9327 (Ont. C.A.), at paragraph 72

[78] Canada Business Corporations Act, R.S.C. 1985, c. C-44, s. 241

[79] BCE Inc. v. 1976 Debentureholders, 2008 SCC 69, para 72.

[80] Moreover, under section 122 of the Ontario Securities Act, directors and officers can be sanctioned if they authorized a breach by the issuer; if they are found to have acted contrary to public interest, they can be prohibited from acting as a director or officer and be ordered to pay penalties. All actions applicable to financial disclosures, in theory, should apply to ESG related disclosure, such as class action litigations (see section 130 of the OSA).

[81] I should stipulate that I do not aim to dive deeply into philosophical issues or policy analysis.

[82] Li-Wen Lin, “The “Good Corporate Citizen” beyond BCE” (2021) 58:3 Alta L Rev 551.

[83] Jennifer Nadler, “What is Distinctive about the Law of Equity?” (2021) Oxford Journal of Legal Studies.

[84] BCE Inc. v. 1976 Debentureholders, 2008 SCC 69, at para 71.

[85] Aaron Dhir, Challenging Boardroom Homogeneity: Corporate Law, Governance, and Diversity (Cambridge: Cambridge University Press, 2016).

[86] Poonam Puri, “The Future of Stakeholder Interests in Corporate Governance” (2009) 48:3 Canadian Business Law Journal 427-445.

[87] First, corporate board diversity requirements for executive officers who identify as women, BIPOC, persons with disabilities, and LGBTQ+. The taskforce recommends that issuers aim for 50% women (implemented over five years) and 30% of the other named groups (implemented over seven years). Second, board tenure limits for most board members. Third, a mandatory (non-binding) say-on-pay votes on executive compensation. Fourth, mandatory annual director elections on uncontested elections.

[88] The heterogeneity and varying demographics can unlock new perspectives, talent, and business acumen which were previously supressed. 

[89] If external incentives of attracting potential shareholders is too weak a foundation to ground the future of voluntary ESG disclosure, then we might look to the internal structure of the corporation for answers.

[90] COVID-19 is one recent example of an unforeseen risk which decimated businesses and had profound impacts on business risk analysis. 

[91] Canada Business Corporations Act, R.S.C. 1985, c. C-44, ss. 83(4), 118(2), 146(5), and 226.

[92] Neil C. Sargent, “Corporate Groups and the Corporate Veil in Canada: A Penetrating Look at Parent-Subsidiary Relations in the Modern Corporate Enterprise” (1987) 17:2 Man LJ 155.

[93] Kosmopoulos v. Constitution Insurance Co., [1987] 1 S.C.R. 2.

[94] Although it is difficult to conceive of this in legal terms because the environment and future generations do not have legal personhood. We might ask who may bring such causes of action. One answer might be the government as they act as the guardians of these interests. Alternatively, we may understand this in slightly more modest terms as stakeholders.

[95] A shareholder might have a right to know about ESG disclosure and a right implies a corresponding duty.

[96] Similar problems are found in the investment sphere where “ESG investing” can trigger a fiduciary duty. ESG investing is a fairly broad term meant to capture an investment strategy that prioritizing a company’s ESG as being ideal for risk-adjusted returns. While directors and officers are not “investing” in the same sense, their decisions in steering the firm and managing its resources has parallels to investing.

[97] Edward J. Waitzer and Douglas Sarro, “Fiduciary Society Unleashed: The Road Ahead for the Financial Sector” (2014), 69 The Bus. Lawyer 1081.

[98] It is also possible to challenge the premise that shareholders actually do care about ESG. Imagine a shareholder population that is adamantly opposed to ESG and aggressively seeks directors that fulfil their anti-ESG agenda. This might lead one to conclude that directors have a fiduciary duty to pursue an anti-ESG agenda. Fortunately, in Canada, shareholder primacy does not inform a director’s fiduciary duty, and ESG can be responsive to multiple stakeholders. Still, even in jurisdictions with shareholder primacy, one can reasonably argue that anti-ESG objectives are oriented towards a short-term strategy and pro-ESG directions may still act in the shareholder’s long-term interest. Directors may still be incentivised to keep shareholders happy so they can avoid being replaced by shareholder votes, but there is little to do about attitudes in the general population that staunchly oppose ESG concerns; after all, in a liberal democracy, we are free to hold views and use our capital power to reflect these views, and forcing the choice to exercise choices of private capital is an unacceptable form of paternalism. 

[99] Paul Halpern, Michael Trebilcock & Stuart Turnbull, “An Economic Analysis of Limited Liability in Corporation Law” (1980) 30:2 U Toronto LJ 117.

[100] Steve Lydenberg, “Reason, Rationality and Fiduciary Duty” (2014), 81 J. Bus. Ethics 365.

[101] One issue that undermines this point is that ESG disclosure is being gamified. For example, stricter disclosure requirements for public companies can incentivize them to go private or change their business structure. This avoidance strategy is just one route companies can take to gamify for their own gain at the detriment of everybody else. Avoidance strategies must be considered for structuring an ESG disclosure regime.

[102] Abraham Singer, “Justice failure: Efficiency and equality in business ethics” (2018), 149:1 Journal of Business Ethics 97-115.

[103] Nevsun Resources Ltd. v. Araya, 2020 SCC 5.

[104] By changing the way we think about a director’s responsibility (metaphorically, the corporation’s brain) we can understand the corporation beyond profit maximizing machine and move towards a more morally sensitive corporation.

[105] Icahn Partners LP v Lions Gate Entertainment Corp., 2011 BCCA 228.

[106] Consistent with skeptical views, corporations are largely responding to temporary market forces favoring detailed ESG disclosure, and the resultant positive moral or ethical policy objectives are also contingent on temporary market forces.

[107] In general, they aim at incentivising good behavior from corporations and disincentivized bad behavior through penalties.

[108] We can try to explore how to incentivise both internal and external stakeholders to care about ESG. We should start by distinguishing duties between current shareholders and potential shareholders. This is important because the duties to current shareholders relate to corporate governance whereas duties to potential shareholders relate to securities disclosure regulations. Failing to consider the long-term value of ESG should be understood as a failure of fiduciary duty understood broadly, and this should be disclosed to potential investors on the outside. This becomes an issue of internal corporate governance and disclosing this issue of corporate governance to the public.

[109] Through this lens, directors are still concerned about the overall value of the company and potentially attracting new shareholders, yet these concerns are secondary to the primary incentive of keeping internal shareholders happy.

[110] Some understand there to be dilemma arising for directors to either follow corporate law or securities law. For example, it is entirely possible that a director may use ESG regulation to look after long-term interests in bad faith and in violation of fiduciary duties owed to shareholders. However, these cases are marginal and the real issue is harmonizing the objectives between these two legal frameworks.

[111] YBM Magnex International Inc (Re), [2003] 26 OSCB 5285.

[112] ESG risks can be important in the bond market for credit analysis (e.g., green bonds, social bonds, sustainability bonds).

[113] Interestingly, creditors could also demand ESG and influence a company’s decisions on developing their ESG. Environmental risks are a part of the profile of a company and inform their creditworthiness.

[114] A clear example of this is the case of the creditor being a government—governments are not private parties incentivized by profit, and governments can directly implement these policy aims through public funds.

[115] Moreover, specialist employees in charge of ESG should be a welcomed addition to the growth of the company. Incidentally, ESG is also crucial for capital raising and M&A, but it is also important for shareholder activism and executive compensation. 

[116] Julia Black, Martyn Hopper, & Christa Band, “Making a success of principles-based regulation” (2007) 1:3 Law and financial markets review 191-206.

[117] Richard E. Mendales, “Intensive Care for the Public Corporation: Securities Law, Corporate Governance, and the Reorganization Process” (2008) 91:4 Marq L Rev 979.

[118] Brigitte Burgemeestre, Joris Hulstijn, & Yao-Hua Tan, “Rule-based versus principle-based regulatory compliance” (2009) Legal Knowledge and Information Systems IOS Press 37-46.

[119] Principles-based regulation can stop gamification of prescriptive rules since it increases the individual accountability for companies and their actions; moreover, this can give a broader scope of enforcement actions and consequently better protect investors.

[120] Virginia Harper Ho, “Disclosure Overload? Lessons for Risk Disclosure & ESG Reform from the Regulation S-K Concept Release” (2020) 65:1 Vill L Rev 67.

[121] An important policy aim is to encourage the growth of the capital markets.

[122] Anita Indira Anand, “An Analysis of Enabling vs. Mandatory Corporate Governance Structures Post-Sarbanes-Oxley” (2006) 31:1 Del J Corp L 229.

[123] A clear instance is in pecuniary or value terms of avoiding future risks or the immediate value-add of ESG; although, this may need more specificity since ESG is such a broad term.

[124] As noted in section 1.1 of the OSA, the statutory and public policy goal of the security regime is investor protection, capital market efficiency, and public confidence in capital markets.

[125] Eric Talley, “Turning Servile Opportunities to Gold: A Strategic Analysis of the Corporate Opportunities Doctrine” (1998) 108:2 Yale LJ 277.

[126] John C Coffee, Jr, “Understanding Enron: “It’s About the Gatekeepers, Stupid,” (2002) 57 Bus. Law. 1403.

[127] Mohammad Fadel, “BCE and the Long Shadow of American Corporate Law” (2009) 48:2 Can Bus LJ 190.

[128] The upshot of this is that in no case should a trustee’s personal morality about ESG be a consideration for investing in ESG. Notably, the fiduciary duty derives the trust law whereby a trustee holds an asset for the benefit of the beneficial owner. In the securities market, intermediaries have this role and owe a fiduciary duty where there is a reasonable expectation.

[129] Max M. Schanzenbach & Robert H. Sitkoff, “Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee” (2020) 72 Stanford Law Review 381.

[130] Cynthia Williams & Jill E Fisch, “Request for rulemaking on environmental, social,

and governance (ESG) disclosure” (2018) Commissioned Reports, Studies and Public Policy Documents Paper 207.

[131] U.S. Securities and Exchange Commission, “Recommendation of the SEC Investor Advisory Committee Relating to ESG Disclosure” (2020) online: <https://www.sec.gov/spotlight/investor-advisory-committee-2012/esg-disclosure.pdf&gt;

[132] U.S. Securities and Exchange Commission, “Asset Management Advisory Committee Potential Recommendations of ESG Subcommittee” (2020) online: <https://www.sec.gov/files/potential-recommendations-of-the-esg-subcommittee-12012020.pdf&gt;

[133] U.S. Securities and Exchange Commission, “Public Input Welcomed on Climate Change Disclosures” (2021) online: <https://www.sec.gov/news/public-statement/lee-climate-change-disclosures&gt;

[134] European Securities and Markets Authority, “ESMA Calls for Legislative Action on ESG Ratings and Assment Tools” (2021) online: <https://www.esma.europa.eu/press-news/esma-news/esma-calls-legislative-action-esg-ratings-and-assessment-tools&gt;

[135] Robert G Eccles et al, “Mandatory Environmental, Social, and Governance Disclosure in the European Union” (2012) Harvard Business School Accounting & Management Unit Case No 111-120.

[136] European Securities and Markets Authority, “ESMA Calls for Legislative Action on ESG Ratings and Assment Tools” (2021) online: <https://www.esma.europa.eu/press-news/esma-news/esma-calls-legislative-action-esg-ratings-and-assessment-tools>

[137] HM Treasury, “A Roadmap towards mandatory climate-related disclosures” (2020) online: <https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/933783/FINAL_TCFD_ROADMAP.pdf&gt;

[138] David Clark, “Financial Sector (Climate-related Disclosures and Other Matters) Amendment Act 2021 (2021/39)” (2021) online: <https://www.parliament.nz/en/pb/bills-and-laws/bills-proposed-laws/document/BILL_109905/financial-sector-climate-related-disclosures-and-other&gt;

[139] Australian Securities & Investments Commission, “21-295MR ASIC and ATO engage with directors as part of ASIC’s Phoenix Surveillance Campaign” (2021) online: <https://asic.gov.au/about-asic/news-centre/find-a-media-release/2021-releases/21-295mr-asic-and-ato-engage-with-directors-as-part-of-asic-s-phoenix-surveillance-campaign/&gt;

[140] In Mark McVeigh v Retail Employees Superannuation Pty Ltd (REST), McVeigh claimed that REST failed to disclose risks which prevented him from making an informed decision about the fund’s performance. This case was settled and REST undertook to adopt TCFD reporting recommendations. In Australian Centre for Corporate Responsibility v Santos Ltd, a shareholder advocacy group alleged misleading and deceptive conduct in Santos’s 2020 report claiming natural gas as a “clean fuel.” They also claimed that Santos’s plan to achieve net zero emissions by 2040 is misleading because it was based on undisclosed assumptions about carbon capturing.

[141] Another salient problem is defining materiality and trying to balance between generally applicable rules while also being flexible.

[142] Different asset classes have different ESG risks and issues. Venture capital, fixed income, private equity or debt have specific strategies that intersect with ESG; more obviously, infrastructure and real estate have environmental concerns. Smaller start-ups have little resources for ESG, but they have a better opportunity to build their board policies around ESG.

[143] Ontario Securities Commission, “Canadian securities regulators seek comment on climate-related disclosure requirements” (2021) online: <https://www.osc.ca/en/news-events/news/canadian-securities-regulators-seek-comment-climate-related-disclosure-requirements&gt;

[144] Douglas Sarro, “Incentives, Experts, and Regulatory Renewal” (2021) 47:1 Queen’s Law Journal.

[145] Ontario Securities Commission, “Canadian securities regulators strongly support the establishment of the International Sustainability Standards Board in Canada” (2021) online: <https://www.osc.ca/en/news-events/news/canadian-securities-regulators-strongly-support-establishment-international-sustainability-standards&gt;

[146] This is problematic because making the actual aims of ESG a mere incidental effect means that the priority is on political gain; in other words, when the aims of ESG and politics conflict, then politics would be prioritized.

[147] It is important to note the limitations of this essay. It would be too ambitious to spell out the details of securities law, corporate law, or comparative perspectives. Additionally, many claims around morality or goodness are contentious and required empirical support.