Commentary

A Sting in the Tail

Pierre Lechat, Head of ESG Solutions at TMF Group, reviews Canada’s efforts to develop local reporting standards in a global context.

 The latest developments in Canada’s ESG reporting regime are significant for investors. Current proposals not only move the country toward mandatory ESG disclosure requirements based on international standards, they also include provision for Canada-specific adaptations.

For investors, such changes should mean greater transparency and access to information regarding the environmental and climate-related risks faced by their (potential) portfolio companies. It should lead to better investment decisions, through improved assessment of the sustainability and long-term viability of investments.

However, for investors and companies alike – especially those operating across international jurisdictions – Canada’s proposed approach carries the risk of adding extra layers of complexity and cost to ESG reporting and analysis.

The potential variances in reporting standards between Canada and those countries adopting International Sustainability Standards Board (ISSB) standards as they are – in terms of adoption (scope), boundary (scale) and implementation timeline – could make it much harder to compare like with like when assessing companies’ ESG performance and risks.

The good news is that investors other interested parties have a chance to influence the shape of Canada’s nascent ESG reporting framework through a two-month consultation period.

Canada’s ESG reporting gathers pace

Canada’s development and implementation of mandatory ESG reporting is gathering pace, hot on the heels of the June 2023 publication by the ISSB of global ESG reporting standards – IFRS S1, General Requirements for Disclosure of Sustainability-related Financial Information, and IFRS S2, Climate-related Disclosures.

2023 also saw the creation of a new sustainability standards body, the Canadian Sustainability Standards Board (CSSB), which has the task of interpreting and supporting the uptake of ISSB standards in Canada – adapting them to the Canadian context, and ensuring interoperability between ISSB standards and any forthcoming CSSB standards.

Beginning in fiscal year 2024, federally-regulated financial institutions in Canada – including banks and insurance companies – are already mandated to report on climate-related financial risks. This is a move from voluntary to mandatory ESG reporting, to promote transparency into how businesses manage and report climate-related risks and exposures. The move is intended to align Canadian companies with international ESG reporting standards and help in the transition to a net zero economy.

March 2024 sees the publication of the CSSB’s proposed Canadian Sustainability Disclosure Standards (CSDS) 1 and 2. According to the CSSB, these will align with IFRS S1 and S2, but will also contain proposals for Canadian-specific modifications. These modifications will include a Canadian-specific effective date, and transition relief proposals to help with eventual implementation of the standards.

It is these Canadian-specific modifications that the board will be consulting on between March and June 2024. Individuals and organisations across the country are needed to ensure that adoption of sustainability disclosures standards in Canada work for the local market.

The aim is to develop Canadian sustainability disclosure standards that support the country’s capital markets, and enhance the reporting of sustainability information by Canadian entities, while considering the costs and benefits to preparers and users of such information. A key aim is to explore methods to better include the voices of Indigenous Peoples in the sustainability standard-setting process.

Furthermore, the CSSB’s efforts to introduce additional reporting standards are also part of a broader aim to enhance accountability among Canadian companies and to help eliminate ‘greenwashing’. By coordinating with the ISSB and developing standards that are fair and equitable, the CSSB intends to improve the transparency and reliability of ESG reporting in Canada, so helping Canadian corporations to compete more effectively on an international level.

However, these efforts to meet the specific needs of the Canadian market may have a sting in the tail for those investing in Canadian, or Canadian listed, companies.

Potential pitfalls for investors

Overall, while the adaptation of the ISSB standards to include Canadian-specific requirements could help address local issues and priorities – and perhaps encourage adoption – it could also pose significant challenges for investors, particularly in terms of comparability, complexity, and compliance:

Complexity and confusion – Investors face increased complexity if they have to navigate through the different ESG reporting requirements. If Canadian standards diverge significantly from the ISSB standards, investors will need to understand and reconcile different sets of metrics and disclosures when evaluating companies. This could lead to confusion and make it more difficult to compare companies’ ESG performance, especially when comparing Canadian companies to those in other jurisdictions.

Increased due diligence – Investors will likely need to conduct more extensive due diligence to understand the nuances of the Canadian ESG reporting standards compared with the ‘pure’ ISSB standards. This could involve additional resources, time, and expertise, particularly for global investors who are accustomed to a more uniform set of standards.

Inconsistency in reporting – Any divergences between Canadian and international standards could impair the reliability and comparability of published ESG information, making it harder for investors to make informed decisions.

Regulatory and compliance risks – Investors might face heightened regulatory and compliance risks if Canadian standards include unique requirements not covered by the ISSB. This could affect their investment strategies if they manage portfolios that include Canadian (listed) companies. Understanding and complying with these additional requirements could pose significant challenges.

Market fragmentation – Customising the ISSB standard could result in market fragmentation, with Canadian companies being assessed differently from their international peers. This could potentially lead to a revaluation of Canadian assets, or alter investment flows into and out of Canada, as investors recalibrate their strategies to account for the different ESG reporting frameworks.

Adaptation costs – For investors with significant exposure to Canadian markets, adapting to a modified ESG reporting standard will incur additional costs in the form of new tools, systems, and training to understand and integrate the unique aspects of Canadian ESG reporting into their investment processes.

Investors and companies should be aware of the timelines and requirements to ensure they remain compliant, and are able to prepare properly for the upcoming changes in Canada’s ESG reporting standards. The CSSB’s public consultation period, set to launch in March 2024, will see key documents issued for public comment, with opportunities to share feedback in various ways. This offers a chance for stakeholders to contribute their views and help shape the standards to better suit the Canadian business environment in a global context.

Canada’s ESG new reporting requirements at a glance

Implementation timeline – The Canadian government has outlined plans to begin mandatory ESG reporting for federally-regulated financial institutions starting in 2024. This includes banks and insurance companies, which will need to report on climate-related financial risks following the Task Force on Climate-related Financial Disclosures (TCFD) framework. This approach indicates a phased rollout, meaning that requirements will gradually extend to different sectors over time.

Consultation period – The CSSB is launching a public consultation process in March 2024 to advance the adoption of sustainability standards in Canada. During this period, three key documents will be released for public comment: drafts of the proposed disclosure standards CSDS 1 and CSDS 2, and a paper discussing potential changes to the international ISSB sustainability disclosure standards for use in Canada. This public consultation will provide opportunities for feedback through various channels, helping shape Canada’s sustainability standards.

Additional reporting requirements – Canadian corporations are also required to report annually on board and management diversity. This includes providing information on policies related to the identification and nomination of directors from designated groups and targets for representation among senior management and board members.

Additionally, Canada’s Bill S-211 mandates detailed public reporting by certain businesses with significant assets or revenue in Canada on their measures to identify, address, and prevent forced labour, prison labour, and child labour in their supply chains, with the first reporting due by 31 May 2024. Furthermore, as of 1 April 2023, major suppliers and contractors to the Government of Canada must disclose their greenhouse gas emissions and set reduction targets.

The changes also include plans to require federally regulated pension funds to disclose their ESG considerations in portfolio construction. This means that pension funds will need to be more transparent about how they are integrating ESG factors into their investment decisions.

This article was co-authored by Ashutosh Gupta, Head of ESG Delivery & Project Management at TMF Group.

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