Exchanging Ideas on Climate
National Round Table on the Environment and the Economy
Exchanging ideas on Climate

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Capital Markets and Sustainability: Investing in a Sustainable Future


Materiality is an important concept for the disclosure of information upon which investment decisions are to be made. The definition of materiality can vary substantially because its meaning can differ greatly between stakeholders. Also, consideration can be material merely because a large stakeholder (e.g., a large pension fund) considers the given issue to be ?material.? As mentioned earlier, although the Task Force decided not to define materiality itself, it noted the traditional approach to materiality as that of information being material if its omission or misstatement could influence the decision of a reasonable investor to invest, or continue to invest, in a company. Thus if risks associated with ESG issues are material to companies, current security requirements would call for disclosures in the MD&A and/or Annual Information Form. Note that if companies are not making disclosures about ESG issues, this may be because they do not consider them material (e.g., ?energy? discloses emissions, ?apparel? discloses labour practices), or they may consider them relevant but would prefer to leave them unreported. That being said, because large capital providers such as pension plans invest across multiple industry sectors, and because issues such as climate change and human rights can crosscut each other, the definition of materiality for pension plans and other large institutions with fiduciary responsibility can be very broad indeed.

Sarbanes-Oxley does not deal with environmental and social risk disclosure.

To take the discussion still further, ?financial materiality? may be used to qualify the general principal of materiality when used in the context of financial reporting and users of financial reporting ? typically investors and financial analysts. However, what is material in reporting to other stakeholders or users of broader types of company reporting, especially regarding environmental and social issues, may be determined by criteria other than just ?financial.?

In addition to the growing body of legislation and regulation that seeks to address these issues in Canada, the U.S., and the U.K., there are a number of important international initiatives that have been undertaken to define ? or at least to facilitate a definition of ? material disclosure for their participants. These include normative frameworks (i.e., the chemical industry?s Responsible Care program, the Forest Stewardship Council?s forest certification programs); process guidelines (i.e., the Global Reporting Initiative); assurance guidelines (i.e., the AA 1000 Framework); and management systems (i.e., the Social Accountability SA8000, the ISO 14000).


In Canada, where the securities industry is regulated at the provincial level, specific requirements call for the disclosure of information concerning a company?s social and environmental affairs through its published documents. The fundamental criterion for reporting is financial materiality. As for the reporting of social and environmental information, it is required to the extent that it is deemed to be financially material. In Ontario, the Securities Act requires the timely disclosure of information about any ?material change? in the affairs of a company.43 As well, the Toronto Stock Exchange (TSX) has established disclosure guidelines in line with the Securities Act (Ontario), although its definition of ?material information? is broader than ?material change?; specifically, the TSX definition includes information concerning rumours and speculation that may also have a financial impact on a company.44

United States

In the U.S., based on federal securities legislation including the Securities Act of 1933 and the Securities Exchange Act of 1934, the Securities and Exchange Commission (SEC) has established an extensive set of rules and guidelines for public disclosure by publicly traded companies. As in Canada, financial materiality is the fundamental criterion for determining specific reporting requirements. The SEC requires the Management?s Discussion and Analysis section of the annual report to detail current conditions that may have a material impact on a company?s financial performance, including specific information on ?material events and uncertainties known to management that would cause reported financial information not to be necessarily indicative of future operating results or of future financial condition.?45 Furthermore, to the extent that social and environmental issues or events may constitute such ?uncertainties,? they must be reported. The SEC regulations differ from Canadian regulations in that specific reference is made to possible events and uncertainties related to a company?s environmental affairs. For example, the SEC regulations require that a company briefly describe any material and pending legal proceedings with respect to environmental issues, including administrative or judicial proceedings.

The UK has social- and labour-issue reporting requirements.

In July 2002, the Sarbanes-Oxley Act of 2002 became law. Among the host of requirements is one that states that the CEO and CFO of each SEC reporting company must (a) certify that, based on the officers? knowledge, no periodic report contains materially false statements or omissions and that financial statements are a fair representation of the financial condition of the company; and (b) certify as to the adequacy of, and any deficiencies in, the internal financial controls. The Act does not deal separately with the issues of environmental and social risk disclosure.

United Kingdom

In comparison, the United Kingdom has specific reporting requirements that are not based on the notion of financial materiality. Schedule 7 of the Companies Act (1985)46 includes a number of reporting requirements relevant to social and labour issues. One such requirement, Part IV, obliges the company to describe the arrangements in force in the financial year for securing the health, safety, and welfare at work of the employees of the company and its subsidiaries, and for protecting other persons against risks to health or safety arising out of, or in connection with, the activities at work of these employees. In March 1998, the British government?s Department of Trade and Industry launched a major review of legislation governing the private sector in the U.K.

The final report of the review, Modern Company Law for a Competitive Economy ? Final Report, was published in July 2001. It proposed that most public companies and large private companies should be required to publish an operating and financial review (OFR) as part of the annual report. The OFR was meant to review the performance, plans and prospects of the business and include information on direction, performance, and dynamics and any information which the directors judge necessary for an understanding of the business. This latter would include matters such as key relationship with employees, suppliers and customers, environmental and community impact, corporate governance and management of risk. The OFR would be subject to review by the auditors.47

The report also recommended that mandatory reporting requirements be modified in certain ways to include the reporting, among other things, of ?risks, opportunities and related responses in connection with ? health and safety [and] environmental costs and liabilities.?48 Discretionary reporting items included:

Policies and performance on environmental, community, social, ethical and reputational issues including compliance with relevant laws and regulations:including any social or community programmes, policies for the business on ethical and environmental issues and their impact for the business, policies on international trade and human rights issues and any political and charitable contributions.49

The Company Law Reform Bill finally brought before the UK Parliament in mid-2006 calls for a Business Review (not an operating and financial review, the proposal for which was dropped late in 2005) to be included in the Directors? Report in UK company annual reports; this review would inform shareholders and other stakeholders about the company and help them assess how the directors have performed their duty to promote the success of the company. Under clause 399 of the bill, the Business Review must contain a description of the principal risks and uncertainties facing the company, as well as a balanced and comprehensive analysis of the development and performance of the company?s business during the past year and of its position at the end of the year. To the extent necessary for an understanding of the development, performance, or position of the company?s business, the Business Review of a quoted company must include information about environmental matters, the company?s employees, and social and community issues, including information about any policies of the company regarding these matters and the effectiveness of the policies.50

Materiality: Barriers/considerations Desired outcomes

Information is material if its omission or misstatement could influence the decision of a ?reasonable? investor to invest, or continue to invest, in a company. The current criterion for reporting is financial materiality, and the reporting of environmental and social information is required to the extent that it is deemed to be financially material. If ESG issues are material, then corporations should disclose that in their Management?s Discussion and Analysis (MD&A).51

That pension plans have a common understanding of the present and future risks
associated with ESG issues.

The Canadian Securities Administrators? rules and the recent work of the Canadian Institute of Chartered Accountants (CICA) help to provide some direction on corporate disclosure of ESG factors in Canada. In October 2005, the CICA?s Canadian Performance Reporting Board published a Discussion Brief on MD&A Disclosure.52 Although it addresses only the ESG issues related to climate change and other environmental issues, it points out that certain environmental (and social) disclosures are already required by securities regulators? rules and, therefore, are in fact mandatory where likely to be material to investors.53 The CICA?s Guidance document on preparation and disclosure of management?s discussion and analysis, in fact, reinforces this principle.54

That pension plans and other
fiduciaries have a process for measuring both the extent to which material issues are being identified and the ways in which they are being addressed in the companies in which they invest.

Furthermore, while the Discussion Brief does not assert that any specific sustainability issue is necessarily material and therefore must be disclosed, it does reinforce the regulators? requirements that matters including known trends, events, risks, and uncertainties that are expected to, or could materially, affect financial results and conditions are to be disclosed in the MD&A. It is worth noting that the Annual Information Form (AIF) that companies must complete requires disclosures about environmental and social policies fundamental to a company?s business. Relevant mandatory disclosure requirements on the part of securities regulators are also discussed in the CICA?s November 2004 paper for the NRTEE.55 The securities regulators? rules and the documents produced by the CICA, cited above, have contributed to the understanding of the materiality of ESG issues, but more work on these areas still needs to be done.

That securities regulators gain
a greater understanding that would enable them to enforce the appropriate level of disclosure of material information. (The
MD&A is too narrow; e.g., there is no MD&A in a Prospectus,
which is one of the primary ?risk delineation? documents available. In effect, the MD&A is read after investors buy, when they read the annual report.)

Companies need to be encouraged or motivated to improve MD&A disclosure about ESG matters material to investors. Research prepared by the Canadian Institute of Chartered Accountants for the Task Force provided options for bringing about changes in corporate disclosure about social, environmental, and ethical matters. Task Force deliberations on this matter also raised the need to address transparency, disclosure, and the reporting of ESG issues from the capital issuer side (that is, the companies that parties were assessing for investment purposes) in the MD&A. Developments in these areas may in turn, facilitate greater transparency regarding social and environmental issues with respect to individual investors, as well as more effective disclosure of sustainability issue management by pension plans and other institutional investors. The Task Force deliberations considered that this could be achieved through engagement by investors with capital issuers, improved disclosure of ESG issues in the MD&A, and the enforcement of existing MD&A disclosure requirements where the failure to disclose has caused damage to investors.

That Canadian pension plans
agree on a common framework
for disclosure of ESG factors.

That all players have the necessary analytical tools and skills at their disposal to evaluate and integrate ESG factors into their capital
allocation decisions.

A difficult decision

In addition to definitional and other challenges, the situation is made more difficult due to the classic ?chicken and egg? scenario affecting the disclosure of ESG factors considered material by investors. Most institutional fund managers in Canada have yet to develop sufficient analytical capabilities to document, analyze, and thereby integrate ESG factors into their financial analysis for investments. Indeed, there is no perceived demand from Canadian institutional investors, and the pension plans will be much less likely to consider such an approach if no fund manager is proposing it. Moreover, in contrast to their European counterparts, Canadian fund managers are not entirely sure how to respond to the growing demand for information concerning the extent to which social and environmental factors are considered in investment decisions.

Materiality: Recommendations

Recommendation 5.1

That the Canadian Institute of Chartered Accountants (CICA) and the Canadian Securities Administrators, in consultation with the federal and provincial governments, establish an outreach and education program for capital issuers so as to increase understanding of the material ESG issues that should form part of the Management Discussion and Analysis (MD&A) section of annual reports.

Recommendation 5.2

That institutional investors, money managers, and trustees engage capital issuers (companies) on the potential materiality of ESG issues, adopt a policy regarding ways of addressing ESG factors in the decision-making process, and encourage the refinement and use of standardized ESG reporting.

Recommendation 5.3

That the Canadian Securities Administrators encourage the disclosure of financially material ESG issues through publication of a guidance or interpretation statement and encourage Canadian firms to be guided by established reporting frameworks such as the Global Reporting Initiative (GRI).

Recommendation 5.4

That securities regulators support the existing MD&A disclosure requirements as they relate to ESG considerations and, when required, enforce the ESG disclosure requirement.

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