An ESG update for boards of directors in view of proxy season 2023

This update covers the latest trends and our recommendations regarding environmental, social and governance (ESG) practices, initially addressed in our 2021 primer “ESG: What boards of directors should do now.” In preparing this update, we reviewed the most recent disclosure of TSX 60 issuers, as was done last year. Please note that variations between 2021 and 2022 should be interpreted with caution since the TSX 60 Index’s composition has changed.

As we are often consulted on the operationalization of ESG, we also share our thoughts on this at the end of this update.

Recent developments

Recent or expected developments related to ESG include the following:

ESG oversight

North American investors and proxy voting advisory firms continue to push for a more robust oversight of ESG matters at the board and committee levels. 

For instance, in its review of Canadian issuers’ governance practices, Glass Lewis identifies which board-level committees have been charged with overseeing ESG issues, and beginning this year, Glass Lewis may recommend voting against the governance chair of a TSX 60 issuer that fails to disclose the board’s role in ESG oversight.¹  

Others continue to take a more targeted approach and will, for instance, vote against the chair of a committee in charge of overseeing climate change where the board has failed to demonstrate adequate consideration for that topic.²  

In 2021, our analysis confirmed that 52 out of 60 (86.7%) issuers composing the TSX 60 Index provided that either their boards and/or at least one committee was tasked with overseeing ESG-related matters. This proportion increased to 54 out of 60 (90.0%) in 2022.

When it comes to committee oversight of ESG matters, the dominant trend remains to delegate such responsibility to either governance committees (or equivalent) or to “specialized” committees such as an ESG committee, a sustainability committee, or an environmental, health, safety and sustainable development committee. Of the 51 issuers that have disclosed overseeing ESG matters at the committee level (48 in 2021), whether in addition to or instead of their boards, 15 assigned ESG oversight to multiple committees (11 in 2021). We also note a fairly significant proportion of boards of directors, namely 28 out of 60 issuers (46.7%), entrust their governance committee with ESG responsibilities. Only four boards of directors (also four in 2021) retain full oversight of ESG matters at the board level. Our findings are summarized in the table below: 

An analysis of the practices of TSX 60 issuers shows 78.3% of them base director nominations or disclose board composition against a matrix that includes some combination of ESG skills.

Factors that may influence issuers in determining if the entire board or a board committee should be responsible for ESG oversight include:

• the scope of responsibilities set forth in board and committee charters and their fit with new ESG responsibilities;
• the skill set of members of the board and its committees relating to ESG; and
• characteristics of issuers that have an impact on the scope and frequency of ESG reporting (see the section Operationalization of ESG oversight in this update).

Benefit corporations

As discussed last year, the corporate statutes of several US and Canadian legislatures now provide for “benefit corporations” or an equivalent corporate vehicle. While such regimes present substantial variations, benefit corporations must typically include in their articles an affirmation and a commitment to operating responsibly, sustainably and in such a way as to promote a social interest or public benefit,³ in addition to being bound by specific reporting requirements. The model has not yet been widely adopted in North America. However, the number of corporations being continued or constituted as benefit corporations continues to grow. 

The Quebec National Assembly tabled Bill 797 in May of 2021, proposing to incorporate a benefit corporation model into the Quebec corporate statute.⁴ We note Bill 797 was tabled by the opposition and, as a consequence, there is currently no guarantee as to its eventual coming into force.

Recommendation: To determine the appropriate ESG oversight structure, directors should consider factors such as current responsibilities of the board and its committees, skill set of directors and characteristics impacting the scope and frequency of ESG reporting (as described below).

ESG considerations in executive compensation

Based on our review of the latest compensation discussion and analysis of TSX 60 issuers, 44 of them (73.3%, up from 68.3% in 2021) consider ESG measures in executive compensation to a certain extent. The most frequent key performance indicators (KPIs) used by such issuers, for compensation purposes, include the following:

ESG-related KPIs can be taken into account in short-term or long-term incentive plans and can be considered on a “stand-alone” basis, as part of a scorecard, as a performance modifier or as a prerequisite to paying certain amounts.⁵ Based on our analysis of TSX 60 issuer disclosure, 38 issuers (63.3%) currently incorporate such KPIs in short-term incentive plans and 25 issuers (41.7%) incorporate them in long-term incentive plans.

Recommendation: Once a board of directors has selected relevant ESG factors, incorporating ESG KPIs into compensation plans should be considered.

Climate-related reporting

On October 18, 2021, the Canadian Securities Administrators (CSA) proposed National Instrument 51-107 – Disclosure of Climate-related Matters (the CSA Climate Disclosure Regime).⁶ 

Largely based on the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), the CSA Climate Disclosure Regime focuses on four areas: (i) governance, (ii) strategy, (iii) risk management, and (iv) metrics and targets. A total of 131 comment letters were submitted during public consultations, which were concluded on February 16, 2022.⁷ A second iteration of the CSA Climate Disclosure Regime is expected, most likely after the US Securities and Exchange Commission (SEC) and the International Sustainability Standards Board (ISSB) finalize their respective instruments (see below).⁸ 

On March 21, 2022, the SEC proposed new rules that would require domestic and foreign registrants to provide climate-related disclosures in their registration statements and annual reports (the SEC Climate Disclosure Regime).⁹

The SEC Climate Disclosure Regime, if adopted, would require registrants to disclose: (i) information about climate-related financial risks over the short, medium, and long term, (ii) information about their governance of climate change risks and relevant risk management processes, (iii) their greenhouse gas emissions that, in certain cases, would be subject to certification requirements, (iv) climate-related financial metrics, and (v) information about climate-related targets, goals, and transition plans. Consult our recent update for a detailed analysis of the SEC Climate Disclosure Regime.

On March 24, 2022, the IFRS Foundation and the Global Reporting Initiative (GRI) announced a collaboration under which their respective standards-setting boards (the ISSB – which recently launched its operations in Montreal¹⁰ – and the Global Sustainability Standards Board) will work towards coordinating their activities. 

ISSB released disclosure prototypes in November 2021 followed by the release of two “exposure drafts” in March 2022, one dealing with general sustainability-related disclosure and one focused on climate-related disclosure. These two exposure drafts, which have now been through a public comment period, are broadly based on the TCFD framework and incorporate SASB standards. GRI has issued climate-related standards but also offers a wide range of sustainability-based standards that consider issues such as biodiversity, human rights and various social issues. The collaboration with GRI and the adoption of SASB (and other) standards by ISSB have the potential to lead to further standardization in ESG disclosure.

On May 26, 2022, the Office of the Superintendent of Financial Institutions published draft guidelines on climate risk management that are expected to impact federally regulated financial institutions.¹¹  

The guidelines cover two main areas: (i) governance and risk management expectations, and (ii) climate-related financial disclosures. While these are (also) largely based on the TCFD recommendations, it is worth noting that they also include climate scenario analysis, requiring financial institutions to describe the resilience of their climate-related strategy, taking into account different scenarios. In contrast, the CSA did not include a climate scenario analysis requirement in its proposed CSA Climate Disclosure Regime.¹² 

Pending the finalization and coming into effect of the above-mentioned initiatives, major Canadian issuers continue to resort to voluntary disclosure frameworks. The TCFD and Sustainability Accounting Standards Board standards are at the top of our watch list. The adoption rates for these leading models increased to 75.0% and 80.0%, respectively, among TSX 60 issuers, as compared to 66.7% and 68.3% in 2021. The table below summarizes the latest data on the adoption of the main standard disclosure frameworks among TSX 60 issuers in 2021 and 2022:

(i) Including four issuers in the process of adopting the framework.
(ii) Including one issuer in the process of adopting the framework.

Several Canadian issuers have recently adopted and publicized climate-related objectives, including targets to cut greenhouse gas emissions. Such objectives are often integrated as forward-looking statements in a number of public documents. Since last year’s publication, in which we discussed secondary market liability considerations in this specific context, many issuers have enhanced their cautionary language for forward-looking statements to better address climate-related statements. We expect this trend to grow in the coming years.

Recommendation: Issuers should be proactive in assessing their ESG reporting practices and consider implementing well-recognized standard frameworks. Be mindful of potential liability. Ensure ESG claims are accurate and integrate forward-looking cautionary language in ESG disclosure where appropriate.

Operationalization of ESG oversight

Our analysis of TSX 60 issuers’ ESG disclosure shows there is no “one-size-fits-all” approach when it comes to the operationalization of ESG oversight.

Some issuers have established management-level committees comprised of members of senior leadership, such as the chief executive officer, the chief sustainability officer, the chief financial officer and the general counsel, to set their ESG oversight in motion. Under the supervision of the board or the board committee accountable for overseeing overall ESG-related matters, these management-level committees develop and implement the issuer’s ESG strategy and action plan and report on progress made in that regard.

For more discrete ESG matters, management teams may be assigned specific ESG-related tasks and responsibilities. For instance, issuers may assign to a disclosure committee (a committee composed of officers, responsible for reviewing contents of documents before their disclosure) the responsibility for reviewing documents containing ESG disclosure before such documents are submitted to the board or to board committees, to ensure these statements are reliable and presented consistently.

When implementing and operating an ESG oversight framework, the board or the board committee responsible for ESG oversight should be provided with sufficient information to be able to assess the progress of the ESG strategy against set goals and monitor current and planned ESG initiatives.

To this end, the board or lead board committee, together with management, should understand and agree on the most important ESG risks and opportunities and develop measurement criteria, such as ESG metrics and KPIs, against which reporting can be made to the board or board committees.¹³

The scope and frequency of ESG reporting may vary depending on the issuer’s specific characteristics, including:

• the board ESG oversight structure and the existence of management-level committees and working groups;
• the size of the issuer and its sector of activity;
• regulatory requirements applicable to the issuer;
• the significance of ESG risks and opportunities for the issuer; and
• stakeholder concerns and priorities.¹⁴  

The frequency of reporting can also differ according to the various “E,” “S” and “G” topics monitored by the issuer, as each topic may evolve at a different pace. As a best practice, issuers may consider using a work plan to coordinate reporting to the board and board committees on various ESG topics. Such work plan should be reviewed periodically to take into account best practices and internal developments.

Recommendation: Consider assigning overall ESG oversight responsibilities to a management committee (ESG steering committee) and ESG-related tasks to relevant management teams. Identify the most important ESG risks and opportunities and develop measurement criteria to assess the progress of the ESG strategy and initiatives. Consolidate ESG responsibilities and work products into a work plan and use such work plan to implement a schedule for reporting to the board and board committees. Review such work plan periodically to adapt to best practices and internal developments.