CSA Releases Updated Guidance On ESG-Related Investment Fund Disclosure – Investment Strategy

Recently, the Canadian Securities Administrators
(CSA) published Staff Notice 81-334 (Revised) – ESG-Related
investment Fund Disclosure (the Notice).
The Notice updates and replaces the CSA Staff Notice 81-334
originally issued in January 2022 (the 2022
Notice) which we discussed in a previous article.

The Notice expands the guidance published in the 2022 Notice
relating to environmental, social and governance
(ESG) for investment funds offered by prospectus
in Canada.

ESG-Related Classification of Funds

The Notice applies to the following four categories of
investment funds offered by prospectus in Canada which are based on
whether a fund considers ESG factors as part of its investment
process and the extent to which such factors are considered:

1. ESG Objective Funds: funds whose investment
   objectives reference ESG factors




2. ESG Strategy Funds: funds whose investment
   objectives do not reference ESG factors but that use ESG
   strategies, where the consideration of ESG factors plays a
   significant role in their investment process




3. ESG Limited Consideration Funds: funds whose
   investment objectives do not reference ESG factors but that use ESG
   strategies, where the consideration of ESG factors plays a limited
   role in their investment process (ESG Limited Consideration Funds
   together with ESG Objective Funds and ESG Strategy Funds are
   referred to as ESG-Related Funds)




4. Non-ESG Funds: funds that do not consider ESG
   factors in their investment process.

The CSA Staff provide the following decision tree in the Notice
to illustrate how an investment fund manager
(“IFM“) would classify an investment
fund in one of the four categories in the Notice:

The Notice also includes numerous guiding questions to assist
IFMs classifying their funds.

New ESG Guidance For All ESG-Related Funds

• Written policies and procedures. CSA Staff
  observed that some IFMs that manage ESG-Related Funds do not have
  written policies and procedures relating to the fund’s
  consideration of ESG factors and/or use of ESG strategies, or in
  the case of IFMs that are not the portfolio adviser of their funds,
  their oversight of the funds’ portfolio adviser(s) in relation
  to the consideration of ESG factors and/or use of ESG strategies.
  An IFM that offers ESG-Related Funds should: (a) establish,
  maintain and apply written policies and procedures that cover its
  consideration of ESG factors and/or use of ESG strategies, or in
  the case of an IFM that is not the portfolio adviser of the funds,
  its oversight of the funds’ portfolio adviser(s) in relation to
  the consideration of ESG factors and/or use of ESG strategies; and
  (b) have processes in place to ensure that its written policies and
  procedures are regularly updated, such as for changes in its
  business practice, industry practice or securities
  legislation.

New ESG Guidance For ESG Objective Funds and ESG Strategy
Funds

• Investment objectives and fund names. A fund
  that references ESG in its name should primarily invest in assets
  that meet the fund’s ESG-related criteria. If a fund is
  permitted to primarily invest in assets that do not meet the
  fund’s ESG-related criteria, the fund should not reference ESG
  in its name or investment objectives, as the name or investment
  objectives would not accurately reflect the primary focus of the
  fund and would therefore be misleading.




• Funds that track the performance of an ESG-related
  index. For ESG Objective Funds that reference any aspect
  of ESG in their name and whose investment objectives indicate that
  the fund tracks the performance of an ESG-related index, CSA
  staff’s view is that:
  

  • the ESG focus(es) of the index should be consistent with the
    ESG focus(es) indicated in the fund’s name; and

  
  

  • the fund’s investment objectives and/or investment
    strategies disclosure should indicate that the fund’s portfolio
    will be comprised primarily of issuers that reflect the ESG
    focus(es) identified in the fund’s name and investment
    objectives.




• Unnamed ESG-related index. For ESG Objective
  Funds whose investment objectives state that the fund will track
  the performance of an ESG-related index in order to meet its
  ESG-related investment objectives, but that does not name the
  specific ESG-related index in the investment objectives, CSA
  staff’s view is that the investment objectives should clearly
  identify the ESG-related characteristics of any ESG-related index
  that the fund will track.




• Investments in issuers that are not index
  constituents. Where an ESG Objective Fund’s investment
  objectives indicate that the fund tracks the performance of an
  ESG-related index but the fund is permitted to track the index by
  investing in issuers that are not constituents of the index
  (including by using a sampling strategy), CSA staff’s view is
  that such issuers should have ESG characteristics that are similar
  to the constituents of the index, particularly in relation to the
  ESG characteristics that are relevant to the ESG focus of the
  fund.




• Funds that invest in underlying funds. For ESG
  Objective Funds that invest in underlying funds in order to meet
  their investment objectives, the ESG focus(es) of the underlying
  funds should be consistent with the ESG focus(es) of the fund. In
  addition, IFMs are reminded that the holdings of any underlying
  funds held by a top fund, including any ESG-Related Fund, should be
  consistent with the investment objectives and strategies of the top
  fund, including, for example, any exclusionary screening criteria
  used by the top fund. ESG Objective Funds and ESG Strategy Funds
  that invest in underlying funds that have an ESG-related focus
  and/or that employ ESG strategies must describe the process or
  criteria used to select the underlying funds and should disclose
  any parameters around the types of ESG focus(es) that the
  underlying funds will have. In addition, staff’s view is that,
  if the underlying funds are named in the prospectus, the investment
  strategies disclosure should describe the ESG strategies that are
  used by the underlying funds. If the underlying funds are not named
  in the prospectus, the investment strategies disclosure should
  describe the ESG strategies that are used by the underlying funds,
  if known.




• Funds that intend to generate a measurable ESG
  outcome. Where an ESG Objective Fund intends to generate a
  measurable ESG outcome, such a fund should clearly state the
  intended outcome as part of its investment objectives in order to
  allow investors to identify funds that match their own ESG-related
  goals. For example, staff encourage funds that aim to reduce carbon
  emissions to disclose a measurable carbon emissions reduction
  target in their investment objectives. The inclusion of a
  measurable ESG outcome in a fund’s investment objectives would
  also allow funds to provide meaningful continuous disclosure that
  reports on whether the fund is achieving its intended ESG
  outcome.




• Funds with carbon offset series. Staff’s
  view is that, if the name of a series of securities of an
  investment fund refers to carbon offsetting, the investment
  objectives of the series should refer to, and explain, the carbon
  offsetting feature of the series and state that prior approval of
  securityholders of the series will be obtained before the carbon
  offset feature of the series is changed.




• Suitability guidance. An ESG Objective Fund
  may state that it is particularly suitable for investors who have
  ESG-related investment objectives or who are interested in
  ESG-focused investments. If the fund is only focused on a
  particular aspect of ESG, such as gender diversity in leadership or
  the reduction of carbon emissions, staff’s view is that any
  suitability statement that indicates that the fund is particularly
  suitable for investors who have ESG-related investment objectives
  should accurately reflect the particular aspect(s) of ESG that the
  fund is focused on.




• Guidance on investment strategies disclosure.
  All ESG strategies (such as carbon offsetting) that are used as
  principal investment strategies or as part of a fund’s
  investment selection process, should be disclosed in the investment
  strategies section of the prospectus. The investment strategies
  disclosure of ESG Objective Funds and ESG Strategy Funds should
  include identifying any ESG factors used and explaining the meaning
  of each ESG factor and how the ESG factors are evaluated and
  monitored. This should include an explanation of the types of
  resources and information used and considered by the IFM in
  evaluating and monitoring the ESG factors (e.g. third-party
  sustainability reports, discussions with management of the issuer,
  disclosure documents), including disclosing whether the evaluation
  of the ESG factor is quantitative or qualitative and whether the
  evaluation is conducted using third-party data.




• Funds that use proxy voting or engagement in relation
  to ESG matters as a principal investment strategy. If a
  fund uses proxy voting or shareholder or issuer engagement in
  relation to ESG matters as a principal investment strategy, the
  fund is required to disclose this in its investment strategies. In
  staff’s view, the disclosure should include the criteria used
  by the proxy voting or engagement strategy, the goal of the proxy
  voting or engagement strategy, and the extent of the monitoring
  process used to assess the success of the proxy voting or
  engagement strategy.




• IFMs that apply an ESG strategy to more than one of
  their funds. In addition to the investment strategies
  section of a prospectus, exchange traded funds
  (“ETFs“) and non-redeemable investment
  funds are required to provide disclosure in the section of the
  prospectus relating to the IFM about an overall investment strategy
  or approach used by the IFM in connection with the funds that it
  manages, which may include any ESG strategies. Similarly, mutual
  funds that are not ETFs are also permitted to include such
  disclosure in their prospectus. Where such disclosure is provided
  in the section of the prospectus about the IFM, staff’s view is
  that the disclosure should be clear as to which of the funds in the
  prospectus the ESG strategy applies to, in order to provide
  transparency to investors as to which specific funds managed by the
  IFM use the ESG strategy. For example, if the IFM’s approach to
  considering ESG factors in its investment process varies for
  different types of funds managed by the IFM, this should be clearly
  articulated, and the differences clearly explained.




• Funds that use targets for specific ESG-related
  metrics. If a fund’s use of one or more ESG strategies
  includes the use of targets for specific ESG-related metrics, such
  as carbon emissions, staff encourage such funds to disclose those
  targets as part of their investment strategies and identify if
  those targets may evolve or change over time in response to
  changing circumstances.




• Funds that use multiple ESG strategies. ESG
  Objective Funds and ESG Strategy Funds that use multiple ESG
  strategies should provide disclosure explaining how the different
  ESG strategies are applied during the investment selection process.
  In staff’s view, this disclosure should include the order in
  which the strategies are applied if the specific order would have
  an impact on the securities being selected for the portfolio.




• Funds that use ESG ratings, scores, indices or
  benchmarks. Where an ESG-Objective Fund or ESG Strategy
  Fund uses internal or third-party company-level ESG ratings or
  scores, or ESG-related indices or benchmarks, as part of its
  principal investment strategies or investment selection process,
  the fund should explain how those ratings, scores, indices or
  benchmarks are used.




• Funds whose names and/or investment objectives include
  the term “impact”. In order to avoid
  greenwashing, if a fund’s name and/or investment objectives
  include the term “impact”, the investment strategies
  disclosure should explain what type of impact the fund is aiming to
  achieve.

New ESG Guidance For ESG Limited Consideration Funds

• ESG Limited Consideration Funds. An ESG
  Limited Consideration Fund is not required to provide disclosure in
  its prospectus about its use of ESG strategies (including its
  consideration of ESG factors in its investment process). Where an
  ESG Limited Consideration Fund includes statements about the
  fund’s use of ESG strategies (including its consideration of
  ESG factors in its investment process) in its sales communications,
  the prospectus should include disclosure about the fund’s use
  of ESG strategies. Specifically, if an IFM of an ESG Limited
  Consideration Fund includes disclosure in the fund’s prospectus
  about its use of ESG strategies, the disclosure should clearly
  explain:
  

  • the limited role that the consideration of ESG factors and/or
    use of ESG strategies plays in the fund’s investment process,
    including the specific parts of the investment process during which
    ESG factors are considered, the weight given to ESG factors as a
    whole (rather than for each particular ESG factor), and the impact
    that ESG factors will have on the portfolio selection process;
    and

  
  

  • whether this approach is specific to the fund in question or
    whether it is part of the IFM’s general process that is applied
    across all or a segment of its funds, and if it is applied to only
    one or a segment of the IFM’s funds, clearly identify the
    fund(s).




• Funds that are subject to IFM’s general proxy
  voting or engagement approaches that address ESG matters.
  Some funds are managed by IFMs that have general proxy voting
  policies and procedures that address ESG matters among other
  matters or have a general shareholder or issuer engagement approach
  that addresses ESG matters among other matters, but the funds do
  not use ESG-focused proxy voting or shareholder or issuer
  engagement as a principal investment strategy. Where such a fund is
  an ESG Limited Consideration Fund, the investment strategies
  section of the prospectus may include disclosure about the
  consideration of ESG issues as part of the fund’s proxy voting
  or engagement approach but should not suggest that ESG-focused
  proxy voting or engagement is a principal investment strategy of
  the fund. The investment strategies section should also be clear
  about the role that the consideration of ESG factors plays in the
  proxy voting or engagement approach. Where such a fund is a Non-ESG
  Fund, staff’s view is that the investment strategies section of
  the prospectus should not include any disclosure about the
  consideration of ESG issues as part of its proxy voting or
  engagement approach.




• Funds that may not always use ESG strategies or that
  use them on a discretionary basis. To the extent that a
  fund’s investment strategies indicate that a particular ESG
  strategy may be used but is not always used, staff’s view is
  that the investment strategies disclosure should explain, where
  possible, when the ESG strategy will be used, including describing
  any parameters around when the ESG strategy will or will not be
  used.

Guidance on Sales Communications of ESG-Related Funds

• ESG Objective Funds. An ESG Objective Fund may
  include statements in its sales communications that accurately
  reflect the extent to which the fund is focused on ESG, as well as
  the particular aspect(s) of ESG that the fund is focused on.




• ESG Strategy Funds. An ESG Strategy Fund may
  include statements in its sales communications that accurately
  reflect the types of ESG strategies used by the fund and the extent
  to which the fund uses ESG strategies. However, such funds should
  not exaggerate the extent of the fund’s focus on ESG in their
  sales communications.




• ESG Limited Consideration Funds. An ESG
  Limited Consideration Fund may include statements in its sales
  communications regarding the fund’s use of ESG strategies as
  part of its investment process (including its consideration of ESG
  factors), but such statements should:
  

  • be clear about the limited role that the consideration of ESG
    factors plays in the fund’s investment process, including
    identifying the specific parts of the investment process in which
    ESG factors are considered, the weight given to ESG factors, and
    the impact that ESG factors will have on the portfolio selection
    process; and

  
  

  • only be included if disclosure relating to the limited role
    that the consideration of ESG factors plays in the funds’
    investment process (including identifying the specific parts of the
    investment process in which ESG factors are considered) is included
    in the prospectus. For greater clarity, this includes sales
    communications relating to the IFM’s ESG investing approach
    where the consideration of ESG factors plays a limited role in the
    investment process.




• Non-ESG Funds. A Non-ESG Fund should not refer
  to ESG in its sales communications, with the exception of factual
  information about the ESG characteristics of its portfolio (such as
  fund-level ESG ratings, scores or rankings, or ESG metrics).
  However, the factual information about the ESG characteristics of
  its portfolio should not be framed in a way that suggests that the
  Non-ESG Fund is aiming to achieve any ESG-related goals or is
  trying to create a portfolio that meets certain ESG-related
  criteria.




• Sales communications that include fund-level ESG
  ratings, scores or rankings. Any sales communication that
  includes fund-level ESG ratings, scores or rankings, including
  Portfolio-Based ESG Ratings and Portfolio-Based ESG Rankings, must
  not be misleading. In staff’s view, a sales communication that
  includes fund-level ESG ratings, scores or rankings may be
  misleading for a number of reasons, including any of the following:
  
  

  • there are conflicts of interest involving the provider that
    prepares the fund-level ESG rating, score or ranking

  
  

  • the selection of the specific fund-level ESG rating, score or
    ranking is the result of cherry-picking fund-level ESG ratings,
    scores or rankings in order to present the fund’s ESG
    characteristics or performance in a positive light

  
  

  • the selected fund-level ESG rating, score or ranking is not
    representative of the ESG characteristics or performance of the
    fund

  
  

  • the sales communication does not include explanations,
    qualifications, limitations or other statements necessary or
    appropriate to make the inclusion of the fund-level ESG ratings,
    scores or rankings in the sales communication not misleading.

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