Environment Committee on Nov. 4th, 2024

[The Chair, Liberal, Francis Scarpaleggia]

Good afternoon, colleagues.

I would like to welcome the witnesses, as well as Ms. Lewis, who is replacing Mr. Kram today.

I've just been informed that the sound checks have been done. It's all good. So we're ready to begin.

In the first hour of the meeting, we have three witnesses. As individuals, we have Hugues Chenet, associate professor at the IESEG School of Management, and Bryce C. Tingle, K.C., N. Murray Edwards chair in business law at the University of Calgary Faculty of Law. From Chartered Professional Accountants of Canada, we have Rosemary McGuire, vice-president.

Each of the witnesses will have five minutes for their presentation. Afterwards, we will proceed with the question and answer period.

We'll start with Professor Chenet.

[Hugues Chenet, Associate Professor, IESEG School of Management, As an Individual]

Thank you, Mr. Chair.

Ladies and gentlemen of the committee, by way of introduction, I would first like to say a few words about the journey that led me to make this presentation today.

First of all, my background is in geoscience. I started out as a geophysicist, but I became a financial consultant after that, just before the 2007 financial crisis. I began wearing two hats, one with a quantitative aspect, since it involves market risk modelling, and the other relating to environmental or climate risks in finance. At the time, those risks were not taken into account, but we'll come back to that.

In 2012, I co-founded a finance and climate think tank, which has had some influence on regulatory mechanisms in France and then in Europe, particularly in the lead-up to COP21.

Finally, for the past eight years or so, I've been completely focused on the academic side of things. I'm a transdisciplinary researcher in management science, economics, finance, a bit of accounting, as well as geoscience and environmental sciences.

I want to start with a positive to frame some of the things I want to talk about with you today. In terms of climate issues and, more recently, biodiversity, finance has more broadly made a lot of progress, because it started from a very long way away, which is a little less positive. I think it's worth revisiting that a bit.

When I started working in finance some 15 years ago, the major financing and investment banks, particularly those that were a little further ahead on environmental issues, were very proud to communicate their response to global warming. One of the biggest things they did was change the light bulbs in their offices. It's a bit disappointing when you get into the financial sector and find that out. In the end, there was virtually no connection between their vocation or their real mission, which is to finance the economy and industry, and climate. So not much was happening and very little was being shared.

What about fossil fuels and renewable energy? There was no comment. Basically, the big answer to the questions we could ask them at the time was that they were just bankers or investors and that people should look to their clients instead. So they had no real sense of responsibility for activities that may have an impact on climate change.

Today, obviously, that has changed a lot. You know the situation as well as I do; we can come back to it. In spite of everything, it's been a resounding success. They have made a lot of progress, but perhaps we need to qualify this positive point. If we look at the economy in its current state and the progress made on climate and the emissions trajectory, we can see that finance—if you'll pardon the expression—is not delivering the goods. We don't have what we should expect to have, which is portfolios that are decarbonizing. Portfolios fund the real economy—at least they're supposed to—but the real economy is still just as carbon intensive. We're still emitting as much carbon and greenhouse gases from year to year. Yes, we've stopped emissions from increasing, but we're still emitting and we've yet to hit the peak.

In short, finance hasn't been able to do this on its own. That may be the problem, meaning that it may not be up to finance to do the work. That could be worth discussing. It's exactly the same thing for biodiversity. In a way, finance may not be designed to decarbonize the economy.

I often quote a well-known financial mathematics professor in France, Nicolas Bouleau, who has written in a number of publications that financial markets were not designed to manage the planet. It's very important to remember that. That's not at all what they were designed for. So if we expect them to do something other than what they were designed for, their ability to do it may be called into question.

In addition, the conditions don't seem to be right for finance to spontaneously take on this decarbonization effort. Typically, if an activity remains legal and, in addition, it's profitable, even very profitable, it's virtually impossible for the vast majority of financial institutions to abandon that type of activity. Most of the time, they themselves feel that stopping that type of activity would be like pulling the rug out from under themselves.

In my opinion, then, either we have to change the tool, or we have to change the rules for using the tool. In other words, either we don't rely, or rely much less, on finance to decarbonize the economy, and instead look to industrial policy to shift demand—financing is very likely, I think, to adapt—or we change the fundamental rules of finance so that it can be effective and really play a leadership role in this decarbonization operation.

However, something else has happened instead. People were mainly banking on the fact that, by taking on significant financial risk related to climate change, or even systemic risk in the more or less distant future, the financial world would steer clear of those risks through its investment and funding decisions. We relied essentially on transparency and disclosure of financial risk that isn't considered material enough right now. There's not much going on.

[The Chair, Liberal, Francis Scarpaleggia]

Thank you, Professor Chenet.

Unfortunately, I have to interrupt you, but you'll have the opportunity to share your point of view as you respond to the questions you will be asked.

We'll now go to Mr. Tingle.

Mr. Tingle, you have the floor.

[Bryce C. Tingle, N. Murray Edwards Chair in Business Law, Faculty of Law, University of Calgary, As an Individual]

Thank you very much for the opportunity to appear before the committee.

My name is Bryce Tingle. I'm the N. Murray Edwards chair in business law at the University of Calgary's faculty of law. My research and writing are largely in the area of corporate governance. I'm a member of the Alberta Securities Commission and of the national special advisory board to the RCMP's integrated market enforcement teams, which investigate financial crimes. I sit on numerous boards and I've spent my career advising boards, investors and managers on issues relating to corporate governance.

All opinions are my own and should not be attributed to any institution that I'm part of.

I'm appearing before you as someone who has spent his professional life working in and studying corporate governance and corporate finance.

For the record, I accept the consensus about the science of global warming contained in the most recent reports from the United Nations' Intergovernmental Panel on Climate Change.

The bottom line from all my research is that there are thousands of empirical studies, and these studies generally show that corporate governance interventions of the sort produced by the financial markets do not produce their intended outcomes. This includes the long-time goals of corporate governance of producing better financial returns for investors and reducing executive pay.

The failures of corporate governance as a channel for producing desired outcomes are a function of, first, the fact that corporations are generally embedded in competitive markets and that these markets constrain the range of behaviours a corporation can undertake if it wishes to remain solvent. The average company doesn't make much over its total expenses.

Second, markets produce incentive structures for managers and shareholders, and these systems of incentives militate against certain desired non-financial outcomes.

Third, corporations, their people, strategies, research programs, opportunities, business partners and competitive situations all vary so much that one-size-fits-all interventions affect them in different and unexpected ways and occasionally in counterproductive ways.

Fourth, the most prominent tools used by corporate governance reformers—disclosure requirements and investor pressure—are not suited to the task, for various reasons.

Given the limited amount of time I have, I'll talk about three examples of governance failures that are relevant to ESG.

The first is disclosure. Most investors do not have the knowledge or the incentives to read or accurately process most of the disclosure we provide, and this is particularly true of rather complex environmental disclosure. As a result, investors tend to rely on third parties to produce ESG ratings or rankings. There are over a dozen empirical studies that find these ratings are invalid.

Different ESG companies rate the same company in very different ways. The disagreements among these companies about the environmental merits of companies appear to be increasing over time. There are several studies that show that ESG ratings are very poor predictors of future environmental or social performance.

Studies also show that disclosure discourages innovation, since it provides competitors with the ability to replicate successful initiatives and avoid failures. As a result, companies stop innovating. They will wait for others in a version of the free rider problem. Disclosure requirements also cause companies to behave defensively in an area. ESG activities, if required to be disclosed, can become less ambitious in order to avoid lawsuits or subsequent criticisms for failures.

A second example is financial divestment, which doesn't work. The value of a company's shares is a function of the company's future cash flows. For this reason, divestment does not affect share value. We know this from multiple studies. Several studies find no evidence of the cost of capital increasing for bad ESG performers. There's also no sign, at least in public markets, of lower costs of capital for good ESG companies.

Another problem is that divestment is too crude. A recent study found that the majority of environmental progressive green patents are produced by low-ESG-rated companies. Usually these are old-economy energy companies. This is particularly true of blockbuster environmental patents that are cited by many other patents. The researchers note that this research and development is being performed by companies that are actually excluded from ESG portfolios.

The third example I'll give is about the nature of investors. They don't focus on ESG. Investor behaviour is produced by strong financial incentives to keep their costs low and to maximize fund returns. ESG investors in companies with ESG profiles are generally no better off than non-ESG investors. Some studies find that ESG-branded funds hold worse-performing companies. Studies that look at what happens when an ESG fund buys a stake in a company find no sign of improvement in that company's environmental or social performance.

My time is up.

I will answer any of your questions when the time comes.

[The Chair, Liberal, Francis Scarpaleggia]

Thank you very much, Mr. Tingle.

We'll go now to the Chartered Professional Accountants of Canada.

Ms. McGuire, you have five minutes.

[Rosemary McGuire, Vice-President of Member Experience, Chartered Professional Accountants of Canada]

Thank you, Mr. Chair and members of the committee.

I am Rosemary McGuire, vice-president of member experience at Chartered Professional Accountants of Canada, known as CPA Canada. I oversee the research team focused on emerging issues in the accounting profession and capital markets. A key area of focus for us is the growing need to account for environmental impacts and for increased transparency around climate-related risks and opportunities.

CPA Canada is one of the most influential accounting organizations in the world. CPA Canada also supports the independent structure of accounting, assurance and sustainability standard-setting in Canada. We have been actively involved in the challenges of climate change for more than three decades, and we are currently an active member of the IFRS Foundation's partnership for capacity building, helping to develop resources to implement international sustainability disclosure standards in Canada and globally.

In my brief remarks, I will address three main points: the evolving expectations around sustainability issues, the importance of standards and third party assurance, and the need for a harmonized approach and policy certainty.

Sustainability is becoming increasingly important for investors and providers of capital. A report by the Bank of Canada and the Office of the Superintendent of Financial Institutions noted that the transition to a low-carbon economy will create opportunities for innovation, investment and potential green growth, but this transition may also lead to economic dislocation and a reassessment of the value of various financial assets.

Confidence in the quality of information is crucial for the integrity of our financial system and efficient capital markets. This need extends beyond financial information to include ESG factors, yet this demand for more transparency is leading to a trust deficit. PwC's 2023 global investor survey found that three-quarters of investors and analysts consider how sustainability is managed to be important to their investment decisions, yet 94% believe that sustainability reporting includes unsupported claims.

That brings me to my second point: the importance of sustainability standards and third party assurance.

We are seeing a push toward a global system for sustainability-related reporting. This began with the creation of the International Sustainability Standards Board, or the ISSB, which aims to develop a global baseline of sustainability disclosure standards for capital markets. The ISSB released its inaugural standards last year, covering general sustainability disclosure requirements and climate-related disclosures. The Canadian Sustainability Standards Board was created shortly thereafter and is expected to finalize standards before the end of the year, tailoring them for the Canadian marketplace.

These new standards aim for better disclosure, not just more of it. The climate disclosure standard will require companies to report on their targets and net-zero commitments, along with information on the anticipated financial impacts.

Materiality is a critical concept in these standards. It recognizes that different sustainability issues affect various industries in unique ways.

Another important concept is proportionality, which allows for adjustments based on the capabilities and circumstances of different companies, and this is vital for the Canadian market, given the large proportion of small and medium-sized entities.

Assurance plays a vital role in enhancing the reliability of ESG and climate-related information. The processes involved are similar to the audits that professional accountants have been conducting for decades.

Sustainability regulation in Canada is evolving rapidly, but concerns have been raised about multiple similar proposals being introduced at the same time. These include securities regulation, the Competition Bureau's new anti-greenwashing legislation, OSFI's guideline on climate risk management, the proposed sustainable finance taxonomy and new federal initiatives.

This may lead to a potentially unnecessary regulatory burden for Canadian companies facing oversight by multiple regulators. There is a need for a harmonized approach.

Education and capacity building are also essential. Standards and regulations that aren't well understood or properly applied won't be very effective.

I have only just skimmed the surface of this very complex and evolving subject, but I would be pleased to elaborate and I look forward to your questions.

Thank you.

[The Chair, Liberal, Francis Scarpaleggia]

Thank you, Ms. McGuire.

We'll go to questions now, and it's Mr. Mazier who will lead off for six minutes.

[Dan Mazier, Conservative, Dauphin—Swan River—Neepawa, MB]

Thank you, Chair.

Thank you to the witnesses for coming here today.

Mr. Tingle, I'll start off with you. Is there any evidence that ESG-branded investment funds hold more environmentally and socially responsible companies in their portfolios than conventional investment funds do?

[Bryce C. Tingle]

There isn't much evidence of this. The Securities and Exchange Commission in the United States has been levying significant fines to a number of ESG funds that it discovered had marketed themselves as ESG funds but didn't actually make share buying and selling decisions on the basis of the ESG performance of the companies.

I think there are at least half a dozen academic studies that tend to suggest that there's no difference between the ESG quality of the companies in ESG funds and the quality of companies in non-ESG-branded funds. There have been at least three studies published in peer-reviewed papers that find the performers in ESG funds are actually worse.

[Dan Mazier, Conservative, Dauphin—Swan River—Neepawa, MB]

Do you believe that ESG ratings and climate-related disclosure statements are a scam?

[Bryce C. Tingle]

There's no question that ESG has been a very powerful marketing tool for the last 10 years. Money has flowed into funds that have advertised their ESG focus, as well as funds that don't compete for money, such as public pension funds and union funds. Those funds have political masters who are very concerned about ESG, so those funds tend to do a lot to advertise their ESG credentials.

What we've seen is that these funds don't reliably hold better ESG performers. If they do anything, they apply very crude screens that just block one or two industries, such as automotive or oil and gas. That's about the limit. They rely on these heavily flawed ESG ratings I was talking about in my remarks.

When we study what the companies actually do, we find no sign that those companies' ESG performance is improving, so it looks like this is mostly a marketing initiative on the part of the financial industry.

[Dan Mazier, Conservative, Dauphin—Swan River—Neepawa, MB]

There's a lot of concern that a lot of companies won't go public if they're forced to produce climate-related disclosure statements. Is this true, and what are the consequences of this?

[Bryce C. Tingle]

What originally got me interested in our corporate governance regime is the fact that Canadian public markets are declining quite seriously. Canada had, about 15 or 18 years ago, something like 1,400 or 1,500 public companies. It now has fewer than 700 operating companies. Similar declines are visible in other markets, and—

[Laurel Collins, NDP, Victoria, BC]

I have a point of order, Mr. Chair.

I'm so sorry to interrupt. There's a microphone on in the room, so there's an echo.

[The Chair, Liberal, Francis Scarpaleggia]

I'm sorry. I'm going to stop. Is there a microphone on in the room?

Try again, Mr. Tingle.

[Bryce C. Tingle]

That's not a problem. I can hear the echo as well, for what it's worth.

Okay, that's better, if it works for everyone else.

We have this growing reluctance of companies to go public. In practice, that means Canadian companies choose to sell themselves as a way of generating liquidity for their investors. In many important industries, like technology and pharmaceuticals, selling themselves means selling themselves to a foreign company, usually an American company.

Our public markets are generally where companies have scaled up, so I've been very concerned about why companies are refusing to go public. I think the increasing regulation we impose on companies when they go public is the most likely explanation.

[Dan Mazier, Conservative, Dauphin—Swan River—Neepawa, MB]

Okay. Thank you.

There was an article in the Financial Post on Justin Trudeau's top economic adviser, Mark Carney, who was forced to retract his false claims about his company's environmental record. The headline says, “Mark Carney walks back claim Brookfield has reached net-zero after criticism”. The article goes on to say, “Backlash from climate experts hinged on Carney's use of 'avoided emissions,' in which a company takes credit for refraining from high-polluting actions”.

Can you tell us what happens to ESG investing when companies greenwash their environmental records?

[Bryce C. Tingle]

There are two possible explanations for the financial market's poor performance on ESG.

One explanation is that they're just not being given accurate information by the companies. Certainly, there are lots of incentives for companies to put the best face on their ESG performance. I tend to think fraud is not common, but there's a lot of spin in ESG reporting.

The other reason the financial market has done a poor job is that the incentives of fund managers are to generate strong relative returns in their funds. Doing that is where they invest most of their time and energy. It's not in reading lengthy and complex ESG disclosure, much of which is inadequate because, in order to evaluate a company's ESG performance, you have to understand the alternatives strategically, in their markets, to decide whether or not they're taking the right path for the company. We don't see that level of engagement in any topic in corporate governance, including straightforward topics like executive compensation or maximizing financial returns. Corporate governance generally gets ignored by investors, aside from rhetoric.

[Dan Mazier, Conservative, Dauphin—Swan River—Neepawa, MB]

Would this be considered fraudulent?

[The Chair, Liberal, Francis Scarpaleggia]

Answer very briefly.

[Bryce C. Tingle]

As I said, the SEC has levied some truly eye-popping fines against ESG funds that aren't doing what the marketing material says they do.

[The Chair, Liberal, Francis Scarpaleggia]

Thank you.

I'll go to Mr. Longfield.

[Lloyd Longfield, Liberal, Guelph, ON]

Thank you, Chair.

Thank you to the witnesses for preparing to be here with your presentations and taking questions.

I'm going to start with Ms. McGuire.

In financial auditing and requirements around taxonomy, what words are used to define ESG goals and how the accounting industry is working internationally to get standards we can audit? Could you comment on the progress on that, please?

[Rosemary McGuire]

You're exactly right. In order to audit, you need a sound financial or reporting framework to audit against. That's why these international standards are so critical. The focus has been on that.

As I said, progress is being made here in Canada to issue our version of those international standards before the end of the year. There is progress being made with respect to auditing standards for sustainability assurance engagements, and we expect those standards will be published shortly as well.

[Lloyd Longfield, Liberal, Guelph, ON]

I heard this morning—and I also heard it in another meeting—that the 17 sustainable development goals of the United Nations were just marketing fluff.

Could you comment on where those standards are at, in terms of reaching into the accounting industry?

I was on the public accounts committee. The Auditor General of Canada, and all auditors general across Canada, are working toward auditing against the 17 SDGs. Is that something your industry is working on?