Getting ahead of proxy season: key ESG considerations

 
Climate and other environmental issues in focus

Proxy advisers: Glass Lewis and Institutional Shareholder Services (ISS) have updated their 2023 guidelines for Canadian companies to make climate board accountability a factor in their assessments. Although their guidelines differ somewhat in approach and scope, in general terms, Canadian companies with financially material climate risk exposure (such as those identified by Climate Action 100+) potentially face a negative voting recommendation for the chair of the committee/board with oversight over climate-related issues if the company:

• does not provide comprehensive disclosure aligned with a global standard such as the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD);
• has not adopted medium-term greenhouse gas (GHG) emissions reductions targets for its Scope 1 and Scope 2 emissions; and/or
• has not defined and disclosed board oversight for climate-related matters.

Although the 2023 proxy advisory guidelines focus primarily on significant GHG emitters, as the TCFD disclosure regime matures, we anticipate that these policies will be incrementally expanded over time to capture more Canadian companies. Glass Lewis is already signalling that it views climate risk as a material risk for all companies and, therefore, it believes all boards should be considering their operational resilience under lower-carbon scenarios.

Institutional investors: The proxy advisory firms’ guidelines described above are broadly consistent with institutional investors’ expectations on climate matters.

 
Shareholder proposal trends: Climate-related shareholder proposals continue to be prominent, with more than 30 climate-related proposals being disclosed in Canadian companies’ circulars and at least 12 going to a vote in 2022. In 2023, we expect the pressure on Canadian companies to ramp up with shareholder proposals requesting companies to adopt more aggressive net-zero or GHG emissions reduction targets, cease developing (or financing) fossil fuel projects, enhance their disclosures about climate-related matters (including greater transparency regarding financing of fossil fuel projects) and/or hold an advisory “say on climate” vote.

Institutional investors, however, are becoming more selective about which shareholder proposals they support. For example, shareholder proposals that are unduly prescriptive, such as calling for specific changes to a company’s strategy or business model or constraining the board’s decision-making with respect to actions or targets that are not material to how the company delivers long-term value, are less likely to receive broad support.

Regulatory developments: If National Instrument 51-107 Disclosure of Climate-Related Matters (NI 51-107) is adopted as proposed², Canadian reporting issuers will be required to disclose climate-related metrics and targets, certain GHG emissions data, and how management assesses and manages—and how the board oversees—climate-related risks and opportunities. Although climate change-related disclosure continues to be a priority for Canadian securities regulators, new rules are not expected to be effective until 2024 or 2025, once greater progress has been made on the equivalent international and SEC disclosure standards.

Beyond climate: With the increasing focus globally on nature-related risks (such as biodiversity loss and ecosystem degradation), investor-led initiatives in this area are gaining momentum. In December 2022, Nature Action 100—an institutional investor-led group—was launched to engage with companies in systemically important sectors to seek to stop or reverse nature and biodiversity loss. Similar to Climate Action 100+, Nature Action 100 initially will identify a list of 100 focus companies (whose operations involve material, nature-related impacts) for investor engagement, which we anticipate will lead to calls for enhanced disclosure and target-setting for nature-related risks. Companies should be prepared to address shareholder proposals and other forms of engagement on this issue in 2023.

Although Canadian securities regulators have not adopted, or proposed, disclosure requirements specifically focusing on nature-related risks, the Taskforce on Nature-related Financial Disclosures (TNFD) is making progress on a global standard that might inform securities regulation³ in the coming years.

Social issues

Modern slavery and human rights: Bill S-211, An Act to enact the Fighting Against Forced Labour and Child Labour in Supply Chains Act and to amend the Customs Tariff is nearing adoption. If enacted as proposed, Bill S-211 will require all companies listed on a Canadian stock exchange, as well as certain companies that meet specified size thresholds, that, directly or indirectly, produce, sell or distribute goods in Canada (or elsewhere) or import goods into Canada to publicly report on steps taken to prevent and reduce the risk that forced labour or child labour is being used in their supply chains. If Bill S-211 is passed in 2023, the first report will be due in May 2024⁴. In the meantime, for the upcoming 2023 proxy season, we expect to see continued investor engagement strategies, including shareholder proposals, calling for enhanced disclosure and impact assessments relating to human rights, including on topics such as protections for migrant labourers, freedom to engage in collective bargaining and the implications of the use of artificial intelligence.

Indigenous reconciliation and inclusion: In the past few years, several Canadian companies have disclosed shareholder proposals calling on them to report on the extent to which their policies and practices regarding Indigenous community relations, internal education in Indigenous reconciliation, procurement from Indigenous-owned businesses, and recruitment and advancement of Indigenous employees meet Indigenous-led standards. In most instances, the companies agreed with the proponent either to take certain actions either in lieu of a vote on the shareholder proposal or to put forward a management-led proposal providing for similar commitments. Given the increasing visibility of matters associated with Indigenous Peoples, including reconciliation, we believe that Canadian companies should be prepared to engage with shareholders, through a shareholder proposal process or other forms of engagement.

Diversity

We expect continued focus on the extent to which Canadian company boards and management ranks reflect the diverse make-up of the company’s stakeholders and society at large, as well as rising interest to identify and take steps to address racial disparities in their workforce.

What to expect: regulatory developments

• New requirements or guidance expected: The Ontario Securities Commission has stated that it expects proposed changes to the disclosure requirements on diversity, board renewal and the director nomination process to be published in the second quarter of 2023. This initiative is part of recent research and consultations by the Canadian Securities Administrators (CSA) in consideration of broader diversity on boards and in executive roles, including the representation of people who self-identify as Black, Indigenous, persons of colour (BIPOC), persons with disabilities, or LGBTQ2+. Although any proposed changes would not apply for the 2023 proxy season, we anticipate that the current disclosure rules, focused solely on the representation of women, will be expanded to cover other underrepresented groups.
• Disclosure format: In the Year 8 Report, the CSA reiterated that the lack of uniformity in diversity reporting may make it difficult for investors to locate and interpret such information. Accordingly, they are encouraging issuers to use a common tabular format to disclose this information. Corporations Canada has also published non-binding guidance for CBCA corporations recommending the use of a common tabular format for disclosure of required information concerning the number and percentage of women, visible minorities, Indigenous Peoples, and people with disabilities (i) on the corporation’s board of directors and (ii) among senior management⁶.

What’s new from proxy advisers: For 2023, both Glass Lewis and ISS are taking an incrementally tougher stance on board diversity.

• Glass Lewis transitioned from a fixed numerical approach to a percentage-based threshold in its gender diversity guidelines for TSX companies. It generally will recommend a vote against: (1) the chair of a TSX company’s nominating committee if the board does not have at least 30% gender-diverse⁷ directors; and (2) all nominating committee members if the board does not have any gender-diverse directors. For boards of issuers listed on other Canadian exchanges, the standard remains a minimum of one gender-diverse director.
• Consistent with its 2022 guidelines, ISS generally will recommend a vote against the chair of the nominating committee (or chair of the board if there is no nominating committee) of:
  • an S&P/TSX Composite Index company if women do not comprise at least 30% of the directors; and
  • a non-Composite Index TSX company or a NEO company that does not have at least one female director.
  New for 2023, ISS has eliminated the exceptions to these guidelines that applied in 2022 if a company had publicly disclosed a written commitment to achieve the relevant target at or prior to its next annual general meeting. Now, exceptions to ISS’s gender diversity policy will apply only if a company is new to the relevant exchange, exchange tier or index or in “extraordinary circumstances”.
• ISS recently announced that beginning in 2024, it will expect Canadian S&P/TSX Composite Index constituents to have at least one racially or ethnically diverse director.

The latest from investors and governance advocates

• Many Canadian institutional investors have already incorporated a 30% standard for the representation of women on boards into their proxy voting guidelines. Increasingly, institutional investors also want to see companies show commitment and progress toward diversity beyond gender.
• The Committee on the Future of Corporate Governance in Canada, a joint initiative of TMX Group Limited and the Institute of Corporate Directors, recently recommended in its report Charting the Future of Canadian Governance⁸ that boards set targets to have at least 40% of their members identify as female and at least 40% identify as male. The Committee also recommends that companies set targets for at least 30% representation on the board from underrepresented racial groups, Indigenous persons in Canada and disabled persons.

What to expect: shareholder proposals

Based on recent trends, Canadian companies should look out for shareholder proposals in 2023 raising the following:

Glass Lewis has signaled in its 2023 global guidelines for ESG initiatives¹⁰ that, after taking into account a number of factors, Glass Lewis generally will recommend in favour of well-crafted shareholder proposals for a racial equity or civil rights-related audit if it believes that doing so will help the company identify and mitigate potentially significant risks.

Cybersecurity

Consistently cited by instititional investors as a high priority issue with potentially significant material financial implications for every company, cybersecurity continues to be a focus this proxy season.

Proxy advisers: Glass Lewis has amended its 2023 guidelines to state that it believes cyber risk is material for all companies and that it expects companies to provide clear disclosure regarding the board’s role in overseeing cybersecurity issues and how companies are ensuring that directors are “fully versed” on this issue. Although Glass Lewis generally will not make recommendations based on a company’s oversight or disclosure concerning cyber-related issues, it may make recommendations against appropriate directors if cyber-attacks have caused significant harm to shareholders and Glass Lewis concludes that the company’s disclosure or oversight is insufficient.

Regulatory developments: In 2022, the SEC proposed rule amendments that would require disclosure of material cybersecurity incidents and about companies’ oversight and policies regarding cybersecurity risk¹¹. Although currently there are no equivalent Canadian securities law requirements in place or proposed, and most of the SEC’s proposed amendments would not apply to Canadian companies that report under the MJDS, we expect that the SEC rules and U.S. market practice will influence market practice in Canada.