ESG Regulation in Canada

A primer on developments in the Canadian ESG regulatory environment

Canada’s Regulatory Landscape

In Canada, existing federal and provincial laws cover a broad range of ESG related topics. For example, there are various “hard” (mandatory) laws regarding the environment, occupational health, and employee safety. These laws are clearly ESG in nature as they set requirements for reporting corporate performance on key environmental and social issues.

However, these laws are not referred to specifically as “ESG laws.” The fact that Canada already had comprehensive, hard laws that cover ESG related issues can be a potential reason the government was seen as being “slow” to legislate regulations that specifically alluded to “ESG.”

This changed recently. Both the federal and provincial governments are setting designated ESG regulations that outline more precise requirements that are more specific to Canada’s ESG-related goals. Additionally, former ESG “soft” laws (e.g., recommendations and policies) are increasingly becoming mandatory laws.

Regulatory Developments to be Aware of

Financial analysts should be aware of the following ESG-specific regulatory developments in Canada.

1. Canada’s Climate Investment Taxonomy

This regulation outlines qualification criteria for investments (and other economic activities) that contribute to Canada’s ambition to ‘transition’ to a Net Zero economy by 2050. This regulation helps differentiate between which activities contribute to this Net Zero objective and which do not.

Who does it Apply to?

This regulation applies to investors, private and public companies, and financial intermediaries such as commercial and investment banks, as well as buy-side players like pension funds and other asset managers.

Its core purpose is to support both the assessment of and disclosure activities around investments, projects, and business activities that support Canada’s Net Zero transition.

The Taxonomy framework can also be used by government policymakers and regulators to determine how to allocate resources toward other climate-related activities that support this transition commitment. For example, local governments can use this framework to decide if investing in a power plant is beneficial to Canada’s transition to a net-zero economy.

Key Concepts & Requirements

The Transition Label: The Canadian Taxonomy presents a new, distinct concept from other country-level taxonomies, pioneering the term “Transition Label.” Taxonomy regulations have been published in other countries like the EU and Australia. Yet, the Canadian Taxonomy is the first to present a transition label in addition to the commonly used green label.

The difference between these two labels is that “Green” projects are low or no carbon solutions (e.g., renewables, clean hydrogen, EV batteries), whereas “Transition” projects refer to those that significantly reduce the emissions from high-emitting sectors—such as oil extraction and coal mining.

This label would apply to projects that reduce emissions from hard-to-decarbonize sectors. Transition-labeled projects are short- medium term, meaning they have limited lifespans (a project of 20 years will not qualify for the transition label). This criterion is set to encourage projects that are more immediate and cost-effective. For example, a steel producer installing a technological solution to reduce emissions from its operations would be a project eligible for transition investment status.

The “Green” Label: This label applies to low-to-no carbon projects or activities that immediately contribute to Canada’s Net Zero commitments—e.g., wind and solar, battery and storage technology, and Electric Vehicle (EV) infrastructure.
“Do no Significant Harm” Requirements: Companies must assess a project against the new “Do no significant harm” criteria set in the regulations. The “do no significant harm” criteria focuses on protecting Indigenous rights and workers while promoting positive environmental outcomes and climate resilience. Companies must assess and ensure the project has no adverse impacts on the environment, local community, and broader, governmental ESG objectives.
Aligned with 1.5° C Degree Scenario: The Taxonomy is grounded in the science-based target of limiting global warming to 1.5° C—and all criteria and thresholds, for green as well as transition labels, are aligned with that pathway. The 1.5° C threshold alludes to the goal of limiting global temperature increases to 1.5° C above pre-industrial levels to avoid the worst impacts of climate change, which is also the level agreed upon in the 2016 Paris Accords (or Agreement), the legally binding international treaty on climate change.

Key Takeaways

Taxonomy is not Mandatory—YET: Currently, using this taxonomy is a “soft” law – meaning – not mandatory. However, it is estimated that it will become mandatory in the near future, as Canada increases public commitments and subsequent enforcement around climate change and its Net Zero transition.
This Regulation has Vast Support: This framework is backed by the twenty-five largest financial institutions in the country, which participated in the process as members of the Taxonomy Technical Expert Group (TTEG), for the Canadian Green and Transition Financial Taxonomy Framework. Since the overarching goal with this Taxonomy is to encourage capital flow to support Canada’s climate targets and associated economic opportunities – complying with it can help drive investment capital. Given the vast support of this regulation, complying with it now will ensure that stakeholders are properly prepared for when it becomes mandatory.

2. The Canadian Securities Administrators (CSA) Corporate Governance Diversity Reporting Rule

This regulation is designed to advance Diversity, Equity, and Inclusion (DEI) in Canadian Corporations and promote greater disclosure on these topics.

Who does it Apply to?

The Corporate Diversity Reporting rules went into effect on January 1, 2020, and apply to federally incorporated public companies and non-venture reporting issuers. Non-venture reporting issuers are typically larger and more established companies that meet specific criteria such as having at least one million freely tradable securities and 300 public holders.

Key Concepts & Requirements

Disclosure of Diversity Policies: Companies must disclose if they have written policies or targets for representing specific groups, such as women, Indigenous peoples, visible minorities, and persons with disabilities, on their boards and in executive positions.
Representation Data: Companies must also disclose how many people from designated groups serve on their boards and in executive positions. This means that general statistics on employee diversity is not enough—the disclosed information should include the number and percentage of these individuals in essential leadership positions.
Director Term Limits and Other Diversity-Related Practices: Companies must disclose if they have term limits for board directors and other controls related to board renewal. This particular requirement is intended to ensure that companies do not appoint an individual for the appearance of diversity alone.

Key Takeaways

Enforcement Ambiguities Addressed: In Canada, the Federal and Provincial governments have the authority to legislate laws. Federally incorporated, public companies are governed by federal laws, while private companies generally follow provincial laws.

Some of the largest companies in Canada are private—such as Walmart Canada, Costco Wholesale Canada, and General Motors of Canada—and in turn have resulted in challenges and ambiguities surrounding enforcement. Now that the federal law applies to both public and private companies, the former regulatory loophole that challenged federal enforcement across the country has been addressed.

By setting these federal regulations that apply to public and non-public companies, the federal government can ensure there is a benchmark for DEI disclosure – regardless of their geographic location and incorporation status. (It should be noted that on April 13, 2023, the CSA published CSA Notice and Request for Comment with respect to proposed amendments to these regulations as the government is looking to enhance the disclosure requirements.)

Applies to More Than Just Canadian Public Companies: Although it is targeted at public companies, this regulation applies to all companies subject to the Canada Business Corporations Act (CBCA), including venture issuers and foreign companies that are trading on Canadian stock exchanges. This means that if a company is traded on a Canadian stock exchange, it is required to comply if it meets certain parameters around size and revenue.
Comply or Explain: These regulations include a legal practice known as Comply or Explain. What this means is that companies must comply with a rule or explain why management is not complying. And while it may sound like it provides a loophole for companies to avoid compliance, it is actually a mechanism that encourages companies to comply with regulations.

Why? Because if a company does not comply, they must give a detailed explanation around why not. This explanation can be more revealing and potentially detrimental to its reputation. For example, if you are not sharing your board diversity statistics you have to explain why not. You can imagine the challenges of substantiating your case as to why you would not be disclosing this basic information.

3. Climate Disclosures for Federally Regulated Institutions

Starting in 2024, federally regulated institutions, like banks and insurance companies, will be required to disclose their climate-related risks and exposure. See full article HERE.

Who does it Apply to?

This regulation will apply to the entire Canadian Market (to varying degrees)—starting with federally regulated financial institutions that must comply starting the end of fiscal year 2024. This includes Canadian banks and all federally incorporated or registered insurance companies.

By the end of 2025, additional companies will be required to comply based on their size, industry, and revenue.

Key Concepts & Requirements

A Transition From “Soft” Law to “Hard” Law: As was presented earlier, the Canadian legal system, like many others, has “hard” and “soft” laws—laws which are mandatory and laws which are more of a recommendation. The Canadian Securities Administrators (CSA) have historically set “soft” ESG regulations. But this regulation is the first of Canada’s ESG regulations to turn into a “hard” law. This is a notable change in the CSA, and the Federal government’s approach and indicates that other “soft” ESG laws can quickly turn into “hard” laws.
Climate-Related Financial Information: Financial institutions will be expected to collect, assess, and disclose information on climate risks and associated emissions from their clients, loan portfolios, assets, and financial products. Assessing the climate risks across all these elements of the business is a massive undertaking that requires dedicated resources and specialized knowledge.

Financial institutions can prepare by developing internal capabilities, resources, and infrastructure to support this annual need. For example, incorporating climate risk and emission information into due diligence can be a significant step in the right direction.

The TCFD Is the Base Framework: This regulation is based on the Task Force for Climate-related Financial Disclosures (TCFD) framework. The TCFD framework has four key pillars:
- Governance: The organization’s governance around climate-related risks.
- Strategy: The actual and potential impacts of climate-related risks and opportunities on the organization’s businesses, processes, and financial planning.
- Risk Management: The processes used by the organization to identify, assess, and manage climate-related risks.
- Metrics and Targets: The long-term goals and associated metrics used to demonstrate progress against climate-related risks.

With that, it is important to note that since the TCFD was incorporated within the ISSB (International Sustainability Standards Boards) in July 2023, it could affect the terms associated with this framework and regulation.

Enhanced Disclosure on Climate Plans: Management at companies will be required to not only disclose climate risk information, but also present a plan on how they will identify, assess, and manage their climate risks moving into the future. This enhanced disclosure around climate plans will support even greater decision-making by investors and associated stakeholders.

Key Takeaways

Indirectly Impacting Many Types of Companies: The new climate-related reporting requirements will apply to federally regulated financial institutions first. However, the impact will extend throughout the entire Canadian economy.

Under these regulations, financial institutions will have to collect information on climate risks and emissions from their clients, which can indirectly impact many different companies within the client’s ecosystem and across their value chains. In short, any disclosure effort by these federally regulated financial institutions will require significant information gathering and provision by many companies that do business with the institution.

Changes Coming for Pensions: The federal government also announced its plans to require federally regulated pensions to disclose the ESG considerations they use in their portfolio construction, including climate-related risks. The federal government didn’t provide any details on how or when this requirement would be rolled out, but it’s safe to say it will be coming in the near future. If pensions are forced to report on how they’re using ESG strategies to build their portfolios, they’ll need reliable disclosure from both financial institutions they associate with and companies they directly invest in.

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