For decades, Canada’s collective retirement savings have been heavily steeped in the fossil fuel sector. In recent years, climate-conscious investors, lawyers and activists warned that many of Canada’s pension funds were risking our future by continuing to pursue investing strategies that keep us on the pathway to catastrophic climate change. But tectonic shifts are happening behind the scenes even at Canada’s most conservative pension plans, as sustainable investing gains momentum worldwide. New research reveals that sustainable investing is becoming a key strategy for Canada’s largest pension fund managers.
Twelve of Canada’s biggest pension funds were analyzed by Corporate Knights, in partnership with the Smart Prosperity Institute and The Natural Step Canada. Over the past decade, these funds have quietly unloaded their fossil fuel stocks as their values have plunged, to the point where they now make up less than a few percent of total investments. Canadian pension portfolio exposures to fossil fuel stocks are down to a 10th of what they were 10 years ago, notwithstanding some controversial private equity investments.
For instance, the two largest funds in Canada (Canada Pension Plan and Caisse de dépôt et placement du Québec) have slashed the value of their fossil fuel holdings by more than 90% over the past 10 years, from more than 22% of total equity investments to less than 2% and 3% as of September 20, 2021.
On the flip side, we found that collectively, their self-defined environmentally sustainable investments have gone from negligible to more than $150 billion – 7% of their total assets – over the last few years.
Many pension funds are also taking a more active role with the companies they invest in, engaging on environmental, social and governance (ESG) issues ranging from board gender diversity to responsible lobbying and payment of taxes. Similarly, many funds are making efforts to improve their own governance by increasing management diversity. This involves aligning their own executive bonuses with ESG targets and increasing ESG competency on their boards.
Pension funds represent a major pool of Canada’s investment capital: the top 12 funds alone control $2.1 trillion, roughly equivalent to Canada’s entire GDP. Many stakeholders – governments, businesses, non-profits like Shift Action for Pension Wealth and Planet Health, and certainly beneficiaries – are increasingly interested in how pension funds are addressing the challenge of the transition to sustainability. A new tool called the Sustainable Investment Dashboard, developed by Corporate Knights with input from the Smart Prosperity Institute, The Natural Step Canada and a panel of experts, aims to highlight which pension funds are pulling their weight on these issues and which ones are falling behind.
As the transition to a climate-friendly economy speeds ahead, global investors are embarking on what is in all likelihood the largest reallocation of capital in our civilization’s history. This could be more than $100 trillion between now and 2050, according to Mark Carney, former governor of the Bank of England.
There still exists tremendous potential for pension funds to play an active ownership role in helping carbon-intensive companies leverage their assets to make the transition from “grey to green,” through initiatives like Say on Climate and Climate Engagement Canada. This engagement must be underpinned by an honest assessment of what kind of future companies are investing in. Many companies claim to be aligned with net-zero emissions, but if they are still plowing most of their growth investments into high-carbon assets, then net-zero is just a slogan.
Ziad Hindo, the chief investment officer for the Ontario Teachers’ Pension Plan (OTPP), told The Globe and Mail that Canadian pension funds need “a fundamental shift.” Some of Canada’s largest pension plans are realizing that they need to keep up with the pace of change and capture their fair share of clean-growth investment opportunities. They’ll need to boost their investments in low-carbon solutions to roughly 20% by 2025 and fully decarbonize across all asset classes. Given the multi-decade ripple effects of capital allocations made today, this will need to happen well before the 2050 net-zero target for the real economy.
This fall, Canada’s second- and third-largest pension fund managers raised the stakes, announcing plans to achieve net-zero emissions, and linked the objective to executive compensation at the funds.
In September, OTPP set targets to reduce portfolio carbon-emissions intensity by 45% by 2025 and by 67% by 2030, compared to their 2019 baseline. Critically, these targets impact all their assets across public and private markets, including external managers. The pension plan also committed to invest $5 billion in climate and transition solutions so far in 2021 and said they would boost their $30-billion portfolio of green investments.
Also in September, CDPQ updated its climate pledges to boost green assets from $36 billion to $54 billion by 2025 and achieve a 60% reduction in the carbon intensity of the total portfolio by 2030. The plan will also create a $10-billion transition envelope to decarbonize the main industrial carbon-emitting sectors and complete its exit from oil production (currently just 1% of its portfolio) by the end of 2022. Other pension funds are also developing net-zero action plans, which are not yet public. So this trend will almost certainly continue.
While it is encouraging to see the “Maple Revolutionaries” (as The Economist dubbed Canada’s large pension funds for their strong governance and performance track record) rising to the climate challenge, there is a risk that the lack of clear definitions and expectations could result in unnecessary costs, delays, lost opportunities and even risks to financial performance.
As the investment wave toward net-zero takes hold globally, now is the time to position Canadian pension funds (large and small alike) for success.
This will require the federal government to establish a Net-Zero Implementation Standard, a clear definition of what constitutes a net-zero-aligned portfolio. And there should also be a net-zero alignment requirement for all pension funds (a Net-Zero Rule). While Canada has a fragmented regulatory landscape (the 12 largest funds are regulated by eight different supervisory bodies), tax-exempt pensions share a common touch point with the Income Tax Act. This is a powerful tool as pensions currently benefit from $85 billion per year in tax subsidies (a sum equal to 25% of all federal government revenues).
The federal government should consider amending the Income Tax Act to introduce a Net-Zero Rule requiring pension funds to demonstrate net-zero alignment in order to maintain full tax-exemp status. This could be phased in starting with the largest funds, which account for the majority of Canada’s $4 trillion in pension wealth, and would help secure Canadian retirement savings on the right side of the transition to a low-carbon economy.
It would ensure that pension plans generously subsidized with public funds are not investing at cross-purposes to the government’s climate goals, according to Jinyan Li, a professor of tax law and former interim dean of Osgoode Hall Law School. And more generally, it would be in line with the rising recognition of the social role of finance.
A variation on this recommendation could be to provide a small (10 to 20 basis points) limited-duration (two-year) enhanced tax incentive for pension funds aligned with the net-zero requirement, after which a partial reversal of tax-exempt status would kick in for non-compliant funds. In light of the urgency of the climate situation, this could be done surgically for net-zero purposes or, as pension expert Keith Ambachtsheer has called for, as part of an expedited, more holistic overhaul. This could also be used to ensure all Canadian tax-deferred asset pools provide integrated annual reports covering their organizational purpose, governance, business model, performance and strategy, including independent certification that the report deals with reality and not fiction.
Though there is no single incontrovertible global standard for how to calculate net-zero, two of Canada’s three largest funds already have developed best-practice methods (both using the Partnership for Carbon Accounting Financials Standard). And there are other credible international standards upon which Canada could issue guidelines, including the Paris Agreement Capital Transition Assessment (PACTA) tool (a free, open-source methodology and tool the UN helped to finance), which the Bank of England has used.
Portfolio analysis done for this report and by the two large Canadian funds with public net-zero goals (CDPQ and OTPP) both found that there is a financial cost to moving too slowly in this period of unprecedented capital reallocation from high-carbon to low-carbon activities. Any concern about a conflict between net-zero alignment and the duty of pension fiduciaries (to focus on risk-adjusted returns) appears increasingly misplaced. Now is the time to act on implementing net-zero portfolio strategies.
If we get this right, then Canadian pension plans can lead in buying us out of the climate jam while earning healthy returns. Bonus: It’s easier to collect a pension in a world that is not on fire.
Toby Heaps is the co-founder and CEO of Corporate Knights.
Ed Waitzer is a lawyer and former chair of the Ontario Securities Commission.
Derek Eaton is the director of public policy research and outreach at the Smart Prosperity Institute.