Government-mandated ESG disclosures—a reality check

Despite the growing momentum of the ESG movement worldwide including in the United States, Canada remains one of the only western countries that does not require public companies to disclose their ESG (environmental, social and governance) practises.

But that’s likely going to change, very much and very soon.

In its latest budget, the Trudeau government outlined plans to require federally-regulated financial institutions including Canada’s big five banks to report on financial risks related to environmental practises beginning in 2024. According to the plan, those institutions must collect and report climate risk and emissions data from their clients. In other words, if you’re a company that wants to do business with a bank in Canada, you’ll soon need to disclose your environmental practises (the E in ESG).

In addition, Canadian Securities Administrators, composed of the country’s 10 provincial and three territorial securities regulators, plan to soon establish requirements for publicly traded companies to disclose their climate-related information including their greenhouse gas emissions, thereby imposing significant new costs on those companies.

Obviously, if governments and regulators impose costly ESG reporting mandates on public companies, there should be compelling offsetting economic benefits to justify such mandates. ESG advocates argue that mandated disclosures will help provide valuable information to investors and lenders about the future prospects of public companies. Absent mandated disclosures, investors and lenders will be ill-informed about future risk-adjusted returns they may realize from their investment in the stocks and bonds of public companies. Hence, mandated ESG disclosures will improve the efficiency of Canada’s capital markets. But is that true?

For many ESG advocates, “better” financial decisions mean increased investments in companies rated highly by ESG rating agencies and ESG-themed mutual funds and Exchange Traded Funds (ETFs). And poorly rated companies and investment portfolios should lose investment dollars. That’s the ESG vision—in theory, companies that comply with ESG criteria have strong financial futures and are less likely to encounter environmental compliance issues, labour conflicts or internal scandals. ESG disclosures, mandated by government, therefore enable investors to do well by doing good.

But if this argument has merit, there should exist consistent evidence that companies and investment portfolios with the ESG stamp of approval enjoy better risk-adjusted financial returns than companies and portfolios with lower ESG rankings. Yet a new study published by the Fraser Institute, which surveys the available literature on financial returns to ESG-themed investing worldwide, finds no consistent evidence that ESG-themed investing produces higher returns for investors compared to conventional investment strategies. This evidence casts doubt on the most popular economic rationale for mandating expansive ESG disclosures—that ESG will make investors more money.

Of course, some argue that many investors will sacrifice financial returns to support highly-rated ESG companies. If this is true, mandated ESG disclosures should result in lower risk-adjusted returns for investors who follow an ESG-themed investment strategy. But here again, according to the available literature, there’s no consistent evidence that highly-rated ESG companies and investment portfolios earn lower returns than lower-ranked alternatives.

What should one make of this evidence? Perhaps current ESG reporting, which varies by jurisdiction, is not sufficiently material to corporate financial performance to alter investment strategies. Or more plausibly, perhaps capital markets in Canada and beyond already efficiently use ESG-related information currently provided voluntarily by companies, and hence ESG-themed investing earns neither above nor below average returns.

In either case, if Canada soon mandates ESG disclosures, it will impose economic costs on Canadian companies that will likely outweigh any economic benefits.