Foundations and importance of ESG: Update and overview with Stephen Pike

Raluca: [00:00:13] Hello and welcome to Lexpert TV. I'm Raluca Urlea. And joining me for this special ESG update and overview is Stephen Pike, a Toronto based partner at Gowling WLG and co-leader of the firm's Canadian ESG advisory services practice. Stephen is the co-editor of ESG In the Boardroom, a guidebook for directors published by the American Bar Association. Welcome, Stephen, and thank you for joining us.

Stephen: [00:00:37] Thank thank you very much. It's a pleasure to be here. A big fan of Lexpert TV. I've watched a number of episodes. I think it's really a great platform to engage with and to get really valuable content. So I'm delighted that I have an opportunity to talk with you today, and I hope that the viewers will enjoy our discussion.

Raluca: [00:01:00] You are very welcome. First off, what is ESG?

Stephen: [00:01:04] Well, ESG is not a precise legal term with a commonly accepted legal or dictionary definition. I call it a dynamic umbrella term dynamic because it continues to evolve and develop and an umbrella term because it sort of rests over a long list, essentially an infinite list of different factors, risks and opportunities. And because it's developing, the number of risks and opportunities and issues keeps growing. So it's really on top. And as an umbrella would be, so why does this matter? It's because businesses need to understand these ESG issues, risks and opportunities, the risks and opportunities and issues that are impacting it and that how it's impacting its stakeholders. So because ESG is dynamic of a business, only uses a fixed and static inventory of ESG risks and opportunities that was compiled, for example, like on a specific date or a particular point in time, the business will only have a limited view and understanding of its ESG landscape and won't be able to optimize how it's going to respond to and manage those risks and opportunities. And because ESG is dynamic and continues to change, it can't be just at one point in time. It can't be a once a year issue for the board to look at. And very importantly, those ESG risks and opportunities for business will be bespoke to the business. It's not one size fits all. There may be commonalities within an industry or an industry sector, but essentially it's going to be bespoke and custom to that specific business.

Raluca: [00:02:58] Thank you. Can you provide a little more detail of what would fit under the ESG umbrella?

Stephen: [00:03:04] And again, it's going to be bespoke to a business, but sort of at the 25,000 foot level, let's go through ESG. So environmental would include or could include climate change net zero scope one, two and three, greenhouse gas emissions, product packaging, logistics, biodiversity, global access to water for irrigation purposes, land use, climate litigation and more. On the social side, it could include social justice issues, treatment of employees, truth and reconciliation, paying a living wage, equity, diversity and inclusion. Pay equity. Security of personal information. Forced labor and child labor and supply chains and employee mental health. You may recall at the beginning of the COVID 19 pandemic, CEO after CEO was telling we're telling us that the health and safety of our people is our number one priority. That's the S in ESG. And then from a governance perspective, corporate purpose, gender representation in the boardroom, and C-suite tax minimisation strategies, directors duties, executive pay, risk management, anti-money laundering, cyber security risk management. I think I said before use of artificial intelligence, anti-corruption, whistleblower policies, ESG reporting, CEO succession and the list goes on and on. The very, very broad terms. Many of them have various perspectives that we could go into in detail. We could take a whole legislative session just to look at specific ESG issues. But almost everything that the corporation has or business has to deal with would fit under the umbrella.

Raluca: [00:05:04] And who are the stakeholders and how are they part of ESG?

Stephen: [00:05:08] Let me give you a pathway into the stakeholders. Underpinning ESG is a foundation of corporate purpose. In other words, the reason why the business exists and as such, corporate purposes are generally articulated by the board and senior management and fit together with a concept called stakeholder capitalism. Stakeholder capitalism is essentially a focus on generating sustainable long term value for the benefit of the stakeholders. So going back a couple of years in 2019 in the US, the Business Roundtable published a statement on the purpose of a corporation designed by 181 CEOs of America's biggest corporations. And they made a number of commitments to parties they call their stakeholders delivering value to our customers, investing in our employees, supporting the communities in which we work, dealing fairly and ethically with suppliers, and generating long term value for shareholders. So customers, employees, communities, suppliers, shareholders, all of them were seen as stakeholders. And as recently as this year, Larry Fink, the CEO of BlackRock, wrote his annual letter to CEOs and talked about stakeholder capitalism, which he said is capitalism, but it's driven by mutually beneficial relationships between the business and the employees, customers, suppliers and communities that the business relies on to prosper. So we see where stakeholder capitalism came from. My definition of stakeholders would be, I would call it people, organizations, businesses, and other collective entities or groups who are impacted by the activities of a business or who impact the business through ownership or through another relationship activity or proximity. And so let me give you go down a level and say, well, who might those stakeholders be? And again, it's going to be bespoke to the corporation or the business or organization that we're talking about. But shareholders, employees, communities, we've heard that unions, lenders, retirees, landlords, first nations, different industry associations, business partners, NGOs compare competitors. So it's a long list. And once you get down to that level, in looking at stakeholder capitalism and looking at the stakeholders, I would suggest, and that's a who kind of question, like who are the stakeholders? I would offer a few more perspectives. I would say that there's a win, which is to integrate a time perspective. So going beyond, for example, next quarter's earnings and looking at the long term, because time is an issue in terms of stakeholder interests, we could also add a where or a global perspective because so many ESG issues, be they environmental or social justice, have a global impact and go far beyond wherever a business has its offices or warehouses or manufacturing facilities.And then so adding to the who, when and where, I would add a what question or what perspective. So looking at what are the stakeholders most material and important issues, so it's more a less holistic review beyond the WHO and including the when, the where and the what. And so I would say that when a business is looking at developing a program to discover and engage with stakeholders, I think it's got to ask two critical questions. The first is what are the most material ESG risks and opportunities from the business? In other words, looking at it from the inside out. And then the business needs to identify and prioritize which issues are the most important to the businesses stakeholders. So to go with the inside out view, we need the perspective of outside in from the stakeholders. And then you can map the answers to those questions on shareholder or a stakeholder materiality matrix and that assists in prioritizing stakeholders and stakeholder issues. The one thing I mentioned is that in many circumstances, stakeholder interests and expectations exceed legal, regulatory and statutory requirements. So it's more than just a pure compliance exercise. It requires deep thought and commitment to the process by the business.

Raluca: [00:10:04] Can you tell us what are the role and duties of directors regarding ESG?

Stephen: [00:10:09] We go beyond just Canada, but you could rename ESG. as GSE. because of the importance of the role of governance in the ESG landscape. I would suggest that the work of the board is crucial to the success of businesses in addressing these ESG risks and opportunities. I mean, let's start with the duties of directors in the Canadian context. And directors have fiduciary duties to act honestly and in good faith in the best interests of the corporation, and as well have a duty of care to exercise the care, due diligence and skill that a reasonably prudent person would exercise in comparable circumstances. So going back to the Supreme Court of Canada, BCE and debenture holders case, the duty of the directors is to the corporation and only to the corporation. So they have to act honestly in good faith with a view to the best interests of the corporation, and they owe that duty to the corporation. However, in Canada they do have the opportunity and the legal backup to take into account the interests of stakeholders. And that was what the Supreme Court of Canada said in the BCE debenture holders case, and that was codified in the 2019 amendments to the Canada Business Corporations Act. So unlike the United States, where the theory of shareholder primacy, in other words, the theory that the corporation exists primarily for the benefit of shareholders, that we've gone past that in Canada and with the Supreme Court of Canada and with the amendments to the Canada Business Corporations Act, it's clear that directors can take into account the interests of stakeholders, but they don't owe a fiduciary duty to the stakeholders, either individually or in groups or as a totality. They owe that duty to the corporation.

Raluca: [00:12:13] Can you also give an example of how our directors exercising their fiduciary duties in respect of ESG.

Stephen: [00:12:20] And the role of the board in exercising those fiduciary duties? Part of the exercise of those duties will be in respect of ESG, and ESG engages at least two of the most critical and important responsibilities of the board oversight of risk management and oversight of strategic planning. So what we're seeing is boards taking an incredibly important role in managing and overseeing that ESG within the business. And from my perspective, some of the questions that relate to that are, again, which ESG risks and opportunities are most essential and mission critical to the business? Has management designed and implemented a stakeholder discovery and engagement program? Has the board implemented an ESG reporting and information system so that the board is informed on a timely basis about the ESG issues, risks and opportunities that require its attention? And then does the board and monitor, discuss and address ESG issues in its meetings on a regular basis. So I would say in conclusion, the board's duties definitely include ESG at the highest level within the business of the corporation. And what we're seeing more and more is those duties being questioned, put it that way, by different stakeholders. So for example, in March in the UK, registered environmental charity called Clientearth initiated a legal action against the directors of Shell, seeking to hold the directors personally liable for an alleged breach of their fiduciary duty under the UK Companies Act, namely a failure to adopt and implement a climate strategy for Shell that would align with the net zero goals of the Paris Accord. Clientearth claims it's the first ever case in the world seeking to hold company directors personally liable for failing to properly prepare for the energy transition. I think in my view, I would venture to say it won't be the last attempt to hold directors personally liable for climate and energy related impacts. So within the G, we're seeing a duty of oversight of the ESG risks and opportunities and definitely a lot of attention focus by stakeholders on the exercise of those duties.

Raluca: [00:14:54] Great. Can you provide an example of an "S" issue that has become much more critical for Canadian businesses?

Stephen: [00:15:02] You know, under the "S", the scope of "S" issues facing Canadian businesses from truth and reconciliation, diversity, equity and inclusion, social justice issues, vaccine mandates, and other COVID 19 pandemic issues to human rights abuses in supply chains. I mean, we could again do another Lexpert TV presentation just on those issues. But let's focus for a few minutes on the issue of forced labor and child labor in supply chains and how Canadian businesses need to focus on these issues now. And the reason now is because there have been a lot of developments and dynamic change both in Canada and the US as well as in Europe. And I'll give you just a brief precis of that to see you see how Canadian businesses need to be adapting. So first of all, in Canada, Bill asks to 11. Canada is fighting against forced labor and child labor and Supply Chains. Act was passed by the Senate. It's now moved to the House of Commons and has had first reading there. This legislation, if it became law, would require annual mandatory reporting by Canadian businesses subject to the act, as well as by federal government institutions and departments. Those reports would require disclosure of the steps taken by the business during the previous year to prevent and reduce the risk of forced labor and child labor in being used at any step of the production of goods in Canada or elsewhere, or in the production of goods imported into Canada by that entity. Interestingly, and tying back into our question on directors duties, this law would require the report to be approved by the entity's board of directors. So it raises this issue right up to the board level and would engage the directors fiduciary duties bill as to 11 would also amend Canada's Tariff Act to prohibit the importation of goods made with child labor. So we have Canadian legislation being looked at right now in the House of Commons and there may be more. In December of 2021, the Prime Minister issued mandate letters to the members of his Cabinet, and the mandate letter to the Minister of Labour was to have him lead the Government's efforts to eradicate forced labor from Canadian supply chains through the introduction of legislation in Canada and three other Cabinet ministers were tasked with supporting the efforts of the Minister of Labour. The other issue in Canada is that in late 2021, the Canada Border Services Agency made its first and only publicized seizure of forced labor made goods since the prohibition on imports of such goods came into effect in July one, 2020. So we're looking at the potential impact on Canadian businesses. Not only could Canadian businesses soon have to begin preparing and posting annual reports on forced labor and child labor in supply chains, but they're going to have to map and understand what's happening in their supply chains to ensure that they are in compliance with Canada's Tariff Act and Customs Act. And earlier this year, in February of 2022, the EU adopted a proposal for a directive on mandatory corporate sustainability due diligence. This would require companies subject to the law to not only carry out mandatory due diligence, but also to be responsible for mitigating and in some cases remediating adverse human rights and environmental impacts that they or those in its value chain have caused. So even though many Canadian businesses may not be operating in the EU, they may be required to report and certify, for example, as a supplier to an EU company that would be subject to the ACT. So Canadian companies need to be aware of what their customers obligations are under the EU directive.

Raluca: [00:19:27] And what about the United States?

Stephen: [00:19:29] In the US, the primary tool to combat forced labor and supply chains is enforcement at the border. The US Tariff Act prohibits the importation of goods made, manufactured or produced with forced labor. And to enforce this legislation, Customs and Border Protection in the US can issue what's called withhold release orders when it receives information that reasonably but not conclusively indicates the goods were produced with forced labor. So once the Commissioner of the Customs and Border Protection issues that withhold release order, the goods are detained at the border and the onus shifts to the importer to prove that the goods were not made with forced labor. And that can be a very difficult, very difficult thing for importers to prove when goods may be made and may have gone through many countries on their way to the US. And they have to source all the way back to the production of raw materials to show that nowhere in the supply chain of forced labor goods in whole or in part in producing the goods. The other big change which will happen next month, is that law was passed in December 2021 by the US government called the Uyghur Forced labor Prevention Act. So that became law in December and essentially under that act by June 21, 2022. Customs and Border Protection in the US will apply a rebuttable presumption that goods, wares, articles and merchandise mined, produced or manufactured in whole or in part in the Xinjiang Uyghur Autonomous Region are prohibited from importation in the US and are deemed to be forced labor goods. That means the importer then has to prove by clear and convincing evidence that the goods are not forced labor made goods and they need to rebut that presumption. So there's a lot going on at the border and for Canadian companies that are shipping into the US. There's certainly a lot of issues they need to be aware of and the goods can get hold of held up at the border or even be banned from importation if they're not careful and are not following American law.

Raluca: [00:21:55] Great. Thank you for joining us today, Stephen.

Stephen: [00:21:58] Well, thank you very much for having me here today. I really enjoyed our conversation and this opportunity to talk about ESG at this stage of its dynamic change. Thank you very much.

Raluca: [00:22:09] And thank you for watching Lexpert TV.