Part E. Key Findings and Guidance

VI. Investment strategies disclosure

Most of the issues raised during the ESG Prospectus Reviews related to investment strategies disclosure. Approximately two-thirds of the comments raised in this area related to unclear or inaccurate investment strategies disclosure, including disclosure relating to: (a) which types of ESG strategies are being used by the fund; (b) which specific ESG factors are considered as p art of the ESG strategies; and (c) how such factors are being evaluated and monitored by the portfolio manager.

Staff also observed a trend of IFMs including disclosure about the consideration of ESG factors in the investment process of the IFM’s funds that was not clear about the limited extent to which ESG factors are considered by many of the funds in the prospectus.

In addition, staff raised comments in relation to unclear or inadequate disclosure about specific elements of the fund’s ESG strategies, including the fund’s use of proxy voting and shareholder engagement as ESG strategies, company-level ESG ratings and scores, ESG-related indices and benchmarks, discretionary negative screening, and ESG-related targets. In particular, staff observed that it was not always clear from prospectus disclosure whether ESG-focused proxy voting and shareholder engagement were principal investment strategies of a fund or whether the IFM had a general proxy voting or shareholder or issuer engagement approach that addressed ESG matters among other matters.

There were also some specific issues raised in relation to index-tracking funds, funds that invest in underlying funds, and IFMs that did not have ESG-related policies and procedures for their funds, which are discussed in the guidance below.

An investment fund is required to disclose in its prospectus the principal investment strategies that the fund intends to use in achieving its investment objectives and the process by which the fund’s portfolio adviser selects securities for the fund’s portfolio, including any investment approach, philosophy, practices and techniques used.¹⁸

Investment strategies disclosure provides clarity to investors about how the fund will achieve its investment objectives, including the nature and extent of the strategies employed by the fund, the investment universe from which the fund will select its investments, and which countries, industries, sectors or companies the fund may invest in. Full, true and plain ESG-related investment strategies disclosure enables investors to understand the types of investments that the fund may make, the types of ESG strategies used by the fund, the ESG factors considered by the fund, and in the case of an ESG Objective Fund, the ways in which the fund will meet its ESG-related investment objectives.

ESG Objective Funds and ESG Strategy Funds should provide disclosure about the ESG-related aspects of their investment selection process and investment strategies. All ESG strategies (such as carbon offsetting), not just the most common ones discussed above under “ESG-Related Terms and Strategies”, that are used as principal investment strategies or as part of a fund’s investment selection process, should be disclosed in the investment strategies section of the prospectus.

In staff’s view, the investment strategies disclosure of ESG Objective Funds and ESG Strategy Funds should include identifying any ESG factors used and explaining the meaning of each ESG factor (to the extent that the factor is not self-explanatory, as discussed further below) and how the ESG factors are evaluated and monitored. This should include an explanation of the types of resources and information used and considered by the IFM in evaluating and monitoring the ESG factors (e.g. third-party sustainability reports, discussions with management of the issuer, disclosure documents), including disclosing whether the evaluation of the ESG factor is quantitative or qualitative and whether the evaluation is conducted using third-party data.

Complicated or non-self-explanatory ESG factors: Some ESG factors may not be self-explanatory based on their name or may be more complicated for investors to understand, such as “involvement in severe controversial events” and “clean air”. Other ESG factors may have a commonly understood meaning outside of the investment industry but may not be self-explanatory as a factor considered in an investment process, such as “climate change” and “human rights”. In all such cases, the ESG factor should be explained clearly.

¹⁸ Item 5(1)(a) and (b) of Part B of Form 81-101F1; Item 6.1(1)(a) and (c) of Form 41-101F2.

Investments that may appear to be inconsistent with ESG values: Staff note that ESG Objective Funds may invest in companies that appear to be inconsistent with ESG values. For example, some investors may expect funds that reference the environment or climate transition in their names or investment objectives to exclude investments in companies involved in thermal coal. However, the fund’s disclosed ESG-related investment objectives and strategies may permit such holdings. For example, some of these funds ma y be permitted to invest in such companies up to a certain percentage of their portfolios, so long as proceeds from the investment are earmarked for environmentally friendly projects, or in order to use shareholder engagement t o improve the environmental practices of those companies. To provide greater clarity to investors and in line with the principle of full, true and plain disclosure of all material facts, staff encourage ESG Objective Funds, particularly those with more specific ESG focuses (as compared to those with a broad ESG focus), to disclose whether the fund may, at any point in time, hold such investments, what those holdings would include (including examples), any thresholds or parameters around such holdings, and how such holdings meet the fun d’s investment objectives. If an ESG Objective Fund is not permitted to hold certain investments that appear to be inconsistent with ESG values at any point in time, staff encourage IFMs to disclose this in the fund’s investment strategies disclosure along with information about the monitoring process used by the fund to screen out such investments, and the fund should ensure that its portfolio does not include any such investments.

Written policies and procedures: During the ESG CD Reviews, staff observed that while most IFMs that manage ESG-Related Funds have written policies and procedures relating to the fund’s consideration of ESG factors and/or use of ESG strategies, or in the case of IFMs that are not the port folio adviser of their funds, their oversight of the funds’ portfolio adviser(s) in relation to the consideration of ESG factors and/or use of ESG strategies, some did not. Staff remind IFMs that an IFM that offers ESG-Related Funds should: (a) establish, maintain and apply written policies and procedures that cover its consideration of ESG factors and/or use of ESG strategies, or in the case of an IFM that is not the portfolio adviser of the funds, its oversight of the funds’ portfolio adviser(s) in relation to the consideration of ESG factors and/or use of ESG strategies; and (b) have processes in place to ensure that its written policies and procedures are regularly updated, such as for changes in its business practice, industry practice or securities legislation.¹⁹

Unless otherwise noted, the above guidance relating to investment strategies disclosure applies to all ESG-Related Funds. The following guidance applies specifically to certain types of funds and funds in certain circumstances.

¹⁹ Sections 11.1 of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations and 11.1 of Companion Policy 31-03CP Registration Requirements, Exemptions and Ongoing Registrant Obligations.

An ESG Limited Consideration Fund is not required to provide disclosure in its prospectus about its use of ESG strategies (including its consideration of ESG factors in its investment process). However, staff’s view is that, where an ESG Limited Consideration Fund includes statements about the fund’s use of ESG strategies (including its consideration of ESG factors in its investment process) in its sales communications, the prospectus should include disclosure about the fund’s use of ESG strategies.²⁰

Specifically, if an IFM of an ESG Limited Consideration Fund includes disclosure in the fund’s prospectus about its use of ESG strategies, the disclosure should clearly explain:

• the limited role that the consideration of ESG factors and/or use of ESG strategies plays in the fund’s investment process, including the specific parts of the investment process during which ESG factors are considered, the weight given to ESG factors as a whole (rather than for each particular ESG factor), and the impact that ESG factors will have on the portfolio selection process; and
• whether this approach is specific to the fund in question or whether it is part of the IFM’s general process that is applied across all or a segment of its funds, and if it is applied to only one or a segment of the IFM’s funds, clearly identify the fund(s).

If the IFM of an ESG Limited Consideration Fund includes such prospectus disclosure, the disclosure must still meet the standard of full, true and plain disclosure.²¹ Specifically, the disclosure should clearly explain the ESG strategies used, and the description of these strategies must be written using plain language²² in order to ensure that investors are able to understand the fund’s investment strategies. However, staff are of the view that an ESG Limited Consideration Fund should avoid including disproportionately extensive disclosure about the consideration of ESG factors in order to avoid misleading investors about the role that ESG factors play in the investment process of the fund.

²⁰ See the guidance below on the sales communications of ESG Limited Consideration Funds under “Sales communications relating to a fund’s ESG focus, use of ESG strategies, etc”.
²¹ See Footnote 5 above.
²² See Footnote 5 above.

If a fund uses proxy voting or shareholder or issuer engagement in relation to ESG matters as a principal investment strategy , the fund is required to disclose this in its investment strategies.²³ In staff’s view, the disclosure should include the criteria used by the proxy voting or engagement strategy, the goal of the proxy voting or engagement strategy, and the extent of the monitoring process used to assess the success of the proxy voting or engagement strategy.

²³ See Footnote 18 above.

Some funds are managed by IFMs that have general proxy voting policies and procedures that address ESG matters among other matters or have a general shareholder or issuer engagement approach that addresses ESG matters among other matters, but the funds do not use ESG-focused proxy voting or shareholder or issuer engagement as a principal investment strategy. As discussed above under “Are ESG factors considered as part of the fund’s investment process?” , depending on the particular circumstances of each IFM’ s investment process, such a fund may be a Non-ESG Fund or ESG Limited Consideration Fund.

Where such a fund is an ESG Limited Consideration Fund, the investment strategies section of the prospectus may include disclosure about the consideration of ESG issues as part of the fund’s proxy voting or engagement approach but should not suggest that E SG-focused proxy voting or engagement is a principal investment strategy of the fund. The investment strategies section should also be clear about the role that the consideration of ESG factors plays in the proxy voting or engagement approach.

Where such a fund is a Non-ESG Fund, staff’s view is that the investment strategies section of the prospectus should not include any disclosure about the consideration of ESG issues as part of its proxy voting or engagement approach.

Disclosure relating to a fund’s proxy voting policies and procedures is discussed below under “Proxy voting and engagement policies and procedures”.

In addition to the investment strategies section of a prospectus, ETFs and non-redeemable investment funds are required to provide disclosure in the section of the prospectus relating to the IFM about an overall investment strategy or approach used by the IFM in connection with the funds that it manages,²⁴ which may include any ESG strategies. Similarly, mutual funds that are not ETFs are also permitted to include such disclosure in their prospectus.²⁵ Where such disclosure is provided in the section of the prospectus about the IFM, staff’s view is that the disclosure should be clear as to which of the funds in the prospectus the ESG strategy applies to, in order to provide transparency to investors as to which specific funds managed by the IFM use the ESG strategy. In addition, if the IFM’s approach to considering ESG factors in its investment process varies for different types of funds managed by the IFM (e.g. if the IFM considers ESG factors in its in vestment process differently for its passive index-tracking funds as compared to its actively managed funds), this should be clearly articulated, and the differences in the IFM’s ESG approach should be clearly explained.

For mutual funds that provide disclosure about an ESG strategy that is applied across more than one of its funds in the intro duction to Part B of the prospectus rather than in the fund-specific sections for each individual fund,²⁶ staff’s view is that the fund-specific sections of the prospectus should include a cross-reference to such disclosure in the introduction to Part B of the prospectus so that it is clear to investors as to which of the funds in the prospectus uses the ESG strategy. In addition, if the IFM’s app roach to considering ESG factors varies for different types of funds, this should also be clearly explained.

²⁴ Item 19.1(5) of Form 41-101F2.
²⁵ Item 4.1(6) of Part A of Form 81-101F1.
²⁶ For mutual fund prospectuses, the investment strategies disclosure required by Item 5 of Part B of Form 81-101F1 may be disclosed under the heading “What Does the Fund Invest In?” as per Item 5(1)(a) and (b) of Part B of Form 81-101F1 or in the introduction to Part B of the prospectus as per Item 2(3) of Part B of Form 81-101F1.

(e) Funds that use targets for specific ESG-related metrics

If a fund’s use of one or more ESG strategies includes the use of targets for specific ESG-related metrics, such as carbon emissions, staff encourage such funds to disclose those targets as part of their investment strategies and identify if those targets may evolve or change over time in response to changing circumstances.

(f) Funds that invest in underlying funds

ESG Objective Funds and ESG Strategy Funds that invest in underlying funds that have an ESG-related focus and/or that employ ESG strategies must describe the process or criteria used to select the underlying funds²⁷ and should disclose any parameters around the types of ESG focus(es) that the underlying funds will have.

In addition, staff’s view is that, if the underlying funds are named in the prospectus, the investment strategies disclosure should describe the ESG strategies that are used by the underlying funds. If the underlying funds are not named in the prospectus, the investment strategies disclosure should describe the ESG strategies that are used by the underlying funds, to the extent that such strategies are known.

(g) Funds that use multiple ESG strategies

ESG Objective Funds and ESG Strategy Funds that use multiple ESG strategies should provide disclosure explaining how the different ESG strategies are applied during the investment selection process. In staff’s view, this disclosure should include the order in which the strategies are applied if the specific order would have an impact on the securities being selected for the portfolio.

²⁷ Item 5(1)(c)(iv) of Part B of Form 81-101F1.

In staff’s view, where an ESG Objective Fund or ESG Strategy Fund uses internal or third-party company-level ESG ratings or scores, or ESG-related indices or benchmarks, as part of its principal investment strategies or investment selection process, the fund should explain how those ratings, scores, indices or benchmarks are used.

For greater clarity, an ESG rating or score is an assessment of an organization or product’s relative ESG characteristics, effectiveness and performance, including its exposure to ESG risks and/or opportunities. In addition, an index that does not have an ESG-related focus may still be considered to be an ESG-related benchmark if it is used as a benchmark to assess ESG-related performance, e.g. where a fund aims to have lower carbon emissions than a specific broad-based index.

Identification of the index, benchmark, rating or score: Staff’s view is that, for ESG Objective Funds and ESG Strategy Funds that use ESG-related indices or benchmarks as part of their principal investment strategies or investment selection process, the fund should identify the index or benchmark used.²⁸ Similarly, for ESG Objective Funds and ESG Strategy Funds that use third-party, company-level ESG ratings or scores as part of their principal investment strategies or investment selection process, staff’s view is that the fund should identify the provide r of the ratings or scores.

Methodology: In staff’s view, the disclosure should also include a description of the methodology used to create the company-level ESG ratings or scores, or ESG-related indices or benchmarks, including, for example, whether the methodology is based on quantitative or qualitative data and the degree to which subjectivity may be involved in the methodology.

²⁸ Staff remind IFMs that index mutual funds are required to, as part of their fundamental investment objectives, (a) disclose t he name or names of the permitted index or permitted indices on which the investments of the index mutual fund are based and (b) briefly describe the nature of that permitted index or those permitted indices, in accordance with Item 4(5) of Part B of Form 81-101F1.

(i) Funds that may not always use ESG strategies or that use them on a discretionary basis

To the extent that a fund’s investment strategies indicate that a particular ESG strategy may be used but is not always used, staff’s view is that the investment strategies disclosure should explain, where possible, when the ESG strategy will be used, including describing any parameters around when the ESG strategy will or will not be used. Similarly, staff have observed that the prospectuses of some funds state that the fund “may” exclude certain types of investments from their portfolios. If a fund has discretion over whether a type of investment is excluded from its portfolio, the level and scope of this discretion should be clearly disclosed.

(j) ESG index-tracking funds that invest in issuers that are not index constituents

Some ESG Objective Funds disclose in their investment strategies that the fund tracks the performance of an ESG-related index, without disclosing this in their investment objectives. For such funds, if the fund is permitted to track the index by investing in issuers that are not constituents of the index (including by using a sampling strategy), staff’s view is that the investment strategies disclosure should be clear as to whether, in tracking the index, the fund may select issuers that are not index constituents. The investment strategies should also be clear as to whether the fund will select issuers with ESG characteristics that are similar to the constituents of the index, including identifying which specific ESG characteristics would be similar, such as, whether the ESG characteristics that would be similar are only those that are relevant to the particular ESG focus(es) of the fund.

(k) Funds that obtain exposure to ESG-related investments indirectly

Where an ESG Objective Fund’s investment objectives state that the fund will primarily invest in investments that are ESG-related (as determined by the ESG focus(es) of the fund) or that meet certain ESG-related criteria, but also state that the fund may meet this objective through indirect investments or by investing in companies with indirect exposure to such investments, the investment strategies should explain the nature of the indirect investments or exposure and how such indirect investments or exposure help the fund meet its ESG-related investment objectives.

(l) Funds whose names and/or investment objectives include the term “impact”

In order to avoid greenwashing, staff’s view is that if a fund’s name and/or investment objectives include the term impact, the investment strategies disclosure should explain what type of impact the fund is aiming to achieve, since the term impact, w hen used in the context of ESG investing, is generally understood to be a reference to impact investing.