Financing Environmental Change: A New
Role for Canadian Environmental Law
Benjamin J. Richardson*
itself but not
sponsor developers. To
Financial institutions occupy a central role
in
equity and debt markets, providing the finance that
shapes economic development and thus environmental
pressures. Environmental regulation has traditionally
focused on development
those that
financially
an
environmentally sustainable economy in Canada, new
regulations and policies to promote environmentally
friendly financing in the financial services sector are
necessary. This
financing
environmental change
is crucial, surveys the main
private financial institutions in Canada relevant to this
task, and makes recommendations on how financial
regulation and its broader institutional context can be
reformed to support sustainable development.
explains why
achieve
article
les
ressources
financi&es modelant
Les institutions financi&es occupent une place
centrale dans les march6s boursiers et obligataires. Elles
foumissent
le
d6veloppement 6conomique et les pressions environne-
mentales qui en d6coulent. Au Canada, la r6glementation
environnementale s’est traditionnellement concentr6e sur
le daveloppement 6conomique plut6t que sur son
financement. Pour davelopper une 6conomie durable, il
est ncessaire d’&noncer de nouveaux r~glements et
politiques promouvant des pratiques de financement
respectueuses de l’environnement dans le secteur des
services financiers. L’auteur explique les raisons pour
lesquelles il est crucial de financer le d6veloppement
durable, passe en
financires
pertinentes A cet 6gard, et recommande des r~formes de la
ruglementation financire et de son contexte institutionnel.
institutions
revue
les
. Associate Professor, Osgoode Hall Law School, York University. Formerly, Senior Lecturer,
University of Manchester School of Law and the University of Auckland Faculty of Law. In revising
this article, the author wishes to acknowledge the helpful comments provided by the anonymous
referees.
McGill Law Journal 2003
Revue de droit de McGill 2003
To be cited as: (2003) 49 McGill L.J. 145
Mode de r6f6rence: (2003) 49 R.D. McGill 145
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
Introduction
1. Environmental Aspects of Financial Markets
A. Sustainable Development, Capital Allocation, and
Financial Institutions
B. The Ethical Investment Movement
C. Environmentally Responsible Financing in Canada
I1. Reforming Financial Markets Regulation
A. The Marginalization of Environmental Policy
B. Bringing the Environment into Financial Services
Regulation
C. New Policies to Link Environmental Performance to
Financial Performance
D. Addressing the Heterogeneity of the Financial Sector
Ill. Regulating for the Financing of Environmental Change:
The Wider Context
A. Corporate Govemance
B. Economic Instruments
C. Environmental Liability for Financial Sponsors
D. Corporate Environmental Reporting
Conclusion
147
148
148
153
155
162
162
168
171
175
182
182
186
189
195
2004]
FINANCING ENVIRONMENTAL CHANGE- B.J. RICHARDSON
Introduction
Environmental regulation in Canada, as in most other nations, hardly addresses
the financial services sector-the banks and investors that finance development. To
most environmental lawyers, this might seem a strange comment, as the province of
environmental law is not normally associated with banks, pension funds, or other
financiers. If anything, those who trade in money are seen as rather environmentally
innocuous or irrelevant, away from the main action, whether it be tackling forestry
in Ontario.
companies
Although Canada has made great strides in improving its environmental laws since
the 1970s, this lack of interaction between environmental and financial policy is
arguably Canadian environmental law’s greatest handicap. Because financial markets
shape decisions concerning future development and thus resulting environmental
pressures, the reform of investment, banking, and other financial services to promote
more environmentally sensitive financing should be a government priority.
in British Columbia or prosecuting midnight polluters
to take
The challenge for Canadian policy reformers, therefore, is to find ways to embed
environmental standards and responsibilities into financial markets. Quite simply,
when granting a loan for a development project or investing in a company’s shares,
financial organizations must be encouraged
into account the possible
environmental impacts of their financing. Notions of environmentally responsible
behaviour must be extended beyond the companies that develop, pollute, and
consume to include the financiers that make possible-and profit from-these often
harmful activities. While financiers might wish to eschew supporting polluting
activities where such activities directly erode investment returns or pose a credit risk,
more often than not, environmental considerations tend to be ignored or trivialized by
financiers. “Defensive” banking to avoid obvious environmental risks and to check
that clients meet existing environmental regulations is usually insufficient to promote
substantial change in corporate environmental performance.
This article considers how financial institutions can be reformed to promote
environmentally responsible financing (“ERF”). It begins by examining the relevance
of financial markets to sustainable development and the various techniques by which
ERF is currently being furthered in Canada. Differences between pension plans,
mutual funds, and other financial organizations are highlighted, as environmental
reformers need to be sensitive to the institutionally specific characteristics of financial
market entities. More generally, the article also canvasses broader reforms to financial
markets as a whole, such as corporate governance and environmental reporting
improvements. In addition to the Canadian perspective, some pertinent reforms from
other countries such as the United Kingdom, United States, and Australia are
considered to illustrate possible new directions for Canadian environmental law.
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
I. Environmental Aspects of Financial Markets
A. Sustainable Development, Capital Allocation, and Financial
Institutions
The biggest environmental
impact of private financiers
is not their own
ecological footprint, but their strategic role in allocating capital to other businesses.1
Since the financial sector sponsors and profits from economic development, it
arguably should share responsibility for ensuring that such development does not
harm the environment. If economic growth is to be kept within ecological limits,
market institutions that finance growth must be given the right directions, incentives,
and information so that financial resources shift from polluting industries in favour of
environmentally benign activities. Once appropriately informed and guided, financial
institutions would, through their investment decisions, conditions of financing, and
monitoring of companies, become an instrument of environmental governance.2
Given their ability to provide financial leverage, financial organizations are in effect
“gate keepers” to the economy. Schemes to diffuse environmental policy more
effectively
through the market must therefore target those strategically placed
financiers that have the capacity to communicate and enforce policy goals and
standards.
Financial institutions are gate keepers principally because they have amassed vast
empires of financial assets. The “institutionalization” of financial markets has put
these assets increasingly into the control of banks, pension funds, and other financial
institutions, rather than into the hands of individual retail investors.3 The contraction
of public sector financing for development has also been a factor in shaping the
phenomenal rise in the number of private financial institutions. Philanthropic bodies
including religious groups, universities, and foundations also participate in financial
markets, but the vast bulk of money flows through private financiers. In 1997,
institutional investors including mutual funds owned nearly fifty per cent of all shares
in Canadian publicly traded corporations, up from ten per cent as recently as 1988
and considerably higher than a miniscule one per cent in the late 1970s.4 By 1998,
1 William L. Thomas, “The Green Nexus: Financiers and Sustainable Development” (2001) 13 Geo.
Int’l Envtl. L. Rev. 899.
2 For an elaboration of this theme see B.J. Richardson, Environmental Regulation Through
Financial Organisations (Toronto: Kluwer Law, 2002) (Richardson, Environmental Regulation].
3 See Jeffrey G. MacIntosh, “The Role of Institutional and Retail Investors in Canadian Capital
Markets” (1993) 31 Osgoode Hall L.J. 371 [MacIntosh, “Canadian Capital Markets”].
4 Canada, Senate, Standing Senate Committee on Banking, Trade and Commerce, “The Governance
Practices of
Internet Parlementaire
investors”, online: Parliamentary
Institutional
2004]
FINANCING ENVIRONMENTAL CHANGE- B.J. RICHARDSON
Canadian institutional investors had amassed financial assets equal to almost 116 per
cent of the country’s GDP, with pension funds holding the largest share.’
Financial service providers are also risk takers, seeking to profit from the
transformation of capital into a development resource.6 Although businesses fund the
majority of their investment projects from the income they generate through sales and
other activities, both the development of new businesses and the expansion of
established businesses often require turning to the financial markets. Businesses have
two main choices for raising money in the financial markets–debt and equity
financing. Firms perceived by financiers to pose a greater risk of business failure or
underperformance can expect to pay higher rates of interest than others. Similarly, the
higher rate of return required by equity holders will force the firm’s stock price down.
Contrary to economic theory, however, empirical evidence suggests that financial
markets do not always allocate capital efficiently. Unsustainable, speculative bubbles
may suck in financial resources at some times, while underinvestment can arise at
other times or in other sectors. Such distortions can be attributed to the “herd
mentality” of investors, along with a preference for quick profits.’ In the process,
financiers are prone to ignoring the social and environmental effects of company and
project investments unless they are perceived as “financially relevant”. Numerous
studies highlight market failures to address environmental impacts, including the
undervaluation of ecological properties, the discounting of future environmental costs
and benefits,8 and an inability to address the problem of “scale”, that is, keeping
aggregate resource use in the economy within biosphere limits.9
Even critics who
ignore the ecological weaknesses of financial markets
acknowledge a telling distinction between the “real” economy and “real” investment
on the one hand and the “financial” economy and its often ephemeral investments on
the other.” The real economy involves investments in functional goods and services,
such as manufactured products, buildings and transportation, as well as investment in
services such as health care and education. By contrast, the financial economy,
managed by banks and investors, emphasizes securities trading and related activities
5OECD, OECD in Figures: Statistics on the Member Countries 2002 (Paris: OECD, 2002) at 58.
As of mid-2001, pension plans managed assets valued at $580.1 billion: Statistics Canada, Quarterly
Estimates of Trusteed Pension Funds: First Quarter 2002, vol. 30:1 (Ottawa: Income Statistics
Division, 2002) [Statistics Canada, Quarterly Estimates].
6 See Ron S. Dembo & Andrew Freeman, Seeing Tomorrow: Rewriting the Rules of Risk (New
York: John Wiley & Sons, 1998) at 5-6.
7 See Adam Harmes, Unseen Power: How Mutual Funds Threaten the Political and Economic
Wealth of Nations (Toronto: Stoddart, 2001) at 76-77.
8 See e.g. Richard Costanza et al., An Introduction to Ecological Economics (Boca Raton, Fl.: St.
Lucie Press, 1997).
9 See Herman E. Daly, “Allocation, Distribution, and Scale: Towards an Economics That Is
Efficient, Just, and Sustainable” (1992) 6 Ecological Econ. 185.
10 See e.g. Jim Stanford, Paper Boom: W’hy Real Prosperity Requires a New Approach to Canadas
Economy (Toronto: J. Lorimer & Canadian Centre for Policy Alternatives, 1999) at 46-47.
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
which may have only a tenuous connection with productive investment. Most stock
purchases do not provide new capital for real investment since the bulk of stocks
traded are not newly issued corporate shares, but rather are traded between investors
looking for profit. To illustrate, between 1990 and 1998, new stock issues by Toronto
Stock Exchange-listed companies accounted for merely five per cent of the value of
all shares traded on the exchange. 1″ Moreover, a considerable portion of investment
by financiers is directed to such securities. For example, some forty per cent of the
total value of occupational pension funds in Canada is invested in stocks and thirty-
seven per cent in bonds. 2 Consequently, conclude Baker and Fung, “insofar as the
financial sector expands and pulls away more resources from the rest of the economy,
it is diminishing the amount of resources available to produce goods and services of
real value.”‘ 3
Of course, some share trading not connected with initial investments can serve
economically and environmentally valuable goals. The trading of previously issued
shares provides
investors with liquidity, which helps to ensure that capital is
efficiently shifted to new investments as necessary. Share trading can also give
investors additional incentives to seek information about the performance of existing
companies, which affects their behaviour. For instance, if investors become aware
that a company has been involved in a costly pollution incident, they may discount
the value of its shares. A highly liquid share market, therefore, can provide a direct
incentive for companies to avoid pollution controversies despite the apparently
fleeting attention of money traders.
trading activities
to a preference
for
According
to a more sanguin6 view of financial markets,
the growing
institutional character of investment activity is leading to a shift away from ephemeral
and short-term
long-term, sustainable
development. In their book, The Rise of Fiduciary Capitalism, Hawley and Williams
herald the institutional investor as a new voice for promoting corporate social and
environmental responsibility. This is because institutional investors are “universal
owners” holding a broad portfolio of stocks and possessing an interest in the health
and long-term sustainability of the entire economy rather than the profitability of
individual businesses. Hawley and Williams argue that institutional investors, as
long-term fiduciary investors and majority shareowners, are not concerned primarily
with short-term returns on investment, but rather with long-term performance to meet
the needs of their present and future beneficiaries. 4 Similarly, Monks argues in The
New Global Investors that the universal investor (or “Global Investor”) “is likely to
” Ibid. at 23.
12 Statistics Canada, Quarterly Estimates, supra note 5 at 8.
13 Dean Baker & Archon Fung, “Collateral Damage: Do Pension Fund Investments Hurt Workers?”
in Archon Fung, Tessa Hebb & Joel Rogers, eds., Working Capital: The Power of Labor s Pensions
(Ithaca: ILR Press, 2001) 13 at 36.
“4 James P. Hawley & Andrew T. Williams, The Rise of Fiduciary Capitalism: How Institutional
Investors Can Make America More Democratic (Philadelphia: University of Pennsylvania Press,
2000) at xv-xvi.
2004]
FINANCING ENVIRONMENTAL CHANGE – B.J. RICHARDSON
make good decisions for the long-term of society, because it can afford in most cases
to take a long-term view, and a diversified view. An ordinary domestic investor may
need to reap profits in the short term.”‘ 5
This universal owner status, Hawley and Williams suggest, gives institutional
investors an interest in public policy issues beyond traditional macroeconomic
concerns, such as the environment, health, and other programs that help build human
and physical capital. They state: “[A] universal owner that really wants to maximize
the shareholder value of its portfolio would need to develop public policy-like
positions and monitor regulatory developments and legislation on a number of key
issues to the economy as a whole.”16 Accordingly, businesses favoured for investment
are those operated in a financially, socially, and environmentally responsible manner
that supports a healthy and sustainable economy. In turn, businesses that pay attention
to environmental and social causes are expected to be stronger financial performers
over the long term. 7
These conflicting perspectives of financial markets can be somewhat reconciled
by taking into account the institutionally specific characteristics of financial service
organizations and the differences in their financial services and products. Financial
organizations are not a homogeneous group, but retain institutionally particular
characteristics arising from their individual legal forms and market sectors.’ There
are, therefore, features of some financial institutions that could create or strengthen a
preference for sustainable, long-term financing, particularly with the aid of certain
environmental law reforms. For example, because of their extended liabilities, life
insurance companies and pension funds should be biased toward longer-term
investment. 9 Banks also should have an interest in the sustainability of a borrower’s
business to ensure loan repayment, which can often be contracted over a thirty-year
period. The trend toward holding stocks in pooled index funds, rather than through ad
hoc, short-term trading, should also reinforce incentives for sustainable financing.2”
15 Robert A.G. Monks, The New Global Investors: How Shareowners Can Unlock Sustainable
Prosperity Worldwide (Oxford: Capstone, 2001) at 105.
16 Hawley & Williams, supra note 14 at 170.
17 See Ronald M. Roman, Sefa Hayibor & Bradley R. Agle, “The Relationship Between Social and
Financial Performance: Repainting a Portrait” (1999) 38 Bus. & Soc’y 109; Jennifer J. Griffin & John
F. Mahon, “The Corporate Social Performance and Corporate Financial Performance Debate: Twenty-
Five Years of Incomparable Research” (1997) 36 Bus. & Soc’y 5.
18 Hawley and Williams indeed admit that the capacity of organized investors
to promote
sustainability is constrained by a variety of legal and institutional structures: Hawley & Williams,
supra note 14 at 148.
19 See Paul L. Davies, “Institutional Investors in the United Kingdom” in D.D. Prentice & P.R.J.
Holland, eds., Contemporary Issues in Corporate Governance (Oxford: Oxford University Press,
1993) 69 at 79.
20 See John C. Coffee, Jr., “Liquidity Versus Control: The Institutional Investor as Corporate
Monitor” (1991) 91 Colum. L. Rev. 1277 at 1288.
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
Mutual funds, however, are more competitive and are prone to myopic trading
practices in the quest to grab profits to attract impatient customers.2′
The responses of all types of financial institutions to environmental issues would
appear at this stage to be driven primarily by the prospect not that an environmental
problem per se will be costly to their corporate clients, but that the accompanying
government environmental policies and regulations will be costly to clients. Although
responsible environmental and social performance can sometimes be treated as a
proxy for a financially well-managed company, the main factor that appears to
encourage investors to respond to long-run sustainability issues is the possibility that
their investors’ failures may result in investors incurring tort or regulatory liability, the
imposition of pollution charges, or the generation of other regulatory costs. This
suggests that the mobilization of financial institutions as a force for environmental
change cannot be divorced from existing environmental law regimes, although, as
will be shown later in this article, some environmental laws are much more likely to
encourage environmentally responsible financing than others.
One reason why institutional investors may fail to support sustainable financing
is because the corporate bosses and money managers through whom they work tend
to favour maximizing short-term gains to enhance their placement in the market.22
Often, because the rules of financial regulation require that persons be authorized to
conduct investment business, investment decisions (particularly of pension funds) are
to authorized fund managers, such as money management firms.23
delegated
Delegating investment strategies to fund managers raises agency problems, and
surveys in Britain have shown that fund managers can deviate from the ethical
investment policies dictated by their principals.24
Another factor that can undermine sustainable financing is the practice among
fund managers of constructing investment portfolios with a diversity of investments
and risks, based on the precepts of modem investment portfolio (“MIP”) theory. This
theory holds that fund managers can mitigate the effects of specific risks associated
with individual firms by holding a diversified portfolio that resembles the overall
market.2 Environmental and ethical investment screens would appear to conflict with
21 See generally Josef Lakonishok, Andrei Shleifer & Robert W. Vishny, “The Structure and
Performance of the Money Management Industry” [1992] Brookings Papers on Economic Activity:
Microeconomics 339.
22 See Robert A.G. Monks & Nell Minow, Power and Accountability (New York: HarperCollins,
1991) at 201-202; see also Allen Sykes, Capitalism for Tomorrow: Reuniting Ownership and Control
(New York: John Wiley & Sons, 2000).
23 See Davies, supra note 19 at 72.
24 See UK Social Investment Forum, “Response of UK Pension Funds to the SRI Disclosure
Regulation” by Eugenie Mathieu, online: UK Social Investment Forum,
25 See generally William E Sharpe, Porfolio Theory and Capital Markets (New York: McGraw-
Hill, 1970); Richard A. Brealey & Stewart C. Myers, Principles of Corporate Finance, 7th ed.
(Boston: McGraw-Hill/Irwin, 2003) at 187-94.
2004]
FINANCING ENVIRONMENTAL CHANGE- B.J. RICHARDSON
153
MIP theory, because screens can make investment portfolios less diverse and so more
vulnerable to market fluctuations, thus possibly generating lower financial returns for
beneficiaries. 26 The implementation of MIP-based investment portfolios can also lead
to fragmented investor shareholdings, which can in turn reduce the leverage of
individual financial institutions wishing to engage in shareholder activism–which as
we will see is another technique of ethical financing. 27 Although the assumptions of
MIP theory are considered problematic by many commentators 28-for
example,
because markets operate under imperfect information and institutional investors are
too large to have a neutral impact on financial markets-MIP theory retains its
prestige among financial regulators and underpins much financial law, which
commonly emphasizes
restrictions on concentrated ownership and fiduciary
obligations that require extensive portfolio diversification.29
B. The Ethical Investment Movement
The capacity of financial institutions to promote sustainable development was
first recognized in the ethical investment movement. Beginning in North America and
Western Europe in the 1970s, a limited number of financial entities-namely, pension
funds, specialist ethical funds, and philanthropic foundations-began to consciously
invest according to environmental, social, and other principles.” The potential of
private financial organizations to be a force for environmentally and socially sound
development is no longer regarded as quackery, but as a serious issue gaining some
policy-makers’
the EU’s Fifth Environment Action
Programme (1992-2000) noted the environmental relevance of investors and
lenders,3 while the United Nations Environment Programme launched a “Financial
attention. For
instance,
26 See Phillips, Hager and North Investment Management Ltd., “Does Socially Responsible
Investing Hurt Investment Returns?”, online: Phillips, Hager and North Investment Management Ltd.
Ethical Investment and Fiduciary Law” (1991) 5:4 Tr. L. Int’l 157.
27 See J.E. Parkinson, Corporate Power and Responsibility: Issues in the Theory of Company Law
(Oxford: Clarendon Press, 1993) at 168-69.
28 On the inefficiency of capital markets see e.g. Werner F.M. De Bondt & Richard H. Thaler,
“Further Evidence on Investor Overreaction and Stock Market Seasonality” (1987) 42 J. Fin. 557;
Bruce N. Lehmann, “Fads, Martingales, and Market Efficiency” (1990) 105 Q. J. Econ. 1.
29 See W.A. Lee, “Modem Portfolio Theory and the Investment of Pension Funds” in P. Finn, ed.,
Equity and Commercial Relationships (Sydney: Law Book Company, 1987) 284 at 303; Michael E.
Porter, “Capital Disadvantage: America’s Failing Capital Investment System” (1992) 70:5 Harv. Bus.
Rev. 65.
30 On the emergence of ethical investment see John G. Simon, Charles W. Powers & Jon P.
Gunneman, The Ethical Investor: Universities and Corporate Responsibility (New Haven: Yale
University Press, 1972); Charles W. Powers, Social Responsibility and Investments (Nashville:
Abingdon Press, 1971).
31 EC, Commission, Towards Sustainability: A European Community Programme of Policy and
Action in Relation to the Environment and Sustainable Development (Luxembourg: EC, 1993) at 58
[EC, Towards Sustainability].
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
Institutions Initiative”, allowing banks and other financial entities
to pledge
themselves to specified sustainable development practices.32 Although Canadian
governments have not yet sponsored any policy initiatives in this field, the National
Round Table on the Environment and the Economy had the prescience to commission
a report on the subject in 1992.” 3 Despite the paucity of encouragement from
governments, greater societal awareness of environmental problems has helped
support a proliferation of environmental financial products.34 These products include
green mortgages, ethical mutual funds, and pollution damage liability insurance.35
For corporate financing, there are three primary ways by which investors and
lenders can promote corporate environmental performance. First, financial institutions
may use positive and negative screens in lending and investment decisions. This
process involves the application of social, environmental, and ethical guidelines or
“screens” to the selection and retention of investments and loans.36 Negative screens
are criteria that exclude certain companies from financing, such as those with poor
environmental records or human rights problems. An example of a positive screen
criterion is a history of having made an exemplary contribution to environmental
sustainability, such as developing new pollution control technologies. As there is no
consensus on what qualifies as “environmental” or “ethical” financing, however,
some form of public benchmarking or standard setting would seem appropriate. A
second
is
economically
the financing of
community development or microenterprise schemes that contribute to the welfare of
local communities.37 Third, shareholder activism and corporate engagement may be
used to influence corporate policy and practice on social and environmental issues.3″
This influence can be applied through various methods, including proxy voting,
corporation-shareholder dialogue, submission of shareholder proposals, and litigation.
for promoting
investment
environmental performance
(“ETI”), which
technique
targeted
corporate
involves
32 UNEP Finance Initiatives, “Statement by Financial Institutions on Environment & Sustainable
Development”, online: UNEP Finance Initiatives
33 See J. Anthony Cassils, The Financial Services Industry and Sustainable Development:
Managing Change, Information and Risk (Ottawa: National Round Table on the Environment and the
Economy, 1993).
34 See Sonia Labatt & R.R. White, Environmental Finance: A Guide to Environmental Risk
35 Insurance is another arm of the financial services sector that is highly relevant to environmental
management, principally in relation to coverage for pollution risks. Insurance is not considered in this
article, but see generally Benjamin J. Richardson, “Mandating Environmental Liability Insurance”
(2002) 12 Duke Envtl. L. & Pol’y E 293 [Richardson, “Mandating”].
Assessment and Financial Products (New York: John Wiley & Sons, 2002) at 10.
36 See generally Peter D. Kinder, Steven D. Lydenberg & Amy L. Domini, The Social Investment
Almanac: A Comprehensive Guide to Socially Responsible Investing (New York: Henry Holt and
Company, 1992); Russell Sparkes, The Ethical Investor (London: HarperCollins, 1995) at 167-92.
37 See Tessa Hebb, “Introduction: The Challenge of Labor’s Capital Strategy” in Fung, Hebb &
Rogers, supra note 13, 1. ETI is discussed in greater detail below at text accompanying notes 80-92.
38 See e.g. David Vogel, “Trends in Shareholder Activism: 1970-1982” (1983) 25:3 Cal. Mgmt. Rev.
68; Andrew K. Prevost & Ramesh P. Rao, “Of What Value Are Shareholder Proposals Sponsored by
Public Pension Funds?” (2000) 73 J. Bus. 177.
2004]
FINANCING ENVIRONMENTAL CHANGE – B.J. RICHARDSON
Where corporations are largely self-financing, with little need for loans or capital
through bond and share issues, shareholder activism becomes more important than
ethical screens as a means to influence corporate behaviour.
Despite such laudable innovations, environmental investment and other forms of
ethical financing are presently not widely practised. For example, in the Netherlands,
ethical investment (excluding bank-based ethical lending) in 2000 amounted to a
mere two per cent share of the nation’s investment market,39 compared to the US with
a high of about twelve per cent.4″ The Canadian ethical investment market is also
quite small, as discussed below.4 While the size of the ethical fund sector currently
appears too small to influence sustainable development by generating a meaningful
share price differential between more and less environmentally sound businesses,
ethical funds are useful for providing liquidity for venture capital and other small,
start-up businesses, which in turn can disseminate wider environmental benefits.
Ethical funds can also be effective when they seek to target and affect a particular
business’s environmental practices.
C. Environmentally Responsible Financing in Canada
A number of investment and lending institutions in Canada are involved to
various degrees
in environmentally and socially responsible financing. These
institutions range from specialist ethical mutual funds to large pension plans.
Canadian ethical investment funds typically target a smorgasbord of concerns, of
which the environment is merely one-albeit a primary-component. Churches led
the way, establishing the Taskforce on the Churches and Corporate Responsibility
(“TCCR”) in 1975 to tackle apartheid in South Africa and human rights abuses in
other countries.42 In the 1980s, the TCCR successfully mobilized shareholder action
to pressure Canadian banks to cease lending to South Africa. In addition to church
groups, the labour movement in Canada emerged in the 1980s as a force for ethical
investment through union-based pension funds and labour-sponsored venture capital
funds.43 The work of the church and labour sectors in turn helped pave the way for
discrete ethical
investment
individual retail
funds catering
to
investors and
39 Ethical Investment Research Service, “Ethical Investment in Europe” at 4, online: Ethical
Investment Research Service
40 Social Investment Forum, 2001 Report on Socially Responsible Investing Trends in the United
States (Washington, D.C.: Social Investment Forum, 2001) at 2, online: Social Investment Forum
41 See Social Investment Organization, “Canadian Social Investment Review 2002”, online: Social
[S10, “Social Investment
Investment Organization
Review”].
42 See Russell Sparkes, Socially Responsible Investment: A Global Revolution (Chichester, U.K.:
John Wiley & Sons, 2002) at 311 [Sparkes, Socially Responsible Investment].
43 See Jack Quarter et al., “Social Investment by Union-Based Pension Funds and Labour-
Sponsored Investment Funds in Canada” (2001) 56 Relations Industrielles 92.
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
[Vol. 49
institutions. These funds chose the mutual fund form as the vehicle for making
investments. The first ethically screened mutual fund in Canada was the Ethical
Growth Fund, founded in 1985. A decade later there were fourteen similar funds
nursing assets of almost two billion dollars.’ Concomitantly, the issue of ethical
screens began to be considered by pension funds, including established public
pension funds like the Ontario Teachers’ Pension Plan Board.45 This evolution in
ethical investment in Canada has occurred without legislative imprimatur.
In terms of financial services regulation, institutions within Canada’s financial
services sector were historically segmented from one another, owing to regulatory
constraints and high transaction costs.46 Canadian financial services were divided into
discrete branches (e.g., banking and insurance), each with its own legislative regime,
which restricted each sector to a specific turf of financial services. There was a mix of
federal and provincial legislation and governing financial regulators, but the regimes
were sufficiently harmonized to ensure segmentation of financial service providers.
After the mid-1970s and especially since the 1990s, financial markets were
deregulated, resulting in a greater mixing of financial products and services across
traditional institutional lines.47 In particular, the Canadian banking industry has been
dramatically transformed due to revisions to the federal Bank Act and related financial
laws,48 enabling banks to extend their financial services to securities trading. Many
banks now operate their own mutual funds.
Nowadays, quantitative and prescriptive regulation of investment businesses in
Canada has been substantially jettisoned in favour of regulation through prudential
investment standards.” Solvency and liquidity requirements and consumer protection
standards are the mainstay of financial regulation. The goals have been to protect
depositors’ and investors’ funds and to avoid broader risks to money supply in the
economy.50 Prudential regulation of financial services is primarily the responsibility
44 See generally Eugene Ellmen, The 1998 Canadian Ethical Money Guide (Toronto: James
Lorimer, 1997) at 89-148; David Skinner, The Ethical Investor: A Guide to Socially Responsible
Investing in Canada (Toronto: Stoddart, 2001).
45 See Greg Crone, “Teachers Debate Ethics of Investing” Financial Post (12 April 1999) C 1.
46 This discussion draws upon Brian Z. Gelfand, Regulation of Financial Institutions in Canada,
looseleaf (Scarborough, Ont.: Carswell, 1999) at par. 1.8; Jacob Ziegel, Leonard Waverman & David
W. Conklin, eds., Canadian Financial Institutions: Changing the Regulatory Environment (Toronto:
Ontario Economic Council, 1985).
47 See Evelyn Kintner, “Politics and Deregulation in the Canadian Banking Industry” (1993) 23
Am. Rev. Can. Stud. 231.
48 See e.g. BankAct, S.C. 1991, c. 46; Financial Consumer Agency of Canada Act, S.C. 2000, c. 9.
49 For example, the federal Bank Act provides: “The directors of a bank shall establish and the bank
shall adhere to investment and lending policies, standards and procedures that a reasonable and
prudent person would apply in respect of a portfolio of investments and loans to avoid undue risk of
loss and obtain a reasonable return” (ibid., s. 465).
50 See generally Edward Tasch & Stephen Viederman, “New Concepts of Fiduciary Responsibility”
in Fritjof Capra & Gunter Pauli, eds., Steering Business Toward Sustainability (Tokyo: United Nations
University Press, 1995) 125.
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FINANCING ENVIRONMENTAL CHANGE- B.J. RICHARDSON
of the federal Office of the Superintendent of Financial Institutions (“OSFI”),51 which
administers banking legislation and regulates federally chartered trust, insurance, loan
companies, and pension plans. 2 The provinces regulate provincially chartered
financial institutions through their ministries of finance and securities commissions
and are moving toward greater administrative centralization of their controls over
financial markets. In Ontario, pension, trust, and insurance regulation has been
brought under the auspices of the Financial Services Commission of Ontario.
Similarly, in Quebec, the regulation of financial products and services has been
amalgamated under a single financial services entity known as the Bureau des
services financiers. Surprisingly, there is little regulation in Canada that specifically
pertains to fund managers, although the potential for abuse of their position, conflicts
of interest, and other maladies has been recognized in Canadian law reform
discussions. 3
To date, however, there remains an enormous abyss between financial services
regulation and environmental law. It is virtually impossible to trace any reference to
the environment in Canadian financial laws. Like other countries, government
strategy has been to treat environmental policy as a distinct sphere of concern, to be
regulated by separate authorities and laws. Interestingly, the Department of Finance
Canada published in 2001 a sustainable development strategy, but its focus is
greening the Department’s internal operations rather than the much more serious
agenda of the environmental impact of its laws and policies. 4
Although
it has attracted little attention from regulators preoccupied with
deregulation reforms, recent studies reveal an emerging niche for ethical financing in
Canada’s financial markets. A national survey conducted in 2002 by the Social
Investment Organization (“SIO”) found assets of environmentally and socially
responsible investments as of June 2002 at $51.4 billion, amounting to 3.3 per cent of
the total investment market (slightly up from 3.2 per cent in the first survey in June
2000).”5 This investment included some $16.7 billion in assets managed by
investment management finns (acting for pension plans, religious institutions, and
universities); a further $4.32 billion of assets held by ethical mutual funds; and $5.62
billion in labour-sponsored, venture capital funds. An additional $24.1 billion was
51 The OSFI was established by the Office of Superintendent of Financial Institutions Act, R.S.C.
1985, c. 18.
52 These institutions are regulated pursuant to the Insurance Companies Act, S.C. 1991, c. 47; Trust
and Loan Companies Act, S.C. 1991, c. 45; Cooperative Credit Associations Act, S.C. 1991, c. 48; and
the Pension Benefits Standards Act, R.S.C. 1985 (2d Supp.), c. 32.
53 See Industry Canada, Investment Funds in Canada and Consumer Protection: Strategies for the
Millennium by Glorianne Stromberg (Ottawa: Industry Canada, 1998) at 113, online: Industry Canada
54 Department of Finance Canada, “The Department of Finance 2001-03 Sustainable Development
Strategy: Planned Results for 2003-04”, online: Department of Finance Canada
55 SIO, “Social Investment Review”, supra note 41.
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invested in assets of institutional investors (e.g., pension funds and investment banks)
that manage their funds primarily or wholly in-house using social or environmental
screens. A further $453 million was the estimated value of shareholder activism (i.e.,
the value of shares voting in favour of initiatives to promote social and environmental
issues). In the lending sector, the survey found some $69 million devoted to
community investment through credit unions and related community-based financiers
and $127 million in ethically responsible lending from banks. Whether these levels of
financing will increase in years to come without any policy reforms is hard to
ascertain, although public opinion and shareholder surveys show that Canadians
increasingly prefer ethical investment.56
In the US and UK, ethical investment has been facilitated by the creation of
ethical investment indexes-the Dow Jones Sustainability Indexes57 and the Financial
Times Stock Exchange’s FTSE4Good,58 respectively. The Toronto Stock Exchange
has not yet followed suit, although in January 2000, Canada’s Michael Jantzi
Research Associates (“MJRA”) introduced the private Jantzi Social Index.59 The rise
of ERF in Canada has been aided by improved research and information on corporate
environmental performance from entities such as MJRA and publications such as
EthicScan Canada’s Corporate Ethics Monitor.6
As can be seen from the ethical investment statistics above, the majority of
ethical financing in Canada occurs in the pension and ethical mutual fund sections.
Occupational pension plans provided by employers hold over seventy per cent of the
combined value of all pension schemes in Canada.” The rise in assets held by
Canadian pension plans in recent decades has been truly astonishing.62 Pension plans
are governed by contract law and trust law overlain by pension legislation. Because
pension plans are established specifically as a vehicle to invest employees’ deferred
salaries and provide them with a retirement income, pension fund trustees are subject
to strict fiduciary duties that can discourage them from considering social and
environmental factors in their investment decision-making.6″ While some of the major
56 See e.g. Ian Jack, “Shareholders Support Social Values, Poll Finds” Financial Post (14 March
2003) FP5.
57 See online: Dow Jones Sustainability Indexes
58 See online: FTSE4Good Index Series
59 See online: Michael Jantzi Research Associates Inc.
60 See Sparkes, Socially Responsible Investment, supra note 42 at 314.
61 See Statistics Canada, “Employer Pension Plans (Trusteed Pension Funds): Third Quarter 2002”,
The Daily (17 March 2003), online: Statistics Canada
and personal pensions that are privately arranged (e.g., an individual’s registered retirement savings
plan [“RRSP”]).
62 See Kirk Falconer, Prudence, Patience and Jobs: Pension Investment in a Changing Canadian
Economy, Technical Report (Ottawa: Canadian Labour Market and Productivity Centre, 1999); see
generally Gordon L. Clark, Pension Fund Capitalism (Oxford: Oxford University Press, 2000).
63 See Al Emid, “The Ethical Choice: It Takes a Steady Hand to Balance Fiduciary Responsibility
with Ethical Goals” Benefits Canada 21:4 (April 1997) 89.
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FINANCING ENVIRONMENTAL CHANGE- B.J. RICHARDSON
public occupational pension funds (e.g., Ontario Municipal Employees Retirement
System)’ and union-controlled pensions are adopting ethical investment policies,65
most private pension plans in the corporate sector ignore environmental issues.66
Unlike pension plans, mutual funds can be flexibly marketed to pursue a wide
range of investment portfolios, including environmental ones. In 2002, some $427
billion was invested in over 2,500 Canadian mutual funds, mostly established by
banks and life insurance companies.67 A mutual fund is essentially a financial
intermediary administered by a fund manager that sells units (shares) to the public
and invests the money it receives. Mutual funds offer investors low-cost access to
professional management of their funds and to a diversified equity portfolio, which
reduces the risk to their investment. Under the current legislation, mutual funds are
subject to provincial securities laws, as harmonized through National Instrument 81-
102.68 Although only a small (albeit growing) proportion of these funds claim to be
dedicated specifically to socially and environmentally responsible investment, there is
no legal barrier to a mutual fund being established for an ethical cause. However,
fiduciary obligations require that ethical mutual funds invest according to what they
preach. A problem here is that “ethical investment” tends to be a self-awarded title;
the institutions set their own criteria for what is ethical. The absence of any objective
basis for determining what qualifies as “ethical” or “environmentally responsible”
the expansion of the ethical mutual fund market.69 Furthermore,
may impede
passively contributing to ethical investment funds arguably cannot be a substitute for
proper ethical deliberation about questions of social and environmental responsibility
in the market.7″ Deliberation is an important facet of shareholder activism, which may
in some cases be the most appropriate method for influencing corporate management.
The ethical mutual fund industry may consequently offer little more than an
64 Ontario Municipal Employees Retirement System, “Statement of Investment Policies and
Procedures for the Ontario Municipal Employees Retirement System”, online: Ontario Municipal
Employees Retirement System
65 See Quarter et al., supra note 43.
66 See Anne Papmehl, “Sustainable Development and Your Portfolio: Does It Make Sense to Invest
in a Company Known for Bad Environmental or Labour Practices? An Increasing Number of Pension
Fund Managers Think Not” Benefits Canada 26:12 (December 2002) 49.
67 Canadian Securities Administrators, “Striking a New Balance: A Framework for Regulating
Mutual Funds and Their Managers” at 1, online: Manitoba Securities Commission
68 “National Instrument 81-102: Mutual Funds” (2000) 23:4 O.S.C. Bull. (Supp.) 59. On mutual
fund governance see generally OECD, Directorate for Financial, Fiscal and Enterprise Affairs,
Governance Systems for Collective Investment Schemes in OECD Countries by John K. Thompson &
Sang-Mok Choi (Paris: OECD, 2001), online: Organisation for Economic Co-operation and
Development
69 See Michael S. Knowl, “Ethical Screening in Modem Financial Markets: The Conflicting Claims
Underlying Socially Responsible Investment” (2002) 57 Bus. Law. 681; Craig Mackenzie, “The
Choice of Criteria in Ethical Investment” (1998) 7 Bus. Ethics: A European Review 81.
70 See Paul F. Ramshaw, “Ethical Investment: Retail Ethics and Participatory Democracy?” (1998)
29 Cambrian L. Rev. 105.
160
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impoverished “retail ethic” that serves to sanitize people’s conscience without any
fundamental challenge to the market status quo. Fortunately, the integrity of ethical
mutual funds can be enhanced where there exist independent, ethical investment
associations and research services that can help formulate criteria and methodologies
for environmental and social investing.7
At the other end of the investment scale, the Canadian statistics reveal a
disappointingly low level of bank-based ethical lending. The SIO figures, however,
probably understate
the extent to which social and environmental factors are
incorporated into bank lending, because some lenders conduct environmental due
diligence appraisals and related checks on regular loans.72 Further, some banks also
provide environmental advisory services, particularly to the small business sector.73
Nonetheless, Canadian banking regulation does not
incorporate any specific
environmental standards or procedures to encourage such practices. The OSFI, which
supervises the banking sector, focuses only on keeping Canadian banks within the
framework of risk-based capital standards. Presently, the only material source of legal
“pressure” on Canadian banks to pay attention to the environment has come from
pollution liability legislation, which has raised the possibility of lenders becoming
jointly liable for the environmental harms caused by their borrowers.74 As Canadian
liability laws tend, however, to narrowly focus on contaminated land and water, rather
than damage to biological diversity and other ecological attributes, the potential of
existing environmental liability rules to encourage lenders to monitor their borrowers’
total environmental performance is reduced.
So far, there is little evidence that Canadian banks pay careful attention to the
long-term environmental performance of borrowers. Indeed, Canadian banks have
been publicly criticized for not being more open about the social and environmental
aspects and effects of their financing.75 Industry surveys have identified the Royal
Bank as the most environmentally and socially responsible bank among mainstream
Canadian lenders.76 The only Canadian bank that has specifically cast itself as an
ethical lender is the Citizens Bank of Canada, which in 2002 disbursed $127 million
in commercial loans that conformed with its ethical policy.77 While the Canadian
Bankers Association (“CBA”) has made public relations statements about the
71 See online: Social Investment Organization
72 See generally Jan Jaap Bouma, Marcel Jeucken & Leon Klinkers, Sustainable Banking:
The Greening of Finance (Sheffield, U.K.: Greenleaf Publishing, 2001).
73 See Labatt & White, supra note 34 at 75.
74 See Scott G. Requadt, “Lender on a Hot Tin Roof: The Developing Doctrine of Lender Liability
for Environmental Cleanup in Canada” (1992) 50 U.T. Fac. L. Rev. 194.
FP2.
75 See e.g. “Banks Urged to Disclose Ethical Issues in Reports” Financial Post (7 November 2002)
76 See e.g. Harvey Schachter, “Beyond the Bottom Line” (1996) 103:5 Canadian Banker 24.
77 SIO, “Social Investment Review”, supra note 41 at 6. See also Citizens Bank of Canada, Ethical
Policy Compliance Report 2001 (Vancouver: Citizens Bank of Canada, 2001), online: Citizens Bank
of Canada
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FINANCING ENVIRONMENTAL CHANGE- B.J. RICHARDSON
environment and banking,78 apart from the usual self-interested statements about
protecting banks from environmental liability, the CBA’s contributions have been
rather brief and superficial.79
Another arm of Canada’s ethical financing movement, ETI, targets economic
investment to local communities, the underprivileged, and charitable causes. This
work is relevant to the environment, as the promotion of social justice has long been
recognized as a pillar of a sustainable society.8 ETI in Canada is financed mainly
through labour-sponsored venture capital funds and community credit unions. A
venture capital fund is similar to a mutual fund but caters to investors prepared to take
higher risks for the promise of greater returns.8′ Venture funds invest in fledgling,
private enterprises that encounter difficulties raising financing from conventional
sources.82
Through Labour-Sponsored Investment Funds (“LSIFs”), trade unions control
some fifty per cent of the available venture capital in Canada.83 The LSIFs were
created under the auspices of provincial legislation, with statutory goals to promote
collateral social and economic benefits to workers and to encourage worker
involvement in fund management. Quebec was the first province to establish an LSIF,
passing legislation in 1983 to establish the Solidarity Fund (Fonds de solidarit6 des
travailleurs du Qudbec), under the financial sponsorship of the Quebec Federation of
Labour.84 Several other Canadian provinces have copied the Quebec model (e.g.,
British Columbia, Manitoba, and New Brunswick), although the Ontario model is
less committed to ensuring worker control and ETI goals in order to aid workers.85 In
all provinces, however, the provision of tax breaks to LSIF contributions has helped
to stimulate their growth, and this may have been a more salient driver than investors’
desire to promote social goals.86
Credit unions (and related co-operatives, such as the “caisses populaires” in
Quebec) are also active in promoting ETI in local communities. A credit union is a
78 See e.g. Canadian Bankers Association, “Your Business, Your Bank and the Environment”,
online: Canadian Bankers Association
79 Canadian Bankers Association, “Lending and the Environment: What Are the Risks to Lenders?”,
online: Canadian Bankers Association
80 On social justice and sustainability see Igor Vojnovic, “Intergenerational and Intragenerational
Equity Requirements for Sustainability” (1995) 22 Envtl. Conservation 223.
81 See generally Chris Bovaird, Introduction to Venture Capital Finance (London: Pitman, 1990).
82 See Edward A. Zelinsky, “The Dilemma of the Local Social Investment: An Essay on ‘Socially
Responsible’ Investing” (1984) 6 Cardozo L. Rev. 111; Sarah Diefendorf, “Venture Capital & the
Environmental Industry” (2000) 7 Corp. Envtl. Strategy 388.
83 See Tessa Hebb & David Mackenzie, “Canadian Labour-Sponsored Investment Funds: A Model
for U.S. Economically Targeted Investments” in Fung, Hebb & Rogers, supra note 13, 128 at 128.
84 An Act to establish the Fonds de solidarit des travailleurs du Quebec (FTQ.), R.S.Q. c. F-3.2. 1;
Hebb & Mackenzie, ibid. at 129.
85 See generally Community Small Business Investment Funds Act, S.O. 1992, c. 18.
86 Hebb & Mackenzie, supra note 83.
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distinct financial co-operative, owned and controlled by its members, who contribute
personal savings into a common fund and in return receive low interest loans and
annual dividends.87 In the 1900s, Quebec was the first province to introduce credit
unions, and this sector is virtually entirely regulated by provincial statutes.88 As of
2001, Canada’s credit union sector consisted of some 681 credit unions and
914 caisses populaires, with a
total of 10 million members.” They hold
approximately seven per cent of the total domestic assets held by Canadian financial
institutions.9″
in common, such as being domiciled
Registration as a credit union removes the need to comply with the more onerous
regulation of ordinary banking businesses, but to be registered, members of the union
must have something
the same
neighbourhood or working for the same employer.9″ As each member becomes a
shareholder and has one vote, regardless of financial contribution, credit unions
provide an alternative and more democratic form of financial management than that
offered by other financial service organizations. Although credit unions and caisses
populaires have traditionally focused on the provision of residential mortgage
financing, consumer credit, and deposit services
they are also
increasingly involved in ethical investment and ETI. A number have established
ethical mutual funds, such as the Ethical Growth Fund founded in 1986 by Vancouver
City Savings Credit Union.92
to members,
in
II. Reforming Financial Markets Regulation
A. The Marginalization of Environmental Policy
It is not easy to integrate environmental policy into financial markets regulation.
Governmental regulation of capital flows has principally been a response to market
failures regarding information asymmetry, externalities, and monopolistic practices.93
Market failures to protect the environment are not ordinarily seen as part of this remit.
87 See generally Charles Ferguson & Donal McKillop, The Strategic Development of Credit Union
(Chichester, U.K.: John Wiley & Sons, 1997).
88 See e.g. Ontario’s Credit Unions and Caisses Populaires Act, S.O. 1994, c. 11; see generally
Canadian Co-operative Credit Society, Canadian Credit Union Law: A Detailed Survey (Don Mills,
Ont.: CCH Canadian, 1987).
89 Department of Finance Canada, “Canada’s Credit Unions and Caisses Populaires”, online:
Department of Finance Canada
90 Ibid.
91 See e.g. Credit Unions and Caisses Populaires Act, supra note 88 at ss. 30(l)-(2).
92 See Carolyn Purden, “B.C. Fund Combines Ethics and Investment Growth” Canadian
Churchman 113:5 (May 1987) 12. See also Feme Burkhardt, “Credit Union Announces New
Stewardship Initiatives” Canadian Mennonite 4:8 (17 April 2000) 23.
93 See generally Tamar Frankel & Clifford E. Kirsch, Investment Management Regulation (Durham,
N.C.: Carolina Academic Press, 1999).
2004]
FINANCING ENVIRONMENTAL CHANGE – B.J. RICHARDSON
In regulating financial markets, states have aimed not to replace market-based capital
allocation with a command economy-which, as the experience of the former
communist bloc showed, can produce massive economic
inefficiencies and
environmental problems-but rather to improve the efficiency and liquidity of capital
allocation so that it can support broader economic activity. Financial reform in OECD
countries has tended to be shaped by the “financial repression” thesis, namely, that
state economic intervention to control where money flows risks provoking capital
flight, fragmented capital markets, and other inefficiencies.94 Instead, it is said that
governments
regulation,
aggressively intervening only in cases of destabilizing market abuses.
to broader, prudential
should confine
themselves
This “softy-softly” approach to financial markets regulation, while promoting
capital liquidity that offers important economic benefits, has had the unfortunate
effect of exacerbating market volatility and speculative booms that ultimately seem
harmful to the economy and society.95 Phillips’s Political History of the American
the growing “financialization” of the economy caused by the
Rich presents
deregulation of financial markets. The effect of deregulation, claims Phillips, has
been to fuel feverish stock market speculation, accompanied by accelerated economic
inequality and the marginalization of communities and workers not considered
relevant to this Wall Street economy.96 The growing globalization of financial markets
appears to be aggravating these effects.97
While there is no apparent move in Canada or other OECD countries to re-
engineer tighter state control over financial markets, new controls over banking and
investment systems will surely be needed if governments are to promote sustainable
financing. Governments’ existing
encompassing planning, environmental impact assessment, pollution licensing, et
cetera-have not achieved a sufficient realignment of economies toward sustainable
development. Major international environmental studies demonstrate a continuing
environmental decline in nearly all countries despite over three decades of legislative
for environmental protection-
techniques
94 See Ronald I. McKinnon, Money and Capital in Economic Development (Washington, D.C.:
Brookings Institution, 1973); Edward S. Shaw, Financial Deepening in Economic Development (New
York: Oxford University Press, 1973); Glenn Yago, “Financial Repression and the Capital Crunch
Recession: Political and Regulatory Barriers to Growth Economics” in Benjamin Zycher & Lewis C.
Solomon, eds., Economic Policy, Financial Markets, and Economic Growth (Boulder, Colo.:
Westview Press, 1993) 81.
95 The Asian financial crisis of the late 1990s is a notorious example of these problems: see David
C. Cole & Betty F. Slade, “The Crisis and Financial Sector Reform” (1998) 15 ASEAN Econ. Bull.
338. See generally Don Goldstein, “Uncertainty, Competition, and Speculative Finance in the
Eighties” (1995) 29 J. Econ. Issues 719.
96 Kevin Phillips, Wealth and Democracy. A Political History of the American Rich (New York:
Broadway Books, 2002) at 108-12.
97 See generally Ilhan Meric & Gulser Meric, eds., Global Financial Markets at the Turn of the
Century (Amsterdam: Pergamon, 2001).
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reform.98 This indicates that a new approach that targets the underlying processes of
capital allocation is needed. The mobilization of financial institutions as a driver for
improved corporate environmental performance does not mean that existing, effective
environmental law techniques should be abandoned, but rather that the targeting of
the financial sector should complement and supplement existing methods. It is
preposterous to suggest that banks or mutual funds could operate national parks or be
urban planners; financial service providers’ truncated expertise and management
capacity preclude them from undertaking many of the specialist functions of modem
government environmental agencies.
incentives
So what can be expected of financial institutions? Their value lies in financiers’
rules,
strategic market position, which can be manipulated by government
information tools, and monetary
to enable environmentally sound
companies to flourish at the expense of polluters and resource degraders. Financial
institutions cannot amorphously coordinate themselves
toward any overarching
environmental policy goals, such as reducing a given pollutant by a desired amount or
conserving a given level of an environmental resource. Only the state can set such
broad environmental policy goals, informed by public consultation and scientific
evidence. The problem for the state, however, is that its existing tools have often not
allowed the attainment of these objectives. In Canada, the government’s ability to
control greenhouse gas emissions, reduce pesticides, curb land clearing, and so on has
been questioned in recent reports.99 The solution is to tackle development patterns at
source in the initial capital allocation processes and thereby reduce the number of
polluting and environmentally destructive companies extant to make overall policy
goals more achievable. In essence, a more environmentally responsible financial
sector is one that will benefit society through its diffused, downstream effects on the
economy, where there will arise many more Body Shops and Ben and Jerry’s
businesses and far fewer Union Carbides and Enrons. Regulation should aim not to
impose pervasive and pedantic environmental requirements on financiers-an
approach that would surely generate a bureaucratic leviathan-but rather to provide
procedural mechanisms
for more
environmentally responsible financing. The aim should be to create a process that
encourages a culture
to
environmental concerns, not a regulatory straitjacket to meet prescribed goals.
that facilitate and nurture
in financial markets
the conditions
that
is much more responsive
Harnessing financiers as a mechanism for environmental change through liability
incentives, and other procedural
rules, environmental risk reporting, economic
techniques would not only plausibly improve the environmental quality of our
economy-as emerging reforms discussed later in this article demonstrate-but
98 See generally Linda Starcke, ed., State of the World 2003: A Worldwatch Institute Report on
Progress Toward a Sustainable Society (New York: WW. Norton & Company, 2003).
99 See e.g. David Richard Boyd, Canada vs. the OECD: An Environmental Comparison (N.p.,
2001), online: Environmentalindicators.com
and Policy (Vancouver: University of British Columbia Press, 2003).
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FINANCING ENVIRONMENTAL CHANGE – B.J. RICHARDSON
would likely do so without unacceptable cost. How would this be possible? The key
is to shift the nature of the environmental regulation system from being primarily
about government inspectors laboriously verifying industry’s compliance with rules
to focusing more on encouraging financiers to implement environmental management
processes which are then scrutinized by regulators. Rather than costly, inflexible,
prescriptive regulation, the new system of incentives would aim to encourage key
market institutions to establish processes of internal self-control to monitor and
control economic activities harmful to the environment. Thus, companies and
industries with a neutral or positive environmental performance seeking approval
from the state to develop would have already passed the environmental appraisal
systems of financial institutions. In contrast, firms potentially injurious
to the
environment would find their proposals grounded without the support of banks and
investors. Government authorities would therefore be substantially relieved of the
difficult cases, and development approvals and ongoing controls for the remainder
could be more readily processed. With fewer environmentally harmful companies
operating, the overall burden on the environmental regulatory system would be
reduced. Of course, it must be acknowledged
that such broad economic and
environmental benefits to society would not necessarily be welcomed by the financial
sector, given that it would carry a greater regulatory burden. If all financial
institutions were required to reform their practices, the additional costs would likely
be passed on to borrowers and clients. But this solution would not take away the
political risks to the state that arise from disciplining financial markets.
Ever since the state became an agent for development, the generation of wealth
and abundance has been the primary foundation of political legitimacy. The rise of
the modem capitalist economy has been accompanied, however, by major
environmental degradation and social inequality that call into question this economic
Zeitgeist.” The state’s options to address these side effects are limited. Lindblom
portrays the market as a “prison” constraining public policy choices.1″‘ The fact that
capital is mostly in private hands means that state institutions are unable to directly
organize economic production according
to necessary environmental or social
criteria. Regulators, in turn, often have a self-interest in giving preferential treatment
to the agents of capitalism, as their prosperity is perceived as a prerequisite to
regulators’ own power in terms of maintenance of mass social loyalty and as a source
of state revenue.0 2 Citizens tend to electorally reward governments that preside over
periods of economic growth and to punish governments associated with economic
100 On the environmental protest that can challenge growth politics see generally Judith I.
McKenzie, Environmental Politics in Canada: Managing the Commons into the Twenty-first Century
(Don Mills, Ont.: Oxford University Press, 2002).
101 Charles E. Lindblom, “The Market as Prison” (1982) 44 J. Pol. 324.
102 See Volkmar Lauber, “Ecology Politics and Liberal Democracy” (1978)
13 Gov’t and
Opposition 199 at 205-12.
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decline. For these reasons, capitalist interests hold a special position of access to
political decision making in market systems.’03
Because individual companies are unable or unwilling to address their own
environmental impacts, the state must intervene selectively to address the most
serious points of conflation. One of the basic factors of production-nature–can no
longer assumed to be a given. The state is consequently in a quagmire in that it must
restrict the mechanisms of capitalist accumulation to minimize their worst excesses
while simultaneously allowing those same mechanisms to operate freely to produce
the abundance necessary to satisfy the collective welfare.” A further aggravation is
that the high public costs of implementing environmental protection and social
welfare measures can exacerbate the budgetary crises that commonly afflict modem
states.’05
tend
to be more willing
to make submissions
One response that Western states have taken is to channel social protest away
from the sphere of production to the domain of consumption.’0 6 The politics of
consumption often involve
less economically sensitive causes, such as urban
amenities, housing, parks, and the like. Social protest tends to be channelled through
the polyarchal institutions of the liberal democratic state, for example through
opportunities
in environmental assessments and public
inquiries.” 7 While governments
to actively protect
communities’ local amenities and public health, interference in investment decisions
and other aspects of the financial and production economy is much less tolerated. In
Canada, for example, the Walkerton water contamination scandal provoked a swift
government response to protect local drinking water, 10 8 but control of industrial
greenhouse gas emissions-which Canada has apparently accepted as posing a
serious and immediate threat to the planet, as evidenced by its recent ratification of
the Kyoto Protocol to the United Nations Framework Convention on Climate
Change’9-has been evaded or delayed by Canadian governments because of the
higher stakes involved in regulating this aspect of economic production.” The state’s
tolerance of consumption politics
is also reflected by its seemingly anomalous
approval of credit unions, building societies, and other types of democratically
103 See Charles Edward Lindblom, Politics and Markets: The World’s Political-Economic Systems
(New York: Basic Books, 1977) at 170-88.
104 See K.J. Walker, “The State in Environmental Management: The Ecological Dimension” (1989)
37 Pol. Stud. 25 at 32; on these contradictions see generally Claus Offe, Contradictions of the Welfare
State (Cambridge, Mass.: MIT Press, 1987) at 119-29.
105 See James O’Connor, The Fiscal Crisis of the State (New York: St. Martin’s Press, 1973).
106 See generally Manuel Castells, City Class and Power (New York: St. Martin’s Press, 1978).
107 For an Australian perspective on these issues see John Cole, “Environmental Law and Politics”
(1981) 4:1 U.N.S.W.L.J. 55.
Drinking Water (Toronto: Ontario Ministry of the Attomey-General, 2002).
108 See Demis R. O’Connor, Part Two, Report of the Walkerton Inquiry: A Strategy for Safe
109 37 I.L.M. 32.
“o See Steven Bernstein, “International Institutions and the Framing of Domestic Policies: The
Kyoto Protocol and Canada’s Response to Climate Change” (2002) 35 Pol’y Sci. 203.
2004]
FINANCING ENVIRONMENTAL CHANGE- B.J. RICHARDSON
167
organized local financial institutions.”‘ Yet these reforms have not disturbed the core
of modem financial markets, and the existence of these institutions has been tolerated
as a way to help fund improvements to living conditions and amenities for poorer
communities and so maintain the legitimacy of financial markets.
For the state to direct where private financial institutions allocate capital in order
to defend social and environmental causes would be a political disaster and would
likely engender major economic inefficiencies given that regulators typically lack the
required information and expertise. However, through national pension schemes
governments could to some extent enhance public control over capital allocation.”‘
The Swedish and New Zealand national pension schemes, for instance, have recently
been amended to enable authorities to better direct funds towards social and
environmental investments.”‘ In Sweden, the AP-fonden (National Pension Funds)
into account … without
must “take environmental and ethical considerations
relinquishing the overall goal of high return on capital.””‘ 4 In the case of New
Zealand, the New Zealand Superannuation Act 2001 specifies in paragraph 61 (d) that
a “statement of investment policies, standards, and procedures must cover (but is not
limited to) … ethical investment, including policies, standards, or procedures for
avoiding prejudice to New Zealand’s reputation as a responsible member of the world
community … ..”.. No such equivalent duties exist in the Canada Pension Plan
Investment Board Act 1997,’6 which governs administration of Canada’s national
pension safety net; indeed, the Pension Plan Investment Board has sustained criticism
for some supposedly unethical investment choices.’7
To influence private pensions and other commercial financial institutions,
however, will require subtle and less intrusive techniques, and crucially, methods that
offer profits
financing. Certainly, ecological
modernization theory suggests that there can be a healthy synergy between economic
development and environmental protection where economies and technologies are
environmentally
from
sound
111 See generally Ferguson & McKillop, supra note 87; Alastair Hudson, The Law on Investment
Entities (London: Sweet & Maxwell, 2000) at 276-94.
112 See Roberto Mangabeira Unger, Democracy Realised: The Progressive Alternative (London:
Verso, 1998) at 148-50.
“13 See generally John Myles & Paul Pierson, “The Comparative Political Economy of Pension
Reform” in Paul Pierson, ed., The New Politics of the Welfare State (Oxford: Oxford University Press,
2001) 305.
114 Tredje AP-fonden, Third Swedish National Pension Fund Annual Report 2002 (Stockholm:
Tredje AP-fonden, 2002) at 6, online: Tredje AP-fonden
“‘ (N.Z.), 2001/84, s. 61(d).
116 S.C. 1997, c. 40.
“17 See Sandra Cordon, “Critics Call for Halt to CPP Investments in Tobacco Companies” Canadian
Press (5 December 2002).
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to allow for more efficient and less wasteful development.” 8
“modernized”
Ecological modernization scholarship, however, has not yet looked at the financial
services sector and the techniques that could promote a similar synergy for investors
and lenders.
laws be reformed
B. Bringing the Environment into Financial Services Regulation
How, then, can financial
to facilitate environmentally
responsible financing? Because private financial institutions will likely remain the
dominant providers of development capital, governments should collaborate with
financiers and share responsibility with them to achieve environmental policy goals.
Harnessing financial service providers in this way would be congruent with broader
shifts in patterns of modem governance oriented toward delegating and sharing
responsibilities with the private sector. Because of the perceived advantages of the
private sector in terms of its managerial skills, cost efficiency, and client knowledge,
private organizations in many Western countries are being enlisted to deliver
government policy in sectors ranging from health and education to local amenities
and transport.” 9 In the environmental field especially, there is wide acknowledgement
of the desirability of “sharing responsibility” with the private sector 2
Such delegations of authority can be viewed in terms of the desire of policy-
congested states, incapable of satisfying competing societal demands, to off-load
some responsibilities to civil society and the market.’ 2′ Many regulatory theorists
emphasize that government agencies operate increasingly in a pluralistic setting
wherein effective governance resides in flexible, collaborative mechanisms by which
state functions are shared with or devolved to private interests.’22 Rather than mere
“government”, which denotes hierarchical, state-based administration and implies a
demarcation between public and private sectors, governance involves the contribution
of, and interaction between, both state and non-state interests in ordering relationships
and making policy. Strategies for governance rely upon a combination of rules,
incentives, and informational mechanisms by which the state seeks to steer and
coordinate the non-governmental sector.’23 Freeman also sees governance as a process
18 See Peter Christoff, “Ecological Modernisation, Ecological Modernities” (1996) 5 Envtl. Pol.
476; Charles 0. Holliday, Stephen Schmidheiny & Philip Watts, Walking the Talk: The Business Case
for Sustainable Development (Sheffield, U.K.: Greenleaf Publishing, 2002).
119 See generally John D. Donahue, The Privatization Decision: Public Ends, Private Means (New
York: Basic Books, 1989).
120 See EC, Towards Sustainability, supra note 31.
121 See generally Jurgen Habermas, Legitimation Crisis, trans. by Thomas McCarthy (Boston:
Beacon Press, 1975).
122 See e.g. Martin Rein, “The Social Structure of Institutions: Neither Public nor Private” in Sheila
B. Kamerman and Alfred J. Kahn, eds., Privatization and the Welfare State (Princeton, N.J.: Princeton
University Press, 1989) 49.
123 See Gerry Stoker, “Governance as Theory: Five Propositions” (1998) 50 Int’l Soc. Sci. J. 17.
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FINANCING ENVIRONMENTAL CHANGE – B.J. RICHARDSON
of “negotiated relationships” between public and powerful private actors.12 4 Because
of their control over capital allocation, financial organizations are the kind of
strategically placed organizations that should be part of processes of environmental
governance. Schemes to more effectively diffuse environmental policy through the
market must therefore address financial institutions that have the capacity, through
their investing and lending decisions, to improve the dissemination of policy goals
and standards.
institutions and methodologies and
The well-documented failings of command-and-control environmental regulation
suggest that regulation-forced changes, such as mandatory financing of ethical causes
and adoption of complex environmental performance standards, would likely be
subverted by the financial sector.”5 Bodies ranging from the European Commission
to the OECD that have examined environmental regulations have found serious
problems and have called for alternative approaches that place more reliance on
market
less emphasis on administrative
governance. 1216 While command regulation has yielded some ad hoc environmental
improvements, such as reduced air emissions of lead and sulphur dioxide, the
deployment of predominantly sector-based controls, organized, for instance, around
pollutant-by-pollutant or industry-by-industry regulation, has produced economic
inefficiencies and sometimes the displacement of the environmental problem rather
than its resolution. 127 The extensive labyrinth of public controls on environmental
activities exemplifies Susskind’s notion that modem governments have produced a
“hyper-regulated” society.’ Regulatory overload has manifested itself as ineffective
law enforcement, unintended side effects, escalation of unresolved conflicts, and
budgetary overruns for environmental agencies.’ 9
Drawing on the theory of autopoietic systems, Teubner and other regulatory
theorists stress that the future of environmental law resides in the use of incentive,
informational, and other procedural policy instruments, coupled with harnessing third
124 Jody Freeman, “The Private Role in Public Governance” (2000) 75 N.YU. L. Rev. 543.
125 On the failings of command environmental regulation see Klaus Bosselmann & Benjamin J.
Richardson, “Introduction: New Challenges for Environmental Law and Policy” in Klaus Bosselmann
& Benjamin J. Richardson, eds., Environmental Justice and Market Mechanisms: Key Challenges for
Environmental Law and Policy (The Hague: Kluwer Law International, 1998) at 1-4; Bruce A.
Ackerman & Richard B. Stewart, “Reforming Environmental Law” (1985) 37 Stan. L. Rev. 1333.
126 See e.g. OECD, Environmental Policy: How to Apply Economic Instruments (Paris: OECD,
1991); EC, Commission, “Economic Evaluation of Environmental Policies and Legislation” by Risk
& Policy Analysts Limited, online: Europa
1217 See Richard B. Stewart, “A New Generation of Environmental Regulation?” (2001) 29 Capital
U. L. Rev. 21.
128 Richard Susskind, The Future of Law: Facing the Challenges of Information Technology
(Oxford: Clarendon Press, 1996).
129 On the limits of regulation generally see Gunther Teubner, “Juridification: Concepts, Aspects,
Limits, Solutions” in Robert Baldwin, Colin Scott & Christopher Hood, eds., A Reader on Regulation
(Oxford: Oxford University Press, 1998) 389 at 406-408.
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to
the
linked
regulation have been
party, non-governmental entities as mechanisms of governance. 3 This approach to
environmental governance has important
implications for strategic reliance on
financial institutions as a mechanism of environmental change. The cognitive limits
of substantive command
increasing
“differentiation” of modem society. Parsons has theorized that modernization is
fundamentally constituted by a process of differentiation that “disaggregates” society
into various subsystems, such as politics, law, and the market. 3′ Taking this further,
according to Luhmann’s theory of autopoiesis (meaning “self-production”),’ 32 modem
societies are essentially systems of communication comprising subsystems that are
cognitively open (i.e.,
they can “observe” and absorb information from their
surroundings) but operationally closed, as their mode of operation is not influenced
by normative factors external to them. These subsystems therefore function self-
referentially in accordance with their own norms and protocols.’33 The legal system
can thus be understood as only one of a plurality of social systems, and as there is no
single,
indirect
mechanisms to influence the behaviour of companies and other entities, rather than
attempt to engineer change through highly interventionist, prescriptive controls.
functionally dominant system, policy-makers must
rely on
to social systems and disagree with
While one can question whether autopoietic theory can be readily transferred
from individual organisms
its positivist
the theory nonetheless assists our understanding of some of the
connotations,
underlying structural problems of contemporary environmental
law (and other
regulatory) systems.’34 The enormous expansion and intensification of environmental
standards and rules in recent decades is now widely observed, and the inflexibilities
and inefficiencies of command regulation tend to confirm the autopoietic thesis
regarding the weaknesses of certain legal controls in directing economic behaviour.
The implication of autopoietic theory, therefore, is that influencing the market
“subsystem” through the mechanisms of law and politics will not be effective unless
130 See Gunther Teubner, Lindsay Farmer & Declan Murphy, eds., Environmental Law and
Ecological Responsibility: The Concept and Practice of Ecological Seif-Organization (Chichester,
U.K.: John Wiley & Sons, 1994); Neil Gunningham & Darren Sinclair, Leaders and Laggards: Next-
Generation Environmental Regulation (Sheffield, U.K.: Greenleaf Publishing, 2002) at 189-204.
131 Talcott Parsons, The Evolution of Societies, ed. by Jackson Toby (Englewood Cliff, N.J.:
Prentice-Hall, 1977); see also Niklas Luhmann, The Differentiation of Society, trans. by Stephen
Holmes & Charles Larmore (New York: Columbia University Press, 1982).
132 Used by biologists and systems theorists, autopoiesis describes a self-referential system, where
its elements are created by, and in turn generate, the operations of the system. An allopoietic system,
by contrast, is one where the system’s elements are derived from the system’s environment: see
Vladimir Degtiar, “Autopoietic-Allopoietic Approach to Social Systems” (2000) 1 J. Applied Sys.
Stud. 31.
133 See Niklas Luhmann, Ecological Communication, trans. by John Bednarz, Jr. (Chicago:
University of Chicago Press, 1986). See also Gunther Teubner, “How the Law Thinks: Toward a
Constructivist Epistemology of Law” (1989) 23 Law & Soc’y Rev. 727.
134 For further analysis of the complexities and problems of autopoietic theory see Arthur J.
Jacobson, “Autopoietic Law: The New Science of Niklas Luhmann” (1989) 87 Mich. L. Rev. 1647.
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FINANCING ENVIRONMENTAL CHANGE – B.J. RICHARDSON
such intervention is conveyed in the norms and codes understood by the market.’35 In
other words, using private financiers as mechanisms of environmental change
requires deploying techniques that are reasonably congruent with the customs and
structure of financial markets; environmental concerns must be presented in
financially relevant terms. Autopoietic theory also suggests that the coordination of
different subsystems can be advanced through organizations that straddle subsystem
boundaries, which can enhance mutual understanding and link subsystem activities.’36
In this sense, financial organizations such as banks and investors can be seen as
“boundary” institutions, straddling the economic and administrative subsystems of
society. For example, banks exposed
financing
environmentally harmful developments
force
for
communicating environmental standards among borrowers
to avoid liability-
producing situations.
rules of
liability
turn can become
to
in
for
a
Because substantive regulation prescribing goals is unrealistic, policy-makers
need to place greater emphasis on procedural techniques of regulation that can
facilitate (but not dictate) change. Such procedural techniques include informational
and incentive policy instruments that encourage greater awareness among regulatees
of their social and environmental impacts. The emphasis on procedure can help
implement, as Orts suggests, a “reflexive” style of legal regulation, whereby
companies learn more about the cost of their impacts and adjust their behaviour
accordingly in light of evidence, publicity, and pressure.’37 Environmental regulation
that can be implemented through the existing structures and procedures of the
financial services sector can thus potentially allow for more effective communication
of environmental concerns and desired management changes than what is attainable
solely through externally directed, administrative-based controls.
C. New Policies to Link Environmental Performance to Financial
Performance
Crucial to this alternative approach to regulation is that corporate environmental
performance must be made more financially relevant. This challenge has two aspects.
First, there is the relationship between a company’s environmental and financial
performance. Second, there is the question of whether ethical investment funds are
more profitable than conventional funds. Regarding the first aspect, there is a
growing body of empirical data being gathered on the profitability of companies that
emphasize environmental performance.’38 There are also numerous studies that
135 See generally Gunther Teubner, Law as an Autopoietic System, trans. by Anne Bankowska &
Ruth Adler (London: Blackwell, 1994).
136 See Bob Jessop, State Theory: Putting the Capitalist State in its Place (Cambridge: Polity Press,
1990) at 330.
13′ Eric W. Orts, “Reflexive Environmental Law” (1995) 89 Nw. U. L. Rev. 1227.
138 See e.g. David Edwards, The Link Between Company Environmental and Financial
Performance (London: Earthscan, 1998).
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
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highlight a correlation between corporate environmental and social performance and
share value.’39 They show in many cases that companies guilty of environmental
regulatory offences suffer a far greater monetary penalty through reduced share value.
As regards the second aspect-profitability, although literature suggests that
ethical investment can match or exceed conventional investment, the evidence is
generally equivocal. 4 ‘ The reasons advanced by commentators for why ethical
investment funds may produce superior returns include: ethical screening helps to
identify companies that manage their risks and liabilities well; and ethical financing is
congruent with and reinforced by a broader social movement concerned with
environmental integrity. 4′ Because ERF is relatively young, however, there is little
evidence that can be used to analyze the returns of using environmental screens.
Many studies have therefore relied on back-testing techniques (i.e., reviewing
existing data to calculate what would have happened in the past if a certain
methodology had been used to construct an investment portfolio).’42 Even if such
methods reveal an ERF advantage, one must not overlook the additional transaction
costs associated with using an ethical screen and the monitoring of companies’
environmental performance. Another consideration is that investment returns in
environmentally problematic industries and companies, such as the oil sector, would
not likely be so profitable if these industries and companies had to pay for their full
environmental impacts through pollution charges.”‘
A requirement on companies to publicly report on their environmental activities
and to present such information in financially relevant terms would be necessary to
make environmental risk a more prominent factor in investment and lending
calculations. Because shareholder activism is also a key means of articulating ethical
financing preferences, reformers should also look at how financial institutions
participate in their investee companies and publicly disclose their shareholder voting
policies. Effective shareholder activism and other strategies of corporate engagement
depend upon reforms to corporate governance to give a voice to shareholders and
139 See e.g. Paul Lanoie, Benoit Laplante & Mait6 Roy, “Can Capital Markets Create Incentives for
Pollution Control?” (1998) 26 Ecological Econ. 31; Paul Asmundson & Stephen R. Foerster,
“Socially Responsible Investing: Better for Your Soul or Your Bottom Line?” (2001) 14:4 Can.
Investment Rev. 26.
140 See e.g. Michael V Russo & Paul A. Fouts, “A Resource-Based Perspective on Corporate
Environmental Performance and Profitability” (1997) 40 Academy of Management J. 534; C.A.
Mallin, B. Saadouni & R.J. Briston, “The Financial Performance of Ethical Investment Funds” (1995)
22 J. Bus. Fin. & Acc. 483.
141 See Peter Camejo, The SRI Advantage: Why Socially Responsible Investing Has Outperformed
Financially (Gabriola Island, B.C.: New Society Publishing, 2002) at 47-49.
142 See Sparkes, Socially Responsible Investment, supra note 42 at 243.
143 See Camejo, supra note 141 at 7.
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FINANCING ENVIRONMENTAL CHANGE – B.J. RICHARDSON
interested
requirements and
other
communication rules are some of the current impediments to this voice.'”
stakeholders. Proxy contest
shareholder
A further tranche of necessary reforms is provision of better economic incentives.
By taxing environmental harms such as waste emissions and resource depletion,
governments can help convey in a more financially relevant way the costs and
benefits of environmental activities. To be politically viable, however, eco-taxes
would need to be offset by reductions in other types of corporate taxes. “Pricing”
environmental use can thus be another building block for reforming financial
the behaviour of
regulation. Environmental
environmental financiers, not only if the businesses they fund are hurt, but also if the
financial sponsors are vicariously liable. Evidence from the US suggests that the
targeting of lenders caused banks to alter quite dramatically their financing practices
in response to the Superfund contaminated land cleanup legislation.’45 The role of
for
these and other
environmental financing is considered later in this article.
in creating a more supportive
rules can also affect
framework
techniques
liability
Apart from getting
the right mix of financial
incentives and reporting
requirements, the internal governance of financial organizations should be reformed.
People who contribute to investment funds arguably should be consulted on how the
administration and investment decisions of those funds are conducted. In relation to
pension funds, for instance, elements in the labour movement have struggled for
years to strengthen worker control of their pension plans to ensure that they only
invest in industries and companies known to treat workers well.'” In 1976, Drucker
prematurely claimed in Unseen Revolution: How Pension Fund Socialism Came to
America that the US was the world’s first socialist country because workers, through
their pension funds, had come to own a significant stake of the equity capital of
7 Drucker overlooked, however, the fact that the pension plan
American businesses. “1
beneficiaries neither controlled nor directed the corporations in which their pension
monies were invested and also ignored the fact that corporate management typically
appointed the trustees that control occupational pension plans. 4 Presently, labour
movement activists in Canada and elsewhere are attempting to acquire greater
representation on pension fund boards of trustees, either through joint or sole
trusteeship or by establishing advisory boards to these bodies.’49 The prospects for
59 U. Cin. L. Rev. 357.
144 See A.A. Sommer, Jr., “Corporate Governance in the Nineties: Managers vs. Institutions” (1990)
145 See Richard K. Harper & Stephen C. Adams, “CERCLA and Deep Pockets: Market Response to
the Superfund Program” (1996) 14:1 Contemp. Econ. Pol’y 107.
146 See Peter F. Drucker, The Unseen Revolution: How Pension Fund Socialism Came to America
(New York: Harper & Row, 1976).
141 Ibid at 1.
148 See Jeremy Rifldn & Randy Barber, The North Will Rise Again: Pensions, Politics and Power in
the 1980s (Boston: Beacon Press, 1978) at 11 -12 (discussing US pensions).
149 Freya Kodar, Corporate Law, Pension Law and the Transformative Potential of Pension Fund
Investment Activism (LL.M. Thesis, Osgoode Hall Law School, 2002) [unpublished] at 57.
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
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democratizing pension administration appear to be greatest in union pension funds
and public pensions, because they are less closely tied to market pressures and
because corporate management does not appoint their pension fund trustees.150
Quebec pension legislation goes the furthest in Canada in providing for worker
control
representatives on pension management
committees.15 ‘
through election of worker
to
regulators
Finally, the prudential controls governing financial organizations would also need
to incorporate environmental risk factors. There could be scope within existing
regulatory parameters for financial
impose some environmental
standards as conditions of financial institutions’ authorizations. For instance, lenders
and investment institutions could be obliged to report on the environmental profiles
and risks of their financing activities. At a minimum, this would seem to require
maintenance of ethical investment disclosure obligations. Further, investors and
lenders arguably should be obliged to consider the social and environmental effects
relevant to the companies and projects they finance. Essentially, this would be a
model of environmental appraisal, complementing existing governmental systems of
environmental impact assessment. Already, the insurance sector undertakes a similar
surrogate regulatory role in relation to the management of pollution liability risks. 52
Of course, to expect financiers to appraise and report on the environmental activities
of their clients would be a wasteful and costly exercise if regulators did not offer clear
guidelines and establish verification and auditing mechanisms. Work on standardizing
possible evaluation criteria is already being made by various bodies, such as the UK’s
Department for Environment, Food and Rural Affairs’53 and the Ethical Investment
Research Service (“EIRIS”).’54 Indeed, the contribution made by ethical advisory and
research bodies such as EIRIS in evaluating corporate environmental performance
points
to a seminal role such bodies can play in the emerging networks of
environmental governance. In reforming financial regulation, lenders may also need
to be offered incentives to introduce differential interest rates (and hence the cost of
capital) to reflect the environmental risks of different types of development.”‘ For
example, the Netherlands in 1995 introduced a Green Investment Directive to provide
150 Marleen O’Connor, “Labor’s Role in the Shareholder Revolution” in Fung, Hebb & Rogers,
supra note 13, 67 at 69.
151 Supplemental Pension Plans Act, R.S.Q. c. R-15.1, s. 147(1).
152 See Richardson, “Mandating”, supra note 35.
153 Corporation of London, Financing the Future: The London Principles: The Role of UK
Financial Services in Sustainable Development by Forum for the Future (London: Department for
Environment, Food and Rural Affairs, 2002), online: Forum for the Future
report.pdf>.
155 In the home loan and building financing markets, some lenders are offering “green mortgages”
as a way of meeting consumer demand for environmentally friendly, energy-efficient houses. See
Labatt & White, supra note 34 at 72.
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FINANCING ENVIRONMENTAL CHANGE- B.J. RICHARDSON
tax deductions
environmental investment funds. 156
for
interest payments and dividend yields
from approved
To ensure
that financial regulators would monitor compliance with such
environmental provisions, it would also be necessary to impose certain fundamental
environmental duties in the main financial statutes. In the UK, for instance, during
drafting of the Financial Services and Markets Act 2000,’
the UK Social Investment
Forum unsuccessfully argued before the House of Commons Environmental Audit
Committee that the act should include a reference to sustainable development in the
Financial Service Authority’s mandate and the Authority should be required to
promote
lending
products. 5 ‘ Ultimately, environmental protection has to be legislated as a core duty of
financial regulators to ensure that it is not trivialized as a marginal statutory
responsibility.
the provision of environmental investment and environmental
Overall, the aim of government regulation should be primarily to make corporate
environmental performance relevant to financial institutions’ evaluation of corporate
economic performance. Without such a synergy, environmental policy measures will
likely be resisted by financial organizations as a set of extraneous,
imposed
requirements. Bringing private financiers into the web of environmental governance
must rely principally upon provision of incentive and informational tools, rather than
authoritarian mechanisms. Financial institutions can assist in the environmental
governance of markets as investors supplying the resources for environmental
initiatives; as stakeholders exercising influence over corporate management; and as
valuers evaluating and pricing businesses’ environmental risks. As financiers become
more sensitive to the social and environmental sequelae of their decisions, they
should become an increasingly important means of transmitting and amplifying
environmental policy through the economy.
D. Addressing the Heterogeneity of the Financial Sector
Reforming
to make
the financial services sector
to
environmental and social concerns must also address the legal and market context of
specific financial institutions. The financial services sector is a heterogeneous
phenomenon. Despite market liberalization reforms that have encouraged convergence
it more responsive
156 See Marcel Jeucken, Sustainable Finance and Banking (London: Earthscan Publications, 2001)
at 92-94.
“‘ (U.K.), 2000, c. 8.
158 UK Social investment Forum, Press Release, “UK Social Investment Fonm Tells MPs of Need to
Include Environment in Framework for Financial Services Regulator” (19 April 1999), online: UK Social
Investment Forum
work has been undertaken in many countries on defining the management principles of “sustainable
development”, and it is now widely referenced in legislation throughout the world, including the
Canadian Environmental Protection Act, 1999, S.C. 1999, c. 33, s. 3 [CEPA]. On what sustainable
development may mean for the financial services sector see Corporation of London, supra note 153.
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
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and assimilation of financial services, financial organizations retain distinctive
institutional characteristics shaped by their legal structure and obligations, the nature of
their financial services, and the influence of market forces involved. Consequently,
financiers may respond differently, and sometimes less effectively, to the same
environmental reforms. Pension schemes and mutual flnds-two of the largest
financial institutions in the Canadian market-have quite different legal personalities
and financial objectives and illustrate this caveat quite well.
Occupational pension funds are unique in that they are established to pay benefits
upon their members’ retirement.’59 The consequential fiduciary obligations on fund
trustees can hamper ethical investment. Although Canadian courts have hardly
considered the issue, there are several cases in the UK and US where the relationship
between ethical investment and pension fund trustees’ fiduciary responsibilities were
considered. 6 In Britain, notions of fiduciary responsibility were interpreted in
Cowan v. Scargill,16 ‘ Martin v. City of Edinburgh District Council,’62 and Harries v.
Church Commissioners for England63 as constraining pension fund trustees from
embracing ethical criteria in investment policy.”6 This constraint arises because the
best interests of trust beneficiaries have generally been considered as their financial
interests. The genesis of this approach is in the conception of trusts in the nineteenth
century as a means of protecting family wealth over succeeding generations. 6’ In
Harries, Donald Nicholls VC. accepted that there were at least two exceptions to the
duty to maximize financial returns; namely, where the aims of the charity and the
objects of investment would conflict and where particular investments would detract
from the charity’s work, the trustees must weigh the extent of financial loss from
offended supporters and the financial risk from exclusion.’66 In the US case of Board
of Trustees of the Employees ‘Retirement System of the City of Baltimore v. Mayor
and City Councillors of Baltimore,’67 a court found that a city ordinance requiring a
municipal authority pension fund to disinvest from companies engaged in business in
South Africa did not cause trustees to violate their prudential investment duties so
long as the cost of investing according to social responsibility precepts was de
minimis.
Investing in Life: The History and Future of Pensions (London: Verso, 2002).
159 On the development and role of pensions see generally Robin Blackburn, Banking on Death, or
160 See James D. Hutchinson & Charles G. Cole, “Legal Standards Governing Investment of
Pension Assets for Social and Political Goals” (1980) 128 U. Pa. L. Rev. 1340; David Hayton,
“English Fiduciary Standards and Trust Law” (1999) 32 Vand. J. Transnat’l L. 555.
161 (1984), [1985] Ch. 270, [1984] 2 All E.R. 750, [1984] 3 W.L.R. 501.
162 (1987), [1988] S.L.T. 329 (Ct. Sess.).
163 (1991), [1993] 2 All E.R. 300, [1992] 1 W.L.R. 1241 [Harries cited to All E.R.].
164 For analysis see J.H. Farrar & J.K. Maxton, “Social Investment and Pension Scheme Trusts”,
Note (1986) 102 Law Q. Rev. 32.
165 On the roots of trusts see Alastair Hudson, Principles of Equity and Trusts (London: Cavendish
Publishing, 1999).
166 Harries, supra note 163 at 304.
167 562 A.2d 720 (Md. C.A. 1989).
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FINANCING ENVIRONMENTAL CHANGE – B.J. RICHARDSON
Although there is growing evidence that pursuing an ethical policy does not
necessarily mean lower financial returns-and may actually enhance returns through
avoidance of companies that pose costly environmental risks-there have been no
emphatic judicial decisions on this aspect of trustees’ fiduciary duties. In Canada,
there is a dearth of case law on ethical investment altogether, although courts have
unequivocally affirmed that pension funds are subject to trust law precepts as clarified
by statute.’68 Both Manitoba and Ontario, however, have enacted legislation to
improve the prospects for ethical investment. Following recommendations from the
Manitoba Law Reform Commission, in 1995 the province’s Trustee Act’69 was
amended to explicitly permit trustees to consider non-financial criteria in developing
investment policies. 7 In 1988, Ontario enacted the South African Trust Investments
Act 171 to permit trustees to divest or to reject investments in companies doing business
in apartheid South Africa without infringing their duty despite the effect on
investment proceeds.
More radical possibilities for reform of pension funds can be found overseas. One
way in which pensions could become an instrument of environmental change is
through legislative requirements for trustees and their agents to take account of the
environmental effects of their investment decisions, if any, or at least to publicly
report on their policies in this respect. The UK was the first country to take a bold
step in this direction when, in July 1999, the government amended a regulation under
the Pensions Act 1995’72 in order to require occupational pension fund trustees to
disclose their policies on socially responsible investment and on the exercise of
shareholder rights, including voting rights.’73 A similar requirement was imposed on
local government pension funds.’74 This UK initiative stimulated similar reforms in
several European countries and Australia.’75 The SIO has been lobbying for such a
reform in Canada, and it supported an unsuccessful attempt in September 2002 to
pass at the federal level an opposition private member’s bill modeled on the UK
168 Bathgate v. National Hockey League Pension Society (1994), 16 O.R. (3d) 761 at 776, 110
D.L.R. (4th) 609 (C.A.), leave to appeal to S.C.C. refused [1994] 2 S.C.R. viii, 114 D.L.R. (4th) vii;
Boe v. Alexander (1987), 41 D.L.R. (4th) 520 at 526-27, 15 B.C.L.R. (2d) 106 (C.A.), leave to appeal
to S.C.C. refused [1988] 1 S.C.R xiv, 43 D.L.R. (4th) vii.
169 S.M. 1995, c. 14, s. 79.1.
170 Manitoba Law Reform Commission, Ethical Investment by Trustees (Winnipeg: Manitoba Law
Reform Commission, 1993).
‘ R.S.O. 1990, c. S.16, as rep. by Government Process Simplification Act (Ministry of the Attorney
General), 1997, S.O. 1997, c. 23, s. 12.
172 (U.K.), 1995, c. 26.
173 Occupational Pension Schemes (Investment, and Assignment, Forfeiture, Bankruptcy etc),
Amendment Regulations 1999, S.I. 1999/1849, s. 2(4).
174 Local Government Pension Scheme (Management and Investment of Funds) (Amendment)
Regulations 1999, S.I. 1999/3259, s. 5.
175 See Benjamin J. Richardson, “Pensions Law Reform and Environmental Policy: A New Role for
Institutional Investors?” (2002) 3:5 J. Int’l Fin. Markets: Law and Regulation 159.
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in
issues
law.’76 Internationally, legislation requiring pension fund managers to disclose or take
account of environmental, social, or ethical considerations in their investment policies
has now arisen in France,’77 Germany, 7 ‘ and Belgium.’79 The French law includes
obligations to actually consider environmental
investment decisions,
although these requirements pertain to public sector pensions. In Australia, the
Financial Services Reform Act 2001’8 applied an ethical disclosure obligation to a
wider range of investment products than that found in the European examples,
covering pensions, managed investment products, and investment life insurance
products. 2 Like the UK initiative, however, none of these reforms statutorily defines
“ethical investment”, and all only superficially address the problem of monitoring
compliance. Recent surveys of the effect of the UK reforms suggest that while there
has been a significant increase in the adoption of ethical investment policies by
pension funds, the quality and implementation of such policies has been quite
variable.’ 83 There has also been a major expansion in ethical investment in France
since 2000, possibly attributable to its recent legislative reforms.’84
Whereas the Canadian pension sector has faced the problem of reconciling
ethical investment with trustees’ fiduciary responsibilities, mutual funds have been
able to largely avoid this problem. This is because the mutual fund form, catering to
both retail and institutional investors, can be adapted to pursue a wide variety of
desired investment goals. Of course, when pursuing an ethical investment policy, a
mutual fund must exercise care to achieve the optimal financial returns within the
176 Bill C-394, An Act to amend the Pension Benefits Standards Act, 1985, 2d Sess., 37th Parl.,
2002.
177 Art. L214-39 C. mon. et fin.; Art. L135-8 C. sdcur soc.
178 Gesetz zur Reform der gesetzlichen Rentenversicherung und zur F6rderung eines
Kapitalgedeckten Altersvorsorgevern6gens (Altersvermdgensetz), v. 29.6.2001 (BGB 1.1, art. 10 115
Nr. 4).
179 Loi relative aux pensions compl~mentaires et au r~gime fiscal de celles-ci et de certains
avantages complkmentaires en matibre de s~curitM sociale, Moniteur belge / Belgisch Staatsblad, 15
May 2003, 2003-04-28/36, art. 42.
180 The relevant part of the French law provides: “I1 met en oeuvre les orientations de la politique de
placement. I1 contr6le le respect de celles-ci. II en rend compte reguli~rement au conseil de
surveillance et retrace notamment, a cet effet, la mani~re dont les orientations g~nrales de la politique
de placement du fonds ont pris en compte des considerations sociales, environnementales et 6thiques”
(C. sdcur soc., supra note 177).
181 (Cth.).
182 See Benjamin J. Richardson, “Ethical Investment and the Commonwealth’s Financial Services
Reform Act 2001” (2002) 2 Nat’l Envtl. L. Rev. 47.
183 Just Pensions, Do UK Pension Funds Invest Responsibly? A Survey of Current Practice on
Socially Responsible Investment by David Coles & Duncan Green (London: Just Pensions, 2002) at 1,
online: UK Social
Investment Forum
184 See European Sustainable and Responsible Investment Forum, “Socially Responsible Investment
Among European Institutional Investors: 2003 Report” at 46-48, online: Eurosif
186 See George Djurasovic, “The Regulation of Socially Responsible Mutual Funds” (1997) 22 J.
Corp. L. 257.
187 See e.g. Stephen I. Erlichman, “Making it Mutual: Aligning the Interests of Investors and
Managers-Recommendations for a Mutual Fund Governance Regime for Canada”, online: Ontario
Securities Commission
Industry
Canada, supra note 53; Ontario Securities Commission, “Regulating Conflicts of Interest in the
Management of Mutual Funds: The Current Regime” (1995) 18:9 O.S.C. Bull. 1167.
’88Supra note 68.
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Admittedly, some mutual funds are voluntarily disclosing their voting guidelines and
voting activity, but this disclosure is not occurring systematically. 189
Although mutual funds are seen as the preferred vehicle for ethical financing, the
mutual fund sector generally is not a natural ally of sustainable investment. Pension
fund investment is probably more compatible with sustainable investment. Pension
funds tend, on average, to hold shares for longer periods than mutual funds because
of their longer-term financial liabilities.’ 9 Because portfolio turnover ratios are lower
in pension funds than among other institutional investors, pension fund managers also
have more opportunity for engaging in shareholder activism. Furthermore, unlike the
mutual fund industry, pension funds are not competitive. Their focus on performance
is one of ensuring that returns are adequate to meet anticipated liabilities, not to
attract investors. Mutual funds do compete to attract investors, and this competition
leads to an emphasis on profit gains and market share, rather than long-term returns.
Furthermore, owing to their competitive nature, mutual funds are much less likely
than pension funds to be shareholder activists. 9′ This is because efforts by mutual
funds to increase corporate value through shareholder activism will benefit all
shareholders and may thus benefit rival funds. It must be noted, however, that the
distinction between mutual and pension fund investment styles can sometimes be
blurred, given that some pension funds invest through mutual funds rather than devise
their own investment portfolios.’92
In contrast
to equity investors, banks face some unique challenges and
opportunities for addressing environmental concerns. Unlike pension or mutual
funds, which must rely on publicly reported information to assess the environmental
performance of companies, banks have the advantage of being able to obtain
additional information about environmental risk and other aspects of a borrower’s
environmental performance as part of the loan process. Another difference between
investors and lenders in their responses to corporate environmental performance
stems from liability rules. Whereas investment shareholders are largely protected by
rules of limited company liability from the environmental liabilities of their investee
companies,’ 93 lenders face liability risks if they become too closely involved in their
189 See e.g. Susan Heinrich, “Ethical Funds Comes Clean on Voting Policies” Financial Post (6 July
2000) D4.
190 Public and union pension funds display this characteristic more than private pension plans: see
O’Connor, supra note 150.
191 See Eric Becker & Patrick McVeigh, “Social Funds in the United States: Their History, Financial
Performance, and Social Impacts”, in Fung, Hebb & Rogers, supra note 13, 44 at 64 (referring to very
low levels of shareholder resolutions sponsored by US ethical mutual funds).
192 See World Bank, Private Capital Flows to Developing Countries: The Road to Financial
Integration (Oxford: Oxford University Press, 1997) at 129.
193 See Kevin E Forbes, “Limited Liability and the Development of the Business Corporation”
(1986) 2 J.L. Econ. & Org. 163.
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FINANCING ENVIRONMENTAL CHANGE – B.J. RICHARDSON
borrower’s business or take possession of loan security. 9 4 So far, there is a paucity of
Canadian case law on lenders’ environmental liabilities, 9 ‘ although US litigation has
demonstrated the powerful effect lender liability can have on banks’ environmental
policies.’96
Even if a lender is shielded from direct environmental liability, its borrower’s
financial difficulties caused by an environmental problem could still be a reason for
concern. Insolvency law can have a bearing on this situation. Conflicts can arise
between the claims of creditor banks and any outstanding environmental expenses
owed by a bankrupt firm, such as the costs associated with a regulator’s cleanup
order.’97 The traditional norm in bankruptcy codes is that priority is given to the
claims of secured creditors such as bank
the absence of court
determinations to the contrary, this norm can result in environmental debts being
unpaid and so displaced onto society. Canadian courts have concluded that
environmental remediation and related expenses should sometimes take priority over
the distribution of assets to the bankrupt company’s creditors. In the notable
Panamericana case, the appointed receiver-manager was directed by the Alberta
Court of Appeal to implement the environmental authority’s order to clean up oil
wells in accordance with provincial environmental regulations, despite the corporate
licensee’s bankruptcy and even though the expense of protecting the wells meant less
money for distribution to creditors.’98 Consequently, when environmental reformers
address the role of the banking sector, they must pay attention to the unique problems
posed by lender liability and insolvency legislation.
lenders. In
Although it can thus be seen that the heterogeneity of financial service providers
requires various institution-specific reforms, there are also some common regulatory
themes. Liability
responsibilities, and
informational policy
to specific
institutional contexts, need to be applied throughout financial markets to create a
stronger foundation for sustainable investment. Harnessing financiers as drivers for
instruments, while all requiring adaptation
fiduciary
rules, economic
incentives,
194 See John J. Lyons, “Deep Pockets and CERCLA: Should Superfumd Liability Be Abolished?”
(1986-87) 6 Stan. Envtl. L.J. 271; Gunther Teubner, “The Invisible Cupola: From Causal to Collective
Attribution in Ecological Liability” (1994) 16 Cardozo L. Rev. 429 [Teubner, “The Invisible Cupola”].
195 See e.g. Busse Farms Ltd. v. Federal Business Development Bank (1996), [1997] 5 W.W.R. 34,
150 Sask. R. 305 (Q.B.), aff’d (1998) 168 D.L.R. (4th) 27, [1999] 7 W.WR. 737, 172 Sask. R. 133
(C.A.), leave to appeal to S.C.C. refused [1999] 3 S.C.R. vi [Busse Farms]. See also Jimmy Y Levy,
“Landlord and Lender Liability for Hazardous Waste Clean-up: A Review of the Evolving Canadian
and American Case Law” (1992) 20 Can. Bus. L.J. 269; Requadt, supra note 74.
196 See Scott R. Alexander, “CERCLA’s Web of Liability Ensnares Secured Lenders: The Scope and
Application of CERCLA’s Security Interest Exception” (1991) 25 Ind. L. Rev. 165.
197 See James D. Barnett, “Conflict Between Bankruptcy and Environmental Law and Policy: The
Courts Are Still Out” (1991) 1:2 Envtl. Fin. 191.
198 Panamericana de Bienes y Servicios v. Northern Badger Oil & Gas Ltd. (1991), 117 A.R. 44 at
59-61, 81 D.L.R. (4th) 280, [1991] 5 W.WR. 577 (C.A.), leave to appeal to S.C.C. refused [1992] 1
S.C.R. x; see also Canada Trust v. Bulora Corp. Ltd. (1980), 34 C.B.R. (N.S.) 145 (Ont. H.C.J.), aff’d
(1981) 39 C.B.R. (N.S.) 152 (Ont. C.A.).
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reforms
to provide stronger
requires complementary
sustainability
financial
incentives, provision of more and clearer environmental information, and more
effective leverage in corporate affairs. These are policy instruments that can support a
reflexive style of environmental governance that works with, rather than against, the
protocols and norms of financial markets. The role of these policy instruments in
promoting a broader climate conducive
to environmental governance through
financial markets is considered in the next section.
Ill. Regulating for the Financing of Environmental Change: The
Wider Context
A. Corporate Governance
A raft of regulatory reforms to financial institutions is necessary to provide a
stronger foundation for sustainable lending and investment. To begin with, the system
of corporate governance in Canada is not sufficiently supportive of shareholder
activism. Given the role of shareholder engagement as a pathway for ethical
investment, systems of corporate governance should be adjusted to enable or direct
investee shareholders to be more active in corporate decision making. Most Canadian
ethical funds merely use a screening approach, which tends to reduce their influence
on corporate management. Yet some companies may not be responsive to ethical
pressures derived simply from buying or selling their shares.199 Ethical fund screening
practices tend to reward “good” businesses but may do little to change the behaviour
of “bad” ones.2″0 A more activist approach may be needed in such circumstances.
Shareholder proposals sponsored by institutional investors are one means by
which institutions can wield influence over company management.” 1 Such proposals
can push companies
into structured dialogues with shareholders and other
stakeholders, in the hopes of changing corporate policy. In theory, given the size of
institutional investors’ stock holdings and their fiduciary obligations to enhance
shareholder value,
to challenge
underperforming companies. The reality, however, is that social and environmental
policy shareholder resolutions are not commonly used in Canada and are only used
with any regularity in the US and Britain; in the 1998 proxy season in the US, for
example, 289 ethical policy shareholder resolutions were filed at 116 companies. 2 2
These figures do not reflect additional, behind-the-scenes diplomacy, such as investor
shareholders meeting privately with management to make their views known.
investors should have adequate
incentives
199 See Sparkes, Socially Responsible Investment, supra note 42 at 29-35.
200 See Hebb, supra note 37 at 5.
201 See Diane Del Guercio & Jennifer Hawkins, “The Motivation and Impact of Pension Fund
Activism” (1999) 52 J. Fin. Econ. 293.
202 See Becker & McVeigh, supra note 191 at 64.
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FINANCING ENVIRONMENTAL CHANGE- B.J. RICHARDSON
Investor activism in Canada is presently limited, but is gradually garnering
support. Shareholder proposals have increased recently, in part due to the stronger
coordination of church-based investors through the TCCR.2 3 Canadian trade unions
through their pension plans are also exerting more influence. Survey data from the
Shareholder Association for Research and Education reveals that the number of
corporate governance and social responsibility proposals submitted by shareholders
increased from less than three in each year from 1994 to 1996, to sixty-three and forty
in 2000 and 2001, respectively.24 In 1998, a coalition of mainly labour unions and
church groups founded the Active Shareholder Working Group, which later played a
key role lobbying for amendments to company law rules on shareholder proposals. 5
Recently, the TCCR campaigned against Talisman Energy for investing in Sudan.
With the aid of public pensions including the Caisse de ddp6t et placement du
Quebec, the TCCR secured twenty-seven per cent support for its social resolution,2 6
which may well have contributed to the twenty-five per cent discount exacted by
shareholders on Talisman’s share price for a period. 7
Most shareholder proposals do not address social or environmental responsibility
concerns. Usually, investors get involved in takeover defences, charter amendments,
corporate restructurings, and CEO compensation deals.20 8 Of the forty proposals filed
in Canada in 2001, only two addressed such ethical concerns, namely proposals made
to Sears Canada and the Hudson’s Bay Company to improve their codes of conduct
with respect to labour standards. None of the forty shareholder proposals wooed a
majority of votes, although they may ultimately achieve more subtle results. On 30
April 2003, a new record was set when a shareholder proposal from Ethical Funds
toxic and
calling upon steel manufacturer IPSCO to disclose facility-specific
203 See online: Taskforce on the Churches and Corporate Responsibility
204 Shareholder Association for Research and Education, “Shareholders Back Calls for Disclosure
on Board Independence” Prospectus 1:2 (Fall/Winter 2001) 2, online: Shareholder Association for
Research and Education
Organization & Taskforce on the Churches and Corporate Responsibility, “Socially Responsible
Shareholdership in Canada: A Handbook for Institutional Investors” by Rory O’Brien at 7, online:
Social Investment Organization
205 Mark Thomsen, “Canadian Parliament Votes to Give Socially Responsible Shareholder Proposals
Equal Billing”, online: SocialFunds.com
206 See Christian Brothers Investment Services, Inc., “SRI: 2000 Active Ownership Strategy”
Principles: An Investment Newsletter (October 2000) 1 at 2, online: Christian Brothers Investment
Services, Inc.
207 See Alan Freeman, “Investors Eye Talisman’s Sudan Stake” The Globe and Mail (17 October
2001) B1; “Talisman Pullout from Sudan Would Benefit Its Investors” The Globe and Mail (17
October 2001) B12. Talisman’s share price began to rise again the day after the company announced
the sale of its controversial holdings in Sudan. See James Stevenson, “Talisman’s Sudanese Ethical
Discount Removed: Stock Closes Up 1.7%” Canadian Press (31 October 2002).
201 See MacIntosh, “Canadian Capital Markets”, supra note 3.
MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL
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greenhouse gas emissions received the support of a huge 49.2 per cent of the shares
voting.20 9
There has been a protracted debate in the corporate governance literature on
shareholder rights and democratization of company affairs. Commentators have
offered various explanations for the low levels of shareholder activism in Canada,
including the difficulty in coordinating and communicating among shareholders,
agency costs, and free rider problems.21 Macintosh argues that institutional investors’
ability to monitor investee companies is hampered by their large portfolios, limited
staff, and lack of appropriate expertise.21′ He also suggests that the need or desire of
investors to maintain liquid portfolios can result in the acquisition of small blocks
without significant voting clout.212 There is also the tendency of fund managers to
side with company management for fear of losing collateral business (e.g., banking
and insurance services). 213 However, a key barrier to institutional activism has been
legal restraints
impeding the ability of institutional investors to become more
involved in corporate governance.214
Recent amendments to the Canada Business Corporations Act (“CBCA”) should
facilitate shareholder proposals and communications on environmental and other
ethical concerns.215 Previously, the CBCA allowed registered shareholders to file
proposals provided that they were not submitted for “promoting general economic,
political, racial, religious, social or similar causes.” ‘216 The exclusion clause had been
exploited several times as grounds for refusing to circulate a shareholder proposal,
such as in 1987 when the Ontario Court of Appeal upheld Varity Corporation’s
in South Africa.217 Further,
refusal
communication between shareholders was severely restricted by reason of the
definition of “solicitation” regarding the soliciting of proxies under the act.2″ ‘
to circulate a proposal on disinvestments
209 Ethical Funds, News Release, “Record Support for Shareholder Proposal at IPSCO to Disclose
Toxic and Greenhouse Gas Emissions” (2 May 2003), online: Ethical Funds
210 See Catherine McCall & R6jane Wilson, “Shareholder Proposals, Why Not in Canada?” (1993)
5:1 Corp. Governance Rev. 12.
26 Can. Bus. L.J. 145 at 158-71.
211 Jeffrey G. Macintosh, “Institutional Shareholders and Corporate Governance in Canada” (1996)
212 ibid
213 Pound argues that banks and insurance companies are more likely than pension funds to support
management in a proxy contest, possibly so as to preserve future business ties with the company: John
Pound, “Proxy Contests and the Efficiency of Shareholder Oversight” (1988) 20 J. Fin. Econ. 237.
214 See Macintosh, “Canadian Capital Markets”, supra note 3 at 387.
215 See An Act to amend the Canada Business Corporations Act and the Canada Cooperatives Act
and to amend other Acts in consequence, S.C. 2001, c. 14 [CBCA Amendments].
216 R.S.C. 1985, c. C-44, s. 137(5)(b) [CBCA].
217 Re Varity Corp. and Jesuit Fathers of Upper Canada (1987), 60 O.R. (2d) 640, 41 D.L.R. 384
(C.A.), aff’g (1987) 59 O.R. (2d) 459, 38 D.L.R. (4th) 157 (H.C.J.) [Varity]; see also Sparkes, Socially
Responsible Investment, supra note 42 at 311.
218 CBCA, supra note 216, s. 150(1)(b).
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FINANCING ENVIRONMENTAL CHANGE – B.J. RICHARDSON
Restrictive interpretations of the rules by the courts narrowed their interpretation even
further.219 The recent amendments to the CBCA were the result of years of lobbying
by the TCCR, a fact that underscores the role of ethical investor associations as a
necessary ingredient for achieving legislative reform.
The amended CBCA requires management to circulate all shareholder proposals
unless they fail to deal substantially with the business affairs of the corporation.22
Concomitant amendments include an increase in the word count for proposals from
two hundred to five hundred words,22 ‘ and a clarification of the definition of
“solicitation” to allow shareholders to communicate freely with each other, provided
that the shareholder is not seeking to obtain another shareholder’s proxy.222 Further,
(i.e.,
rules permitting shareholder proposals only from registered shareholders
investment companies that are the shareholders of record) have been repealed, now
allowing beneficial shareholders to also file proposals. 223 Apart from the shareholder
proposal provisions, the CBCA requires that shareholders approve fundamental
changes to the corporation, including changes to the corporate articles and bylaws.224
As the CBCA covers some 160,000 federally incorporated businesses, including
almost fifty per cent of the largest companies in Canada, the potential impact of these
reforms is significant.
Commentators have suggested a range of other corporate governance reforms that
could further empower institutional investors. For example, Gilson and Kraakman
independent directors to corporate boards,
proposed appointment of minority
nominated by institutional investor groups rather than enterprise management.225
Another approach, based on the idea of obliging investee shareholders to be more
active, would require investment institutions to register their share votes, thereby
spurring institutions to formulate and express a view on all issues put to a vote at
shareholder meetings. In response to the Myners report, which was critical of the
“culture of non-intervention” among British
the UK
Department for Work and Pensions has proposed a legal duty that pension fund
administrators “must, in respect of any company or undertaking … in which they
invest such assets, use such rights and powers as arise by virtue of such investment in
institutional
investors,
219 See e.g. Verdun v. Toronto-Dominion Bank, [1996] 3 S.C.R. 550, 139 D.L.R. (4th) 415
(beneficial owner not entitled to submit proposals); Varity, supra note 217.
220 CBCA, supra note 216, s. 137(5), as am. by CBCA Amendments, supra note 215, s. 59(3).
221 CBCA,
ibid., s. 137(3), as am. by CBCA Amendments, ibid., s. 59(2); Canada Business
Corporations Act Regulations 2001, S.O.R./2001-512, s. 49.
222 CBCA, ibid., s. 147, as am. by CBCA Amendments, ibid., s. 67(2).
223 CBCA, ibid., s. 137(3), as am. by CBCA Amendments, ibid., s. 59(1).
224 CBCA, ibid., ss. 103, 173.
225 Ronald J. Gilson & Reinier Kraakman, “Reinventing the Outside Director: An Agenda for
Institutional Investors” (1991) 43 Stan. L. Rev. 863.
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the best interests of the members and beneficiaries of such scheme.” ‘226 This would
include diligent voting of shareholding rights. The US has also made reforms in this
area. Effective 6 August 2003, the Securities and Exchange Commission (“SEC”) has
amended its regulations under the Investment Advisers Act of 1940227 to require all US
mutual fund companies and investment advisers to disclose proxy votes, voting
policies, and their actual voting record.228
Canadian regulators have been toying with changes to the rules governing
disclosure of institutional investors’ voting policies and practices. The Canadian
Securities Administrators recently proposed a rule that would require mutual funds’
annual Management Discussion of Fund Performance (“MDFP”) to include a
statement of “how the portfolio advisers or the manager of the investment fund voted
on matters relating to issuers of portfolio assets of the investment fund, other than
routine business of those issuers. 229 While this proposal ostensibly mandates
disclosure of voting, because the disclosure would appear in the annual MDFP, any
discussion by the mutual fund of its voting record would likely be cursory,
perfunctory, and rather abstract. There would likely be few details given of votes on a
company-specific basis, so investors would lack information to determine whether
votes were being cast appropriately. Coupled with the existing rule prohibiting mutual
funds from acquiring active, large ownership rights in investee companies, the scope
for investor participation in corporate governance remains legally quite restricted in
Canada.
230
B. Economic Instruments
Economic
instruments such as environmental taxes and tradable pollution
allowances can greatly improve the pricing of environmental behaviour in markets
and thereby provide incentives to financial institutions to favour companies that are
less injurious to the environment. Economic instruments have figured prominently in
2 2 6 U.K., Department for Work and Pensions, “Encouraging Shareholder Activism: A Consultation
for Work and Pensions
227 15 U.S.C. 80b-I (2003).
228 Proxy voting, 17 C.F.R. 275.206(4)-6 (2003).
229 “National Instrument 81-106: Investment Fund Continuous Disclosure: Form 81-106F1 Contents
of Annual and Quarterly Management of Report of Fund Performance” at 6, online: Saskatchewan
Financial Services Commission
230 See “National Instrument 81-102: Mutual Funds” (supra note 68), which restricts mutual funds
to holding securities representing no more than 10 per cent of the voting ights of issued shares, or
purchasing a security for the purpose of exercising control over management of the issuer of the
security. Similar restrictions exist in other jurisdictions, such as in the EU. See EC, Directive
2001/108/EC of the European Parliament and of the Council of 21 January 2002 amending Council
Directive 85/611/EEC on the coordination of laws, regulations and administrative provisions relating
to undertakings for collective investment in transferable securities (UCITS), with regard to
investments of UCITS, [2002] O.J. L. 41/35.
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FINANCING ENVIRONMENTAL CHANGE – B.J. RICHARDSON
recent environmental law reform debates. 231′ The OECD, an active proponent of their
use, has defined them as “instruments that affect costs and benefits of alternative
actions open to economic agents, with the effect of influencing behaviour in a way
that is favourable to the environment.” 232 Economic instruments are applauded for
their ability to promote more cost-effective achievement of environmental policy.233
The methodological pluralism of economic instruments allows each business to tailor
its own means of reducing pollution. In relation to the financial side of sustainable
development, economic instruments should help make the financial costs and benefits
of corporate environmental behaviour more
to the
calculations of investors and lenders. By harnessing the methodologies of the market,
economic policy instruments can help implement a “reflexive” style of legal
regulation, whereby businesses can learn more about the cost of their impacts and
adjust
reflect
environmental performance and risk, ethical financing will remain somewhat
arbitrary in determining which businesses to support.
their behaviour accordingly.234 Unless equity and debt prices
transparent and relevant
Not only can economic instruments be used to good effect as a means of
environmental policy, they can be applied directly to the activities of lenders and
investors to encourage environmentally beneficial financing. For instance, a tax on
transactions in financial markets could discourage short-term speculative trading and
thereby promote sustainable productive investments. Baker and Fung advocate a tax
on financial market short-term trading (covering trades in stock, bonds, options, etc.),
and the allocation of the money raised to public investments. 235 They point out that
the US, for instance, actually had a short-term trading tax until 1964.236
Another possibility
is to offer tax concessions
to profits associated with
environmental financing. Because companies engaged in environmentally beneficial
activities tend to be disadvantaged by markets that fail to take account of the negative
and positive environmental externalities of economic activity, such tax concessions
are a justified subsidy. The Netherlands has gone the furthest in using tax law in this
way. The Dutch Green Investment Directive was established in 1995 to provide tax
deductions for interest payments and dividend yields from government-approved
231 See generally Theodore Panayotou, Instruments of Change: Motivating and Financing
Sustainable Development (London: Earthscan, 1998).
232 OECD, Environmental Policy: How to Apply Economic Instruments (Paris: OECD, 1991) at 10.
See also OECD, Climate Change: Designing a Practical Tax System (Paris: OECD, 1992); OECD,
Managing the Environment: The Role of Economic Instruments (Paris: OECD, 1994).
233 See generally Richard B. Stewart, “Economic Incentives for Environmental Protection:
Opportunities and Obstacles” in Richard L. Revesz, Phillippe Sands & Richard B. Stewart, eds.,
Environmental Law, the Economy and Sustainable Development (Cambridge: Cambridge University
Press, 2000) 171; T.H. Tietenberg, “Economic Instruments for Environmental Regulation” (1990) 6:1
Oxford Rev. Econ. Pol’y 17.
234 See Orts, supra note 137.
235 Baker & Fung, supra note 13, 36.
236 Ibid. at 37.
188
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that
the Dutch environmental agency has determined
environmental investment funds.237 To qualify, a fund must invest at least seventy per
cent of its assets in environmentally friendly projects (e.g., renewable energy
technologies)
to be
acceptable.238 The attractive interest rate returns help improve the risk-return margin
and thereby induce more investors to support these types of developments.239 Recent
analyses herald the success of the Dutch scheme in generating increased investment
in environmental projects.24 The Dutch innovation also points to how one determines
objective criteria for ethical investment.
Although such an initiative has not yet been contemplated in Canada, the SIO has
sought to have income tax legislation amended to provide more finance for ET. The
SIO has been lobbying the federal government to give individuals the right to invest
their Retirement Savings Restoration Plan (“RSRP”) in loan funds for low-income
communities through ETI schemes.’ Currently, federal policy is to permit RSRP
eligibility only to funds that are guaranteed by governments. The federal Department
of Finance has cited technical considerations, such as non-arm’s-length dealing, in
rejecting the SIO’s proposal.242
While the history of implementing economic instruments suggests that staunch
industry opposition can emasculate reform proposals,243 in the context of financial
service markets, the prospects for reform seem more promising. Environmental taxes
directly affect company balance sheets, and financial institutions should support
pollution charges, since as low-energy users, they would not be heavily penalized by
new charges.2″ For tradable pollution allowances, companies that are able to generate
cost savings through trade in pollution allowances could become more attractive
investment opportunities for financial organizations. Creating new markets for
environmental goods could thereby also significantly augment environmental
financing.245
237 Jeucken, supra note 156 at 92-94.
238 Ibid. at 94.
239 Ibid. at 95.
240 Bert Scholtens, “Greenlining: Economic and Environmental Effects of Government Facilitated
Lending to Sustainable Economic Activities in the Netherlands”, online: Rijksuniversiteit Groningen
241 Social Investment Organization, “SIO Calls for RRSP Fairness” 10 Forum (December 2001) 4.
242 Ibid.
243 See e.g. Benjamin J. Richardson, “Economic Instruments and Sustainable Management in New
Zealand” (1998) 10 J. Envtl. L. 21; Benjamin J. Richardson, “Economic Instruments in UK
Environmental Law Reform: Is the UK Government ‘Sending the Right Signals’?” (2001) 3 Eur. J. L.
Ref. 427.
244 On the in-house environmental impacts of financiers see e.g. Penny Street & Philip E.
Monaghan, “Assessing the Sustainability of Bank Service Channels” in Bouma, Jencken & Klinkers,
supra note 72, 72.
245 See Sparkes, Socially Responsible Investment, supra note 42 at 168-69 (discussing new market
opportunities for financiers from carbon trading schemes).
2004]
FINANCING ENVIRONMENTAL CHANGE- B.J. RICHARDSON
in 1994,
To what extent would Canadian authorities be prepared
to use economic
instruments in these ways? Compared to other OECD nations, Canada has been rather
taciturn in embracing economic instruments for environmental policy.2 46 In an
the Canadian ministers of the
exploration of possible applications
environment and finance established the Task Force on Economic Instruments and
Disincentives to Sound Environmental Practices.247 The Canadian Environmental
Protection Act, 1999’s mandate to authorities to introduce economic instruments248
has not yet been translated into practice, though Canadian authorities have tentatively
begun to implement pollution allowance trading.249 Ontario, for instance, has adopted
an emissions reduction trading program for sulphur dioxide and nitrogen oxides.25
Further, commercial fisheries accounting for over half of the value of Canadian fish
landings have been managed since the early 1990s through more than forty property
rights-based programs analogous to emissions trading.25′ The federal government’s
Climate Change Plan of 2000 envisages a domestic, carbon trading scheme to help
meet obligations under the Kyoto Protocol,2 2 but the government has so far rejected
using energy taxes.253 Certain tax concessions are being offered for accelerated
.2 The extensive environmental
depreciation of some renewable energy technologies
taxes in the EU, particularly the Benelux and Scandinavian countries, point to some
new directions Canadian authorities might one day pursue if the political will
arises.
255
4
C. Environmental Liability for Financial Sponsors
Because financial institutions intend to profit from the companies they fund,
arguably they should share responsibility for any environmental costs caused by such
companies. The “polluter pays” principle, which has dominated discussions of
246 See Russell S. Jutlah, “Economic Instruments and Environmental Policy in Canada” (1998) J.
Envtl. L. & Prac. 323.
247 Canada, Final Report of the Task Force on Economic Instruments and Disincentives to Sound
Environmental Practices (Ottawa: Task Force on Economic Instruments and Disincentives to Sound
Environmental Practices, 1994).
248 CEPA, supra note 158, s. 322.
249 See Katrina Miriam Wyman, “Why Regulators Turn to Tradeable Permits: A Canadian Case
Study” (2002) 52 U.T.L.J. 419.
250 Emissions Trading, 0. Reg. 397/01.
251 See Wyman, supra note 249 at 423-24.
252 Government of Canada, “Climate Change Plan for Canada”, online: Government of Canada
253 See “Environment Minister Rules Out Carbon Tax to Fight Greenhouse Gases” Canadian Press
(1 May 1999).
254 See Government of Canada, supra note 252.
255 Among the growing literature see EC, Commission, Database on Environmental Taxes in the
European Union Member States, Plus Norway and Switzerland; Evaluation of Environmental Effects
of Environmental Taxes (Luxembourg: EC, 1999); Jarmo Vehmas et al., “Environmental Taxes on
Fuels and Electricity-Some Experiences from the Nordic Countries” (1999) 27 Energy Pol’y 343.
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environmental liability, focuses on what should be paid for rather than who is the
polluter.256 The precept that liability should attach to those that “cause” pollution begs
the question of what is meant by “cause”. Without loans from banks or equity
purchases by investors, many companies would be unable to continue financing their
activities without major adjustment. Financial sponsorship is thus intimately part of
the “cause” of corporate activities that harm the environment. Financiers’ contribution
here differs from that of other stakeholders in a business, such as its workers and
suppliers, because lenders and investors potentially wield considerably more power
over corporate management than other stakeholders. By making financial sponsors
partly liable for such harms, there would exist a potent disincentive to enter into
financial relationships with polluting industries. This should lead to fewer polluting
developments and the decline of harmful industries.
lender liability, whereby a bank becomes responsible for
Environmental liabilities have so far arisen primarily in relation to debt financing.
There are several ways by which environmental pollution might affect banks.”7 The
first is direct
the
environmental liabilities of its client. Depending on the applicable environmental law,
this could arise for a bank by: taking title to property pursuant to foreclosure; acting
in a fiduciary capacity, including managing day-to-day operations of industrial
facilities; and owning premises previously contaminated by toxic substances. The
financial institution may find itself faced with remediation costs imposed by an
environmental regulator that far exceed the value of the original loan. Second,
associating with polluting companies might pose a “reputational” risk for lenders. In
the context of heightened societal concem for the environment, financial institutions
may feel the need to attach more importance to the fostering of good standing in areas
of social responsibility, environmental performance, and ethical integrity.2 8 Third,
lenders may be confronted with indirect credit risks caused by environmental
problems that pose a financial hardship to a borrower. Environmental costs that
undermine a company’s ability to repay loans can ensue from the purchase of
equipment required to meet pollution permit standards or fines for non-compliance.
The value of contaminated real property collateral can also decline dramatically, and
in an insolvency situation, a lender’s claims may not necessarily have priority over
those of other creditors. 9
256 See Sanford E. Gaines, “The Polluter-Pays Principle: From Economic Equity to Environmental
Ethos” (1991) 26 Tex. Int’l L.J. 463.
257 See Christopher Stoakes, “The Loans that Come Back to Haunt” Euromoney (March 1997) 34;
Mark A. Hofmann, “Banks Must Use Care in Assessing EEL Risks” (1994) 28:15 Bus. Ins. 31.
258 Consider, for example, how the World Bank’s reputation has suffered from its sponsorship of
environmentally harmful projects in developing countries. See Bnuce Rich, Mortgaging the Earth:
The World Bank, Environmental Impoverishment and the Crisis of Development (Boston: Beacon
Press, 1994).
259 See Debra L. Baker, “Bankruptcy-The Last Environmental Loophole?” (1993) 34 S. Tex. L.
Rev. 379.
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FINANCING ENVIRONMENTAL CHANGE – B.J. RICHARDSON
to eschew
incentives for banks
Apart from the likely political obstacles to making lenders vicariously liable for
the environmental harms of their borrowers, commentators have discovered that there
is considerable difficulty in designing an optimal liability regime–one that provides
appropriate
the funding of environmentally
contentious developments, but does not stifle socially valuable investments.26 Two
aspects to this problem are retroactive liability and joint and several liability. While
the retroactive character of some environmental
liability regimes may further
environmental compensation goals, there is not much of a deterrence effect from
penalizing organizations for unforeseeable, non-negligent contamination caused by
distant activities.26 This situation can be compounded by the presence of joint and
several liability, which is a mechanism for mutual regulation, encouraging each party
to contract only with other reputable parties and creating strong incentives for parties
to monitor one another’s behaviour.262 Joint and several liability rules may be at odds
with the polluter pays principle to the extent that they encourage the channelling of
liability to the deepest pockets, often those of the financial lenders.263 This can cause
“overdeterrence” of deep pocket parties and “underdeterrence” of less solvent parties,
who may believe that no claims will be brought against them for environmental
harm.”6 Allowing deep pocket parties to recover contributions from joint tortfeasors
generates additional transaction costs and is of little value if the joint tortfeasors are
insolvent.
Overall, current economic theory suggests that a model of “partial”
lender
liability for borrowers’ environmental harms is appropriate.265 This may mean limiting
liability, as banks suggest, to where they exercise operational control, because it is
only in such cases that lenders can reasonably be assumed to understand what is
actually happening. However, in the context of reforms proposed to corporate
environmental reporting and financial regulation, liability may be justified in a wider
class of situations where financiers have the capacity to
influence corporate
environmental conduct.
Since the early 1990s, Canadian
to
environmental liability threats.2″ The Canadian Bankers Association has expressed
its opposition to environmental liability laws that would impose retroactive and joint
liability, and it has stated that merely holding a security interest in contaminated
lenders have become more sensitive
260 See Rohan Pitchford, “How Liable Should a Lender Be? The Case of Judgment-Proof Finns and
Environmental Risk” (1995) 85 Am. Econ. Rev. 1171.
261 See Lyons, supra note 194.
262 See Teubner, “The Invisible Cupola”, supra note 194.
263 See Tom H. Tietenberg, “Indivisible Toxic Torts: The Economics of Joint and Several Liability”
(1989) 65 Land Econ. 305.
264 See Michael J. Gergen, “The Failed Promise of the ‘Polluter Pays’ Principle: An Economic
Analysis of Landowner Liability for Hazardous Waste” (1994) 69 N.YU.L. Rev. 624.
265 For details on what is “partial” see Pitchford, supra note 260.
266 See Heather D. Whyte, “Environmental Liability Scares Away Bank Loans” The Financial Post
(19 June 1992) 5; Tyrus Reiman, “Lender Liability All the Rage” (1991) 15:4 Can. Law. 33.
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property should not trigger liability for environmental cleanup.267 Under both
provincial and federal environmental legislation, owners and those in possession or
control of property may be held liable for any environmental damage.26 Lenders who
hold a security interest the land of the creditor may be exposed to environmental
liability if the lender claims the security and possesses the property. It is unlikely,
however, that current legislation would ensnare lenders. In British Columbia, for
instance, the Waste Management Ac.?69 and the Contaminated Sites Regulation27
impose liability on lenders and their representatives only when their acts or omissions
directly cause or contribute to the contamination of the property. There is, as yet, little
liabilities.27″ ‘ It should be noted,
Canadian case
however, that since banks generally act through receivers, who are agents of the
defaulting corporation and not the lender, banks are still financially vulnerable if a
client’s loans cannot be repaid and its collateral property is degraded and made
worthless.
law on lenders’ environmental
As the US Superfund experience demonstrates, the banking industry is able to
effectively lobby against changes to environmental liability regimes that might hurt
its financial position. Following a series of court judgments that interpreted the
environmental liability provisions of the Superfund legislation272 as making banks
jointly liable for cleanup of contaminated land when they had the “capacity to
influence” clients
their financing of the management of polluting
enterprises,”‘ the major banks successfully pressured Congress into amending the
legislation to provide them with a stronger safe harbour.274 The legislation clarified
what actions lenders may take without becoming liable as an owner of contaminated
property, including what conduct constitutes “participation in management”. The US
experience has influenced developments in Europe, where the European Commission
through
267 Letter from Paul Griffin, Director, Provincial & Community Affairs, Western Canada, Canadian
Bankers Association, to Margaret Eriksson, Chair, British Columbia Advisory Panel on Contaminated
Sites (23 July 2002), online: Ministry of Water, Air & Land Protection
268 See Adam Szweras & Risa Schwartz, “Lender Liability: Responsibility vs. Deep Pockets”
(1995) 19:4 Can. Law. 39.
269 R.S.B.C. 1996, c. 482, s. 26.5(3).
270 B.C. Reg. 375/96, ss. 20, 25.
271 See e.g. Busse Farms, supra note 195. See also Levy, supra note 195.
272 Known in full as the Comprehensive Environmental Response, Compensation and Liability Act,
42 U.S.C. 9601-9675 (1980).
273 See especially United States v. Fleet Factors Corp., 901 F.2d 1550 (11th Cir. 1990) [Fleet]; see
further Joseph Jude Norton, “Lender Liability in the United States” in Ross Cranston ed., Banks,
Liability andRisk (London: Lloyd’s of London Press, 1995) 329 at 358.
274 See Asset Conservation, Lender Liability and Deposit Insurance Protection Act of 1996, Pub. L.
No. 104-208, 2501-04, 110 Stat. 3009; see also Olaf de Senerpont Domis, “New Law Finally
Limits Environmental Liability” American Banker (2 October 1996) 3.
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FINANCING ENVIRONMENTAL CHANGE – B.J. RICHARDSON
released in 2002 a draft environmental liability directive.275 Following pressure from
financial markets, the Commission’s proposal avoids specifically attaching liability to
financial sponsors but leaves open the possibility of lender liability where banks
exercise operational control over polluting facilities or sites.276 Canadian banks have
similarly demonstrated
liability-
producing laws. Recently, the federal government amended the Nuclear Safety and
Control Act to make it easier for private sector financial institutions to own and build
nuclear power plants in Canada by making it clear that banks and other financing
institutions
that invest in nuclear reactors could not be held responsible for
environmental expenses.277
their ability to thwart potential environmental
In addition to the question of lender environmental liability, there is the older and
more heated debate on shareholder liability.278 The cardinal principle in Western
systems of company law is that the company is a separate legal person from the
members who constitute it.279 A corollary principle is that, absent exceptional
circumstances, investors (i.e., shareholders) in the company are not liable beyond the
amount they invest. If the value of liability or other claims against the company
exceeds the value of the firm’s assets, the owners risk losing only their investment in
the company. Corporate limited liability has the side effect of transferring business
risks to creditors, and it can undermine the polluter pays principle to the extent that
insolvent firms are able to abandon environmental debts. Thus, in principle, imposing
liability on institutional shareholding investors for the environmental impacts of their
portfolio companies could promote ethical investment because of the lower liability
risks offered by green companies.
In reality, the issue of shareholder liability is politically contentious-at odds
with revered notions of corporate
limited liability-and could create major
disincentives to new investment. The ceiling on shareholder liability is said to be
justified as serving a number of beneficial functions,280 including encouraging new
business formation; improving the liquidity and efficiency of security markets; and
enabling investors to achieve a less risky, diversified portfolio of assets by reducing
275 EC, Commission, Proposal for a Directive of the European Parliament and of the Council on
Environmental Liability with Regard to the Prevention and Remedying of Environmental Damage,
[2002] O.J. C. 151/132. The directive is likely to be adopted into law in 2004.
276 See Benjamin J. Richardson, “Environmental Liability and Banks: Recent European
Developments” [2002] J.I.B.L. 287.
277 Nuclear Safety and Control Act, S.C. 1997, c. 9, as am. by An Act to Amend certain Acts and
instruments and to repeal the Fisheries Prices Support Act, S.C. 2002, c. 17, ss. 22-23.
278 See Frank H. Easterbrook & Daniel R. Fischel, “Limited Liability and the Corporation” (1985)
52 U. Chicago L. Rev. 89.
279 See e.g. Salomon v. Salomon and Co. Ltd. (1896), [1897] A.C. 22, [1895-991 All E.R. Rep. 33,
13 T.L.R. 46 (H.L.). On Canadian law see e.g. Jacob S. Ziegel, “Is Incorporation (with Limited
Liability) Too Easily Available?” (1990) 31 C. de D. 1075.
280 See Easterbrook & Fischel, supra note 278 at 94.
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investors’ needs to closely monitor corporate management.2″‘ These justifications for
limited liability have, however, been strongly contested.282 First, limited shareholder
liability is, in effect, a subsidy for investment, insulating shareholders from the
environmental risks of their corporations and so encouraging overinvestment in
hazardous activities.283 Moreover, the concentration of stock ownership in a few
hands suggests that the reality of shareholder and corporation separation can be a
fiction. In fact, for a closely held corporation or corporations wholly owned by a
parent corporation, it has been argued that limited liability should be abandoned.284
Additionally, major institutional shareholders, who are relatively well placed to
obtain information and monitor the risks of companies’ activities, may be in a
position to influence the environmental activities of corporations. By contrast, the
victims of toxic torts and statutory violations are arguably less well placed to monitor
and avoid the hazards of companies.
Various mechanisms have been devised to neutralize the adverse effects of
limited liability short of its wholesale abandonment. These
include equitable
corporate veil-piercing rules and statutory exceptions where actions inconsistent with
the separation of the corporation from its owners have been taken.285 Among the
various academic proposals on where to strike the balance on the continuum of
liability, Mendelson has advocated a “capacity to control” test whereby major
investors possessing a controlling influence would be held liable for corporate
wrongs.286 Already, Superfund liability was interpreted in the seminal Fleet Factors
Corporation case as extending to a bank where its involvement in the financial
management of the corporation gave it the “capacity to influence” decisions despite
no actual involvement in the business.287 Liability for a corporation’s environmental
damages could also be imposed on a shareholder when the size of its holdings gave it
the capacity to significantly influence the corporation. Consequently, institutional
investors
to supervise company
managers more closely.288 While Canadian legislators and courts do not appear likely
in a controlling position would be compelled
281 See Forbes, supra note 193; Frank H. Easterbrook & Daniel R. Fischel, The Economic Structure
of Corporate Law (Cambridge, Mass.: Harvard University Press, 1991).
282 See Christopher D. Stone, “The Place of Enterprise Liability in the Control of Corporate
Conduct” (1980) 90 Yale L.J. 1; James A. Brander & Tracy R. Lewis, “Oligopoly and Financial
Structure: The Limited Liability Effect” (1986) 76 Am. Econ. Rev. 956.
283 See Stone, ibid.
284 See Paul Halpern, Michael Trebilcock & Stuart Tumbull, “An Economic Analysis of Limited
Liability in Corporation Law” (1980) 30 U.T.L.J. 117 at 148.
285 See e.g. Stephen B. Presser, “Thwarting the Killing of the Corporation: Limited Liability,
Democracy, and Economics” (1992) 87 Nw. U. L. Rev. 148; Carsten Alting, “Piercing the Corporate
Veil in American and German Law-Liability of Individuals and Entities: A Comparative View”
(1995) 2 Tulsa J. Comp. Int’l L. 187.
(2002) 102 Colum. L. Rev. 1203.
286 Nina A. Mendelson, “A Control-Based Approach to Shareholder Liability for Corporate Torts”
287 Fleet, supra note 273 at 1557.
288 See Mendelson, supra note 286.
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FINANCING ENVIRONMENTAL CHANGE- B.J. RICHARDSON
to embrace any far-reaching changes to the doctrine of corporate limited liability in
the foreseeable future, some measure of corporate veil-piercing should be encouraged
if financial institutions are to take more care in assessing the environmental risks
associated with the companies they sponsor.
required
to routinely report
D. Corporate Environmental Reporting
A fourth pillar for environmentally responsible financing is obliging companies
to report on their environmental performance. While Canadian companies are not
currently
their fmancial statements on their
environmental activities and costs, the regulatory trend in other jurisdictions is
towards mandatory corporate environmental
is environmental
reporting relevant to ethical investment and lending? It is well documented that the
ethical financing sector utilizes corporate annual reports and accounts in their
assessment of companies. 89 Financial
and
comprehensive information available to support efficient investment and lending
decisions. Mandating disclosure of environmental liabilities and costs under securities
laws and other company legislation can facilitate financiers’ appraisal of the
environmental behaviour of businesses. In theory, if accurate information is publicly
available, market forces can respond by feeding environmental costs and performance
into the cost and terms of finance.
institutions must have
reporting. Why
in
timely
Corporate environmental reporting in Canada and other countries so far has
occurred mostly on a voluntary basis, and consequently, the scope and quality of
corporate disclosure has been uneven.29 Although banks can use contractual
mechanisms to compel borrowers to provide certain environmental information as
part of loan appraisal procedures, equity investors depend on publicly available
information. European countries are leading the trend toward mandatory public
environmental reporting, with reforms to this end adopted in Denmark, Norway,
Sweden, the Netherlands, and Australia.29″ ‘ In 2002, the European Commission
published a report entitled Corporate Social Responsibility, which refers to the
reporting standards.292 There are also
desirability of corporate environmental
extensive environmental disclosure
the SEC’s reporting
rules contained
in
289 See George Harte, Linda Lewis & David Owen, “Ethical Investment and the Corporate
Reporting Function” (1991) 2 Critical Persp. Acct. 227 at 234.
290 See e.g. James Guthrie & Lee D. Parker, “Corporate Social Disclosure Practice: A Comparative
International Analysis” (1990) 3 Advances in Pub. Int. Acct. 159.
291 See KPMG Environmental Consulting, International Survey of Environmental Reporting (De
Meern, Neths.: KPMG Environmental Consulting, 1999), online: Scientific
for
Environmental Management
292 EC, Commission, Corporate Social Responsibility: A Business Contribution to Sustainable
Development (Luxembourg: EC, 2002) at 19, online: Europa
Institute
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requirements, which have operated since the early 1970s.293 Yet even the previously
revered US reporting system showed itself to have serious flaws in the wake of the
Enron scandal, which occurred in part because of the SEC’s inadequate monitoring of
Enron’s financial accounts and reports. 94 Regulating environmental reporting is most
likely to be effective when accompanied by detailed guidance on reporting criteria.
is no reference
While the CBCA contains extensive provisions on corporate financial disclosures,
to environmental reporting.295 The provincial securities
there
commissions oblige public corporations to report the current and anticipated financial
or operational effects of environmental protection requirements
in an Annual
Information Form (“mIF”). 2 96 This requirement, however, is easily discharged with a
few perfunctory words. For example, Shell Canada’s 2002 AIF, a short document of
to environmental
some twenty-five pages, contains only one page devoted
information with a brief statement of environmental expenditures. 297 The AlE
is
complemented by other Canadian environmental reporting systems, such as the
National Pollutant Release Inventory, which requires businesses to report on releases
and transfers of many substances. 298 A recent survey commissioned by Industry
Canada on corporate environmental reporting revealed that only twenty-six per cent
of Canada’s one hundred largest companies routinely prepare environmental or social
reports, many of which offer only single, issue-by-issue analyses without canvassing
broader linkages between economic and environmental practices.299 Other studies of
environmental reporting
in Canada have concluded that mandating additional
disclosure “would seem to be the only successful alternative.””3 ‘
Besides regular
systems
(“EMS”s) can help financial institutions evaluate the environmental performance of
clients.30 ‘ In essence, EMSs provide a framework of standards and processes for
reporting, corporate environmental management
293 See Cynthia A. Williams, The Securities and Exchange Commission and Corporate Social
Transparency” (1999) 112 Harv. L. Rev. 1197.
294 See U.S., Staff of Senate Committee on Governmental Affairs, Financial Oversight of Enron:
The SEC and Private-Sector Watchdogs, 107th Cong., Committee Print (2002).
295 Supra note 216, Part XIV on financial reporting.
296 For instance, as prepared in accordance with the Ontario Securities Commission, “Policy
Statement 5.10: Rule 51-501 AIF and MD&A” (2000) 23:50 O.S.C. Bull. 8365.
297 Shell Canada, “Annual Information Form” at 14, online: Shell Canada Limited
298 See Bradley C. Karkkainen, “Information as Environmental Regulation: TRI and Performance
Benchmarking, Precursor to a New Paradigm?” (2001) 89 Geo. L.J. 257 at 348.
299 Stratos, Stepping Forward: Corporate Sustainability Reporting in Canada (Ottawa: Stratos,
2001), online: Stratos
300 Nola Buhr & Marty Freedman, “A Comparison of Mandated and Voluntary Environmental
Disclosure: The Case of Canada and the United States”, online: California State University Stanislaus
301 See John Voorhees, “Global Environmental Solutions: Management Systems and Synchronicity”
(1999) 28 Stetson L. Rev. 1155; David Monsma, “Sustainable Development and the Global Economy:
New Systems in Environmental Management” (2000) 24 Vt. L. Rev. 1245.
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FINANCING ENVIRONMENTAL CHANGE- B.J. RICHARDSON
197
corporations to adopt so as to improve their internal use of materials and energy and a
structure for companies to identify, appraise, and minimize their environmental risks.
By summarizing environmental performance data, EMSs can help
financial
organizations efficiently assess the risks posed by clients. Davies suggests that “by
looking for [EMS] registration in loan applications, banks can determine several facts
relevant to the health of their loan portfolios.””3 2
and
the EU’s Eco-Management and Audit Scheme
Financial institutions may also benefit when they adopt an EMS to control their
own direct and indirect environmental effects. There are a burgeoning number of
packaged EMSs, 3 notably the International Standardization Organization 14000
(“EMAS”).3 5
series”
Significantly, the EMAS was amended in 2001 to encompass financial services.” 6
The previously narrower focus of EMAS on industrial sites rather than company-
wide environmental practice impeded the adoption of EMAS to the service sector,
including financial service organizations. Under Annex VI of the new EMAS
Regulation of 2001, participating organizations must consider all environmental
aspects of their activities, including “indirect environmental aspects” arising from
“capital investments, granting loans and insurance services.”3 7 This is a seminal
change, because a financial organization’s direct ecological footprint (e.g., its energy
use and waste) is markedly different from the impact of the companies it finances,
which will usually be much more pervasive.
Obliging financial institutions to report on their own environmental impacts
could also be beneficial. Regular reports would include information on in-house
resource consumption and waste and, more
the environmental
dimensions of loans and investments. In addition to the “reflexive” qualities of such a
procedural regulation, which would stimulate organizational change by increasing
financiers’ awareness of their environmental impacts, these environmental reports
could help financial authorities in their prudential regulation of banks and investors.
Regrettably, current international surveys show little evidence of environmental
reporting by financial service organizations.30 On 30 May 2001, the European
Commission issued a recommendation on corporate environmental reporting, which
importantly,
302 Chris Davies, “What ISO 14001 Means for the Banking Industry” (1999) 106:3 Can. Banker 8
at8.
303 See generally Jennifer Nash & John Ehrenfeld, “Codes of Environmental Management Practice:
Assessing their Potential as a Tool for Change” (1997) 22 Ann. Rev. Energy & Envt. 487.
304 See generally Ruth Hillary, ed., ISO 14001: Case Studies and Practical Experiences (Sheffield,
U.K.: Greenleaf Publishing, 2000).
305 EC, Council Regulation 1836/93 of29 June 1993 allowing voluntary participation by companies
in a Community eco-management and audit scheme (EMAS), [1993] O.J. L. 168/1.
306 EC, Council Regulation 761/2001 of 19 March 2001 allowing voluntary participation by
organisations in a Community eco-management and audit scheme, [2001] O.J. L. 114/1.
307 Ibid., 26.
308 See Riva Krut & Ashley Moretz, “The State of Global Environmental Reporting: Lessons from
the Global 100″ (2000) 7 Corp. Envtl. Strategy 85.
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demanded that financial institutions also be required to report on their environmental
activities.” 9 To date, the German banking and insurance sectors have demonstrated
the strongest commitment to environmental reporting but have acknowledged the
difficulties in extending environmental accounting from the direct environmental
effects of the financial organization to the indirect environmental effects of its
investment decisions.3 10 There is no systematic environmental reporting by Canadian
financial institutions, apart from the inclusion of environmental statements in the AIF
required of all CBCA businesses.3 ‘
that enable
to assess
third parties
Financial institutions’ environmental reporting could be enhanced if linked to
eco-labelling schemes
the environmental
performance of lenders and investors. This would be particularly useful in the retail
investment markets, where individual investors could direct their money to those
mutual funds that practice sustainable financing. Environmental reporting would also
assist consumers interested in green mortgages in the housing finance market. To
date, the EU is the only jurisdiction to have introduced an eco-label scheme capable
of being adapted to financial services and products.31 The EU’s Eco-label Regulation
was revised in 2000 to enable the scheme to apply to a much wider range of contexts,
covering “any goods and services” including, in theory, financial services. 3 The
development of an eco-label for the financial sector should stimulate marketing and
reward innovation in this area.
Conclusion
This article has argued that because of their gatekeeping role within the economy,
financial market institutions should be environmentally regulated and, thereby,
become a force for promoting positive environmental change. Unfortunately, apart
309 EC, Commission Recommendation of 30 May 2001 on the recognition, measurement and
disclosure of environmental issues in the annual accounts and annual reports of companies, [2001]
O.J. L. 156/33 at 36.
310 See Association for Environmental Management in Banks, Savings Banks, and Insurance
Companies, “Time to Act: Environmental Management in Financial Institutions”, by Gabriele Urban
& Karin von der Emde at 10, online: Association for Environmental Management in Banks, Savings
Banks, and
Insurance Companies
“‘Environmental Protection and Financial Services’ Policy Measures Taken in Germany” in EC,
Commission, Final Report: Workshop on Sustainable Development-Challenge for the Financial
Sector (Luxembourg: EC, 1998) at 54-59.
311 See e.g. Ethical Funds, “Annual Information Forn”, online: Ethical Funds
312 Traditionally, eco-labels are applied to individual consumer products rather than services, for
which the environmental impact is much harder to assess: see generally OECD, Eco-Labelling:
Actual Effects of Selected Programmes, Working Paper No. 44, Doc. No. OCDE/GC(97)105 (1997),
online: OECD
313 EC, Council Regulation 1980/2000 of 17 July 2000 on a revised Community eco-label award
scheme, [2000] O.J. L. 237/1.
2004]
FINANCING ENVIRONMENTAL CHANGE- B.J. RICHARDSON
from the desire to avoid the traditional kinds of environmental liabilities, financial
institutions often lack the motivation to care for the environment. Regulatory reform
of this sector also faces considerable political and economic barriers. Consequently,
governments will need to rely principally on financial incentive and informational
mechanisms to steer financiers towards- sustainable investment. An economy in which
environmentally benign companies enjoy a priority to capital allocation is one that
will surely align us much closer to sustainability than current forms of environmental
law can achieve.
While there has been a paucity of environmental reform of Canadian financial
markets to date, this article has revealed some positive initiatives in other countries
including Australia, the Netherlands, and the UK. Even in these jurisdictions,
however, there is considerable room for more extensive reform. The history of
environmental law in Canada and elsewhere reveals that what was once unimaginable
is today the ordinary. In the UK a decade ago, the Thatcher government was among
the most belligerent opponents of a carbon
tax proposed by the European
Commission, but now Britain has its own carbon tax and did not even wait for the
rest of Europe to lead the way.314 Ultimately, the momentum for reform in Canada and
other countries will hinge upon a sense of environmental urgency in society and the
consequential political mandate for reform. The recent announcement of Canada’s
National Round Table on the Environment and the Economy to undertake a major
study of the role of capital markets in shaping sustainable development may suggest
that the prospects for reform in Canada are strengthening.315
314 Richardson, Environmental Regulation, supra note 2.
315 National Round Table on the Environment and the Economy, “Capital Markets”, online:
National Round Table on the Environment and the Economy
