March 8, 2022

By Derek Eaton & Anik Islam


As stewards of capital, the main objective of Canadian pension funds is to maximize risk-adjusted financial returns in order to meet the lifetime income requirement of their beneficiaries. However, pension funds and their beneficiaries are operating in a world that is undergoing increasingly rapid climate change. With Canada experiencing more wildfires and floods, it is abundantly clear that greenhouse gas emissions need to be reduced to net-zero by 2050. To achieve this target, significant investments need to be made in businesses and infrastructure to change their emissions profile and transition to a net-zero economy.  Global investors will need to embark on the largest global reallocation of capital in history – more than U$100 trillion between now and 2050. Most of the capital needs to come from private sources. At the United Nations Climate Change Conference of Parties or COP 26, the world put the private sector in center stage and financial actors pledged to channel private capital towards the global net-zero transition through high level commitments such as the Glasgow Financial Alliance for Net Zero

Pension funds, as long term allocators of capital, have a critical role to play in this transition. They can make investments in assets and companies that are already net-zero aligned or are planning to transition towards the low-carbon future. As our report Canadian Pensions Dashboard for Responsible Investing recommends, Canadian pension funds should have around 20% of total asset under management (AUM) allocated to low-carbon investments, with annual low-carbon investments totalling 2% to 5% of total AUM or net assets, which is around C$80 to C$200 million of new investments per year. Without net-zero alignment, pension funds face significant risks on their investment returns, which ultimately affects the future income of beneficiaries and in turn impinges on funds’ fiduciary responsibilities.


How Have Pension Funds Progressed So Far?

Canadian pension funds are well-placed relative to other global institutional investors owing to the funds’ independent governance, in-house investment expertise and extensive geographic and asset class coverage. Pension funds have been making progress in recent years by developing climate action plans, issuing responsible investment reports, changing organizational structures to account for climate related financial risks, and increasing their investments in renewable and clean energy assets. However, to reach the sustainable AUM targets, pension funds need to quickly build on this progress and align with net-zero emissions investment practices and portfolio allocation. Four of the pension funds analyzed in the Canadian Pensions Dashboard report - Caisse de dépôt et placement du Québec, Canada Pension Plan Investment Board, Ontario Municipal Employees' Retirement System and Ontario Teachers’ Pension Plan - have made net-zero emissions commitments and some of them have set interim targets to govern shifts in their investment strategies. Other pension funds need to do the same and keep the momentum going.


Challenges with Net-Zero Alignment

Nonetheless, for pension funds to realize their net-zero alignment objectives, it is important to recognize the challenges that the funds and broader stakeholders face. Some of them are as follows:

1) The larger pension funds were established under separate legislation with differing objectives and regulatory bodies. As a result, they have different goals, which range from focusing on absolute returns (financial returns on investment) to funded status (keeping enough assets to cover beneficiary payment obligations). Moreover, the twelve largest funds in Canada are governed by eight separate supervisory structures. With differing objectives and regulatory supervision, it is more complicated to align all the funds towards a common net-zero alignment objective.

2) There is a lack of clarity on the scope of fiduciary duty in context of climate change related risks. This has been highlighted as a major challenge. Many market participants, including pension funds, recognize that it is a fiduciary obligation to consider the implications of climate change risk, both physical risks (associated with extreme weather events) and transition risks (associated with not shifting investments consistent with a low-carbon economy). Nonetheless, there is some hesitancy in the absence of clear guidance from provincial and federal regulators, which slows progress on net-zero alignment.

3) A common definition on sustainable environmental solutions is lacking. Pension funds use external taxonomies or adopt thematic investment strategies. However, most of the investments are focused on clean energy solutions (e.g. solar, wind energy investments). This approach risks missing out on a larger set of environmentally sustainable solutions, which require investments and might provide commercially attractive returns, such as sustainable agriculture and responsibly mined metals.

4) There is inconsistency in the methodology to measure carbon footprints. Measuring financed emissions is crucial in identifying and managing climate risks, navigating emission reduction goals and disclosing progress to stakeholders. The Pensions Dashboard finds that pension funds adopt different approaches to report their portfolio carbon footprint. Some of the funds use a market approach, while others use portfolio enterprise value, the latter accounts for fixed income investments. Moreover, carbon footprint measurement does not cover all asset classes and sometimes uses proxy emissions data based on average emissions in the sector and country of investment.

5) There is a broader lack of information disclosure on climate related risks by companies within pension funds’ equity portfolios. Full climate-related disclosure sends clear signals to pension funds on the relative risks and expected returns from investments. There are calls, most recently in the Finance Minister’s mandate letter, to work with provinces and territories to move toward mandatory climate-related financial disclosures. However, the Canadian Securities Administrators - the provincial regulators - have proposed rules that would allow companies to opt out of such disclosure entirely or significantly limit the scope of their assessment and reporting. This is not in line with international best practices, with other countries opting for disclosures on the full scope of emissions and scenario analysis. Notably, global standards need to be set to enhance industry reporting and disclosure that yields reliable, complete, and comparable information for investors. The role of the International Sustainability Standards Board, where Canada is expected to play a major role with its offices in Montreal, Quebec, will be crucial.

6) Owing to Canada’s natural resource based economy, pension funds have significant investments in oil & gas assets. Through market forces and uncertainties about future returns, many of the funds have reduced their portfolio exposures to fossil fuel equities over the last 10 years. However, they might be holding on to fossil fuel assets in order to capitalize on returns. There are calls from stakeholders to completely divest from oil & gas assets in the short run. However, this might not be the optimal approach considering Canada’s economic dependence and pension fund’s fiduciary duty towards beneficiaries.


What Can Governments and Pension Funds Do?

These challenges need to be addressed by both policy makers and the pension funds themselves. The Canadian Pensions Dashboard recommends that governments and regulators, with support from the Sustainable Finance Action Council and the Net Zero Advisory Body:

1) Amend the Canada Business Corporation Act, Canada Pensions Benefit Standards Act and other provincial regulations to create new provisions for net-zero alignment. A separate recommendation is to amend the Income Tax Act, which provides tax-exempt status to pension funds, to conform to this status by demonstrating net-zero alignment.

2) Develop regulations or make amendments to the above-mentioned legislation that ensures climate and broader social and governance integration is a part of the fiduciary responsibility of pension funds.

3) Make climate related financial risk disclosures mandatory, including disclosures on the full scope of emissions and scenario analysis, for all companies operating in Canada. This needs to be completed through a systematic phased approach in line with the Task Force on Climate-Related Financial Disclosures recommendations and Sustainability Accounting Standards Board standards.

For their part, pension funds need to:

1) Develop a common taxonomy for sustainable environmental solutions using the CSA Group’s transition finance taxonomy, EU taxonomy for sustainable activities or Corporate Knight’s clean economy taxonomy.

2) Align with approaches such as the Science Based Targets Initiative for Financial Institutions for effective net-zero emissions target setting.

3) Make credible commitments to the net-zero emissions targets at the portfolio level with interim GHG reduction targets and financing plans in line with the United Nations convened Net-Zero Asset Owner Alliance.

4) Use tools such as Paris Agreement Capital Transition Assessment for net-zero scenario analysis.

5) Join the Partnership for Carbon Accounting Financial and adopt their greenhouse gas accounting and reporting standards for measuring and reporting financed emissions.

6) Engage with fossil fuel based companies in which funds have a stake to set targets and plans to reduce emissions and to share these with other stakeholders.

7) Design strategies to direct investments towards environmentally sustainable solutions. This would include those assets which are already environmentally sustainable (i.e. green) and those which can be made environmentally sustainable (i.e. transition).

8) Share lessons learnt on challenges and pathways to net-zero portfolio alignment implementations with each other and other institutional investors.

As the world is undergoing rapid climate change, significant financial resources and sound investment are required to transition to a net-zero emissions based economy. By solving the challenges mentioned above and aligning their investment strategies and portfolio allocations with net-zero, Canadian pension funds can not only reduce existing emissions but also provide much needed capital to businesses and infrastructure to transition. This will allow them to meet their fiduciary responsibilities as well as help to build a sustainable future.


On March 9th, Smart Prosperity Institute will be discussing these challenges and recommendations in detail together with our partners - The Natural Step Canada, Corporate Knights and Trottier Family Foundation - at the upcoming event Taking It to the Next Level: Canadian Pensions and Sustainability. Register today!

To learn more, read our report “The Canadian Pensions Dashboard for Responsible Investing - A navigational tool to increase ambition for a sustainable, inclusive future

Anik Islam

Senior Research Associate