CAER’s Jacob Laurent and Duncan Paterson examine the emerging area of ESG risks related to recreational cannabis use.
The recreational use of cannabis has been legalised in two major global markets – Canada and numerous US states – with serious implications for responsible investors. Asset owners and asset managers will need to develop policies to manage the environmental, social and governance (ESG) risks associated with this emerging industry.
Asset owners in particular need to start preparing to answer three key questions:
- Is there pot in my portfolio?
- Should I care?
- What can I do about it?
CAER has recently worked with a client to develop one of the worlds’ first broad datasets seeking to capture all companies within the global supply chain for cannabis. Rather than just listing companies with an association with cannabis, we have drilled down into the nature of each company’s activities to ascertain the nature of their involvement, including distinguishing between genuine medicinal vs recreational products and services.
In this paper, we discuss how asset owners and managers are likely to be exposed to the industry, and look at how the risk of exposure can be addressed. We also argue that a regulated recreational cannabis industry is likely to evolve into something akin to the current tobacco and alcohol industries ― with a number of familiar ethical issues.
Is there pot in my portfolio?
In Australia, cannabis companies are currently relatively small, so the average domestic asset manager is unlikely to have them in their investible universe. This is likely to change as the industry grows. Global asset managers may be exposed to the cannabis sector indirectly, however. Large companies in other industries are already dipping their toes in the water. For instance, Constellation Brands, a multinational alcohol company and owner of Corona beer, bought a 9.9% stake in the Canadian cannabis company Canopy Growth in early 2018. Constellation aims to capitalise on the expected national legalisation of recreational cannabis products across Canada.
The rapid growth of the cannabis market, and its presence on stock markets around the world, means that asset owners in particular are likely to already have at least some exposure to cannabis in their portfolio. Asset owners invested in alternative asset classes can be exposed through either venture and/or micro venture capital. Venture capitalists seeking high growth and increased portfolio performance are jumping into the cannabis market, particularly as legislation continues to be passed internationally to legalise parts of the industry.
In addition to the growth in the industry, two other factors influence whether or not an investor has considered the presence of cannabis in their portfolio: local geographical regulations; and uncertainty around terminology used by the industry, especially regarding the term ‘medicinal cannabis’.
Cannabis Legislation and Regulation around the World
While several markets relevant to Australian investors have legislated cannabis cultivation and use, the approach taken has varied from jurisdiction to jurisdiction.
In Australia the focus has been on the clearly defined production of medicinal cannabis, as set out by the Australian government’s Office of Drug Control. A licence enables the lawful cultivation of cannabis, and the permit specifies the amount, type and timeframe of crop production. In January 2018, the Australian government announced that it would allow medicinal cannabis products to be legally exported.
The ASX has a number of companies involved in the production of cannabis, such as AusCann Group, Algae.Tec and Creso Pharma. Legislation relating to the consumption of marijuana for recreational purposes is the purview of State governments. South Australia and the Australian Capital Territory have decriminalised minor drug offences, but the production and use of cannabis for recreational purposes remains a criminal activity in all State and Territories.
Australia’s neighbour New Zealand has also put in place legislation governing the medicinal use of cannabis. The New Zealand government has recently passed the Misuse of Drugs (Medicinal Cannabis) Amendment Bill which introduced an exception and statutory defence for the possession and use of illicit cannabis by terminally ill people with a year left to live, providing the licenced products meet legal standards.
The Bill also amended the classification of medicinal cannabis products that don’t contain the psychoactive ingredient THC so that they are no longer classified as controlled drugs (unlike THC). Interestingly, New Zealand is contemplating a national referendum on the full legalisation of recreational marijuana use in 2019, something that was a condition of the Labour/Green agreement to govern in the their most recent election. A number of companies such as Hikurangi Hemp and Helius Therapeutics are positioning themselves for a potential expanded market for cannabis in NZ.
In June, Canada’s parliament voted in favour of legalising recreational cannabis use, and it is expected that the new laws will come into effect in October. Canada has had regulations relating to the medicinal use of cannabis in place since 2001, and will be the first of the G7 nations to move to full legalisation. This will give a big boost for listed cannabis producers in that country, and has been described by Canada’s Prime Minister Justin Trudeau as ‘daring’.
The US has legalised recreational cannabis for people aged 21 and over in 9 states including Washington, DC. ‘Medicinal’ cannabis is legal in 29 states with California and Colorado being two of the biggest industry players. The US has a number of significant cannabis companies listed on its stock markets. Canopy Growth is one of the largest with a market capital of $US5.68 billion – and there are a range of other brands positioned to grow rapidly when recreational sales begin in Canada and other US states.
In the EU, all member countries regard the supply and possession of marijuana as an offence, although the approach to penalties varies from State to State. The Netherlands has for many years deliberately (and famously) turned a blind eye to the sale of marijuana at coffee shops in specific cities. The Portuguese approach of decriminalising of a range of drugs, coupled with strong investment in diversion and addiction treatment programs, has attracted a lot of interest from other regulators in recent years. To date, however, no European State has gone down the road of full legalisation.
Figure 1: Extract from European Monitoring Centre for Drugs and Drug Addiction (EMCDDA) website: http://www.emcdda.europa.eu/publications/topic-overviews/cannabis-policy/html_en
Medicinal versus recreational cannabis
The term ‘medicinal cannabis’ is one that comes with a lot of baggage. The therapeutic benefits of marijuana consumption are hotly contested.
On the one hand, you have advocates for recreational cannabis use stressing benefits that can arise from the product’s consumption, particularly in the areas of appetite stimulation, suppression of nausea and muscle control problems.
On the other hand, you have organisations such as the US government-backed National Institute on Drug Abuse (NIDA) noting that while there are definitely a small number of medicines on the market that are derived from cannabinoids, there are no approved uses of the whole cannabis plant as a medicine.
For investors seeking to make a distinction between recreational and bona fide medicinal cannabis, the separation can be a little hazy.
Recreational cannabis tends to encompass strains with higher amounts of the psychoactive substance delta-9-tetrahydrocannabinol (THC), the primary psychoactive component in cannabis, whereas the bulk of research interest to date for medicinal cannabis has been using strains of cannabis with lower levels of THC and higher levels of the less psychoactive ingredient cannabidiol (CBD).
The good: medicinal cannabis use for epilepsy
Medicinal uses for extracts from the cannabis plant show strong therapeutic potential. For instance, they have been identified as having the potential to relieve the symptoms of conditions such as epilepsy. The use of CBD by patients with Dravet syndrome, a rare genetic form of epilepsy, has been reported as resulting in ‘a greater reduction in convulsive-seizure frequency than placebo’, although the result ‘was associated with higher rates of adverse events’ such as vomiting, fatigue and upper respiratory tract infection.
The bad: concerns raised through medicinal cannabis research
Although research has found that the use of CBD can reduce the frequency of epileptic seizures, research in the Medical Journal of Australia argues that the use of medicinal cannabis for epilepsy requires ‘better treatment and more high quality trials assessing effectiveness.’
The paper argues that existing research needs to be sufficiently replicated to temper media hype and ensure that public perception is moderated by clinical trial data. The authors also highlight a number of challenges that require professional attention before further medicinal cannabis products should be made available, including long-term safety, dosing, efficacy, guaranteeing a consistent and high quality product and concerns around addiction.
The Royal Australasian College of Physicians is also concerned that the introduction of medicinal cannabis into the healthcare industry ‘has not followed the usual research-based safety and effectiveness processes’ advocated by Australia’s Therapeutic Goods Administration (TGA), New Zealand’s Medsafe and the Narcotic Drugs Act 1967.
The ugly: bogus health claims of cannabis
The US cannabis industry is occasionally referred to as a ‘Wild-West’ operation due to the number of bogus health claims being made by US companies. Such claims have included that ‘medicinal’ cannabis products are able to reverse Alzheimer’s disease, cure cancer and fade scars, although no good scientific evidence has been provided to back them.
Australia’s Alcohol and Drug Foundation is clear that caution should be used when describing cannabis use as ‘medicinal’, however, investors in cannabis companies need to consider that the term ‘medicinal’ has been used in international markets as a cover for the sale of recreational products with a high THC content.
This issue is perhaps best captured by the European Monitoring Centre for Drugs and Drug Addiction (EMCDDA):
“‘Medical marijuana’ was legalised by popular vote in California, in 1996, to treat symptoms including chronic pain. As there is no objective test for pain, public access to legal smokable cannabis became a formality.”
But how can an investor make a distinction between companies with a genuine focus on medicinal outcomes for their clients, versus those companies selling what is effectively recreational cannabis?
The ‘medicinal’ fig leaf
Canada has for some time had legislation in place that allows for the consumption of marijuana for ‘therapeutic’ purposes. A closer examination of the industry, however, illustrates that many cannabis companies with licences to distribute cannabis for therapeutic purposes are selling whole cannabis plant products (for example unprocessed marijuana heads or buds) with high THC contents– in other words products with an established appeal for the recreational market.
There are two useful indicators for an investor seeking to distinguish between recreational and genuinely medicinal cannabis products:
- the percentage of THC in the product: THC is the ingredient in cannabis that has psychoactive properties, and the higher the level of THC, the higher the consumer will get. To date there is a limited number of properly established studies demonstrating a medical need for whole plant marijuana products high in THC.
- the nature of the marketing and packaging of the products in question: Many Canadian and US cannabis companies selling ‘medicinal’ products high in THC are marketing them in a distinctly un-medical fashion.
Figure 2: Extract from Aurora Cannabis website product list: www.auroramj.com/strains
Large Canadian companies such as Aurora Cannabis are licenced under Canada’s Access to Cannabis for Medical Purposes Regulations (ACMPR), and sell dried whole cannabis products online with high THC levels and names such as Thor (Ghost Train Haze), Snow Dome (LA Confidential) and Aurora THC Drops. By using product names such as these, one can make a case that the company is marketing recreational products with high percentages of THC (between 10-20%) to a recreational demographic.
Herein lies the central problem with the current state of business activity and regulation within the cannabis industry in Canada and around the world. Businesses are taking advantage of what appears to be intentionally relaxed legislation, with companies allowed to sell to the recreational market under the guise of a ‘medicinal’ licence.
Given the rapidly developing market and the difficulty of distinguishing genuine medicinal product from recreational, it is important that investors develop clear processes to enable them to clearly distinguish between investment in genuinely medicinal cannabis products vs recreational cannabis use. The alternative approach is of course to conclude that there are no significant ESG concerns associated with recreational cannabis use.
Should I care about pot in my portfolio?
Asset owners both in Australia and around the world currently have a range of policies in place relating to investment in activities judged to pose social risks, such as tobacco, alcohol and gambling. A fully legalised recreational cannabis market would be associated with a number of similar risks, meaning that investors will need to be prepared for this discussion.
The key ESG risk for investors in cannabis companies lies in the area of regulation. It has been noted that US federal authorities could begin to crack down on states that have legalised cannabis products. US Attorney-General Jeff Sessions heads the Drug Enforcement Administration (DEA), which continues to classify cannabis as a Schedule 1 drug, in the same group as heroin.
Sessions has publicly opposed the cannabis industry and has previously used research to argue that in states where cannabis has been legalised, there has been a rise in the number of drivers testing positive for THC. He has famously stated that “good people don’t smoke marijuana”.
Illegal activity is also a potential problem for the industry. In the US in 2016 authorities investigated accusations made by a former employee that Vireo Health, a licenced medicinal cannabis company in New York, had illegally transported $USD 500,000 worth of cannabis oil out of Minnesota state. Two employees were charged under Minnesota’s medical marijuana law for intentionally transferring cannabis to a person other than a patient, caregiver or guardian of a patient.
The possibility of much stricter federal legislation poses a threat to the growth of the industry, and could impact the portfolio performance of asset owners exposed to cannabis in the US and internationally.
This is a potentially problematic area for the progressive investor. There is likely to be a strong over-lap between traditional supporters of ethical/green investment, and supporters of more relaxed regulations for marijuana.
In a recent opinion piece, CAER has emphasised the importance of looking at the macro impacts of a business activity when making ethical investment decisions, rather than focussing on impacts at an individual level. This logic is particularly applicable in the case of cannabis.
The potential ethical risks of cannabis relate to the broader implications its increased use within the community could have on the healthcare and law enforcement sectors:
- Dependency – it is estimated that up to 10% of users will be become dependent;
- Regular use increases risks of psychotic symptoms and schizophrenia;
- Smoking while pregnant is associated with low birth weights;
- Teen cannabis use is associated with poorer school outcomes, but it is not clear that the relationship is causative; and
- Driving under the influence of cannabis doubles the risk of a car accident.
There is also some evidence that smoking cannabis, the traditional method of accessing THC from the whole plant, can be linked with lung cancer.
Investors who screen tobacco from their portfolios should be conscious of the similarities between regulated recreational tobacco consumption as a delivery method for nicotine, and regulated recreational marijuana consumption as a delivery method for THC.
There are community-level health and safety risks in both instances. The primary difference is that the tobacco market is relatively mature, with large established players, whereas the cannabis market is still in growth phase. It is inevitable however, that at some point the cannabis market will also mature, and that several large global cannabis companies will be supplying a product that comes with health risks and is potentially habit-forming. At that point, it will be difficult to distinguish between the ethical risks of investment in tobacco or cannabis companies.
The current opioid epidemic in the US highlights how the rapid uptake of regulated drugs can increase risks to the community.
Addiction to opioids such as painkillers, heroin, and fentanyl has become a national problem in the US affecting public health and social and economic welfare. The economic burden of prescription opioid dependence in the US is estimated to be $US78.5 billion, with over a third of this amount linked to increased health care and substance abuse treatment costs. The opioid epidemic presents an example of the impact of an over-prescribed and poorly understood addictive substance can have, acting as a cautionary tale for the legalisation of cannabis.
As cannabis companies grow and they face increased pressure from shareholders to generate reliable returns, other ethical risks also arise. In countries and states where cannabis is legal, growth in the sector and increased competition are likely to push prices down, making consumption more affordable for a greater proportion of the population. Greater consumption is then likely to be linked to issues associated with dependency, as has been seen with alcohol and tobacco.
Will cannabis companies be held to account for the potential harms caused by overuse or dependency on their products? Or will government have to step in?
Steps to manage the ESG and ethical risks of investment in cannabis
Proponents of the full legalisation of recreational cannabis use point to a range of potential positive outcomes, such as reducing harm to minor users, reducing crime associated with the criminality of marijuana, and supporting civil liberties for consumers of cannabis. It should be noted that that majority of these outcomes can be achieved through decriminalisation. Another positive cited is the additional taxation revenue associated with a regulated market, although there is some question as to whether such revenue would be impacted by lower prices in a legal market.
As noted in CAER’s recent paper Legal Sins – is there value in vice?, the legality of an industry does not necessarily mean that it is an appropriate inclusion in a responsible investor’s portfolio. It is important that the society-level impacts of an activity are considered, rather than simply the impacts on the individual consumer of the product.
When considering investment in the cannabis industry, there are a number of reasonable conclusions an investor can arrive at:
- The benefits to society of legalising cannabis will outweigh the ESG risks;
- Investment in cannabis is appropriate for genuinely medical purposes, but recreational cannabis use is to be avoided, given the ESG risks associated with its widespread use; or
- Investment in cannabis is to be avoided.
In each case, conversations will need to take place in order to determine the definitions used and the materiality thresholds needed for determining whether a company’s involvement is sufficient to warrant further scrutiny.
Once an investor’s responsible investment policy has been amended to include this additional set of criteria, it is important that appropriate steps are taken to ensure that the policy can be properly implemented. This will include accessing research on the topic, and for asset owners discussions will need to take place with outsourced fund managers, particularly international managers operating in the growth or small-cap space.
And of course the investor will need to include this policy development process in their communications with investors and stakeholders, whether this means involving the stakeholders in the discussion process, or alternatively communicating the results of the process once it has been implemented.
Those investors with strict tobacco screens should consider the similarities between that industry and a mature cannabis industry, and decide whether or not to add recreational cannabis companies to their exclusion list.
A legal cannabis market will not be the romanticised free-for-all envisaged and endorsed by the current industry and its advocates. The pot industry could quite easily go to pot.
Interested in discussing this issue further? Feel free to get in touch.
CAER is able to work with clients to develop customised screens. Issues can be screened based on products, industry, countries or subsidiaries, and can be tailored to investor requirements around thresholds. Our Controversial Activities Screen research incorporates leading risk areas as elected by investors into one screening package that can be adjusted to specific requirements.