Institutional investors may have a fiduciary duty to consider environmental, social, and governance (ESG) factors, according to a new study from the United Nations Environment Programme Finance Initiative (UNEP FI). In reporting on "Fiduciary Responsibility," Social Funds' Robert Kropp expressed the uncertainty that still surrounds the question of ESG-related fiduciary responsibilities:
"The report argues that consultants may well have a legal duty to proactively raise ESG issues with their clients. The report also recommends that ESG issues be embedded into legal contracts between asset owners and asset managers."
As the case for managers' ESG-related obligations under securities and trust law is still open, UNEP FI says, ESG proponents should encourage clients to demand integration from their advisors. For now, asset owners, not courts, must drive ESG integration – though lawmakers may yet embed responsible investing into managers' obligations.
"We need to live off the interest"
In his introduction to the 101-page report, Achim Steiner of UNEP FI says that the economic crisis "requires us to review the economic models this century has inherited from the last one." He places particular emphasis on the environment, declaring that "we are living off the Earth's capital – we need to live off the interest."
Towards this end, "Fiduciary Responsibility" describes how some shareholders have begun to consider the ESG performance of the companies they invest in. While the report does not prove that ESG integration is a fiduciary duty, it does offer practical reforms that would help create such duties. For example, UNEP FI calls out signatories of the Principles for Responsible Investment (PRI): "…In order to maintain their membership, all asset manager and asset owner signatories [should be required to] embed ESG issues in their legal contracts."
UNEP FI also says that government should redefine the work of fiduciaries:
"Global capital market policymakers should also make it clear that advisors to institutional investors have a duty to proactively raise ESG issues within the advice that they provide, and that a responsible investment option should be the default position. "Furthermore, policymakers should ensure prudential regulatory frameworks that enable greater transparency and disclosure from institutional investors and their agents on the integration of ESG issues into their investment."
Commentary on ESG and Fiduciary Duty
"Fiduciary Responsibility" is the sequel to a 2005 UNEP FI study, called the "Freshfields report" after the consultants who prepared it, that helped spur the creation of the PRI. The new report includes a literature review of "practical developments" in ESG integration; the results of a survey of how major investment managers approach the topic; and commentary from UK and US experts in fiduciary law.
Quayle Watchman Consulting describes how attitudes and laws have changed since 2005. In the UK, the law now impels corporate directors to consider the broader effects of their decisions:
"Under current United Kingdom company law legislation, the Companies Act 2006 (the '2006 Act') imposes duties on company directors to report on the environmental and social impacts of their business activities. "[Guidance] on the duty of directors to promote the success of the company under section 172 of the 2006 Act, which is the principal replacement duty for the common law fiduciary duties of company directors, also adds that 'success' is to be judged in terms of long-term increase in the value of the company rather than short-term gains."
The obligations of directors have changed, but Quayle Watchman notes that "the government declined to introduce amending legislation to clarify the position of pension fund trustees." While trustees may consider ESG factors in their investment decisions, there is no legal imperative to do so. Quayle Watchman considers the roots of trustees' "short-termism":
"There appears to be resistors to responsible investing which relate to deeply-rooted characteristics of the investment decision-making system including: the mandates that pension funds and their investment consultants set; the systems for measuring and rewarding performance (which focus on peer comparison and beating benchmarks rather than on fulfilling the long-term liabilities of pension funds); and the competencies of service providers (e.g. sell-side analysts). "The effect of this resulting short-termism is that less attention is paid to responsible investment matters than is appropriate–these issues are too long-term in nature to affect the day-to-day behavior of fund managers."
Asset Owners Must Lead Their Managers
Quayle Watchman explains how investors, "in the absence of government legislation or regulations, codes of practice or guidance," can build a long-term perspective into capital markets. They note the impact of the PRI program, which has attracted more than 550 signatories, representing approximately $18 trillion in assets under management.
Responsible investment, conducted at this scale, has helped shift the financial sector's priorities. "Fiduciary Responsibility" cites Bloomberg's placement of carbon emissions data on its terminals as evidence that sustainability is now a mainstream concern.
In the aftermath of the global financial crisis, fiduciary duties may undergo a broader philosophical shift. According to Quayle Watchman:
"The courts accept, despite the widespread use of mathematical modeling, that investment is an art rather than a science, and that there is a wide spectrum of opinion on investment which may be held by advisers without an adviser acting negligently."