Progressive fiduciary duty regulation requires that beneficiaries are heard on environmental, social and governance (ESG) issues regardless of whether these are financially material, a report says.
The Principles for Responsible Investing (PRI) together with UNEP FI have compiled a ‘modern’ definition of fiduciary duty, which they published as part of results of a four-year project to clarify investor obligations and duties (see box below).
Rory Sullivan, co-founder and director at Chronos Sustainability and one of the authors of the final report, points to the importance of the view of beneficiaries in the modern definition.
He told Expert Investor: “It says to pension funds you need to explicitly engage with and consult your beneficiaries on their ethical, social and environmental value.
“It’s not saying, you must act on this; it’s saying, you must identify it, take account of it and explain how you have taken account of it.”
Financial materiality
Integrating the sustainability-related preferences of beneficiaries is required even if these are not financially material as of today. This means that ESG issues with increasing impacts, such as climate change, could rise on the agenda of pension funds.
When considering beneficiaries pension funds might also decide to prepare their portfolios for the future, Sullivan believes.
In 2014, the PRI, UNEP FI and UN partners identified the misinterpretation of fiduciary duties as the primary barrier to ESG incorporation and started the project to end this debate.
The report demolishes this misunderstanding of fiduciary duty, Sullivan says.
It reconfirms that ESG issues are material and that investors who look at these issues can generate investment value from doing so, he adds.
It cites policy instruments promoting sustainable investments by pension funds.
Most recently, the EU has put forward a proposal for a regulation on disclosures relating to sustainable investments and sustainability risks in this regard.
The PRI says that of the hard and soft law instruments identified in its Responsible Investment Database, 97% were developed after the year 2000 and that the rate of adoption has accelerated in recent years.
Of the top 50 economies worldwide, 48 have some form of policy designed to help investors consider sustainability risks, opportunities or outcomes, the report writes.
Legal development
Going forward, Sullivan expects ESG law to continuously evolve in terms of robustness.
While it is still in many countries a “piecemeal” approach as of today, Sullivan has seen regulators and policymakers in more progressive countries saying that regulation needs to move from voluntary to mandatory form.
“In five years, we will not be at a point where it is hardwired mandatory regulation, that may take longer; it will probably be somewhere in between that journey, in between voluntary and mandatory,” he notes.
Meanwhile, Sullivan believes that those pension funds that properly consider ESG issues should not encounter any legal risks.
Only those who fail to demonstrate that they took ESG matters into account in their decision-making process could face a legal challenge, he explains.
In the future, Sullivan expects the law to develop to impact requirements.
“When we look at issues like climate change, it’s clear that we need to go beyond a process-oriented approach towards much more outcomes and impacts,” he notes.
Rory Sullivan will speak at the Expert Investor ESG Congress in Berlin today.
Source: PRI
