Failing to consider long-term investment value drivers – which include environmental, social and governance issues – in investment practice is a failure of fiduciary duty.
Fiduciary duty in the 21st century aims to end the debate about whether fiduciary duty is a legitimate barrier to investors integrating environmental, social and governance (ESG) issues into their investment processes.
Its precursor, a 2005 report commissioned by UNEP FI from law firm Freshfields Bruckhaus Deringer concluded that integrating ESG considerations into investment analysis is “clearly permissible and is arguably required.”
In the decade that followed, many asset owners have made commitments to responsible investment. Many countries have introduced regulations and codes requiring institutional investors to take account of ESG issues in their investment decision-making. These changes – in investment practice and in public policy – demonstrate that, far from being a barrier, there are positive duties on investors to integrate ESG issues.
When evaluating whether or not an institutional investor has delivered on its fiduciary duties, both the outcomes achieved and the process followed are of critical importance. For example, a decision not to invest in a high-carbon asset because of financial concerns about stranded assets is likely to be seen as consistent with fiduciary duties, providing that the decision is based on credible assumptions and robust processes.
Despite significant progress, many investors have yet to fully integrate environmental, social and governance issues into their investment decision-making processes.
This report identifies a series of challenges:
- outdated perceptions about fiduciary duty and responsible investment – this is particularly the case in the United States where lawyers and consultants too often characterise ESG issues as non-financial factors;
- alack of clarity within prevailing definitions of fiduciary duty about what ESG integration means in practice and, in particular, whether active ownership and public policy engagement form part of investors’ fiduciary duties;
- limited knowledge of the evidence base for responsible investment, including the strength of the relationship between ESG issues and investment performance;
- lack of transparency on responsible investment practices, processes, performance and outcomes, limiting investors’ accountability to their beneficiaries, their clients and wider society;
- inconsistency in corporate reporting, including inadequate analysis of the financial materiality of ESG issues, making it hard to assess investment implications;
- weaknesses in the implementation, oversight and enforcement of legislation and industry codes on responsible investment.
Our research finds that fiduciary duties have played, and continue to play, a critical role in ensuring that fiduciaries are loyal to their beneficiaries and carry out their duties in a prudent manner. However, we conclude that action is needed to modernise definitions and interpretations of fiduciary duty in a way that ensures these duties are relevant to 21st century investors.
To overcome these challenges, this report proposes a series of recommendations for institutional investors, financial intermediaries and policymakers.
In particular, policymakers and regulators should:
- clarify that fiduciary duty requires investors to take account of ESG issues in their investment processes, in their active ownership activities, and in their public policy engagement;
- strengthen implementation of legislation and codes, clarifying that these refer to ESG issues, and require investor transparency on all aspects of ESG integration, supported by enhanced corporate reporting on ESG issues;
- clarify the expectations of trustees’ competence and skill and support the development of guidance on investor implementation processes, including investment beliefs, long-term mandates, integrated reporting and performance;
- support efforts to harmonise legislation and policy instruments on responsible investment globally, with an international statement or agreement on the duties that fiduciaries owe to their beneficiaries – this statement should reinforce the core duties of loyalty and prudence, and should stress that investors must pay attention to long-term investment value drivers, including ESG issues, in their investment processes, in their active ownership activities, and in their public policy engagement.
Integrating ESG issues into investment research and processes will enable investors to make better investment decisions and improve investment performance consistent with their fiduciary duties. This will result in capital being allocated towards well-governed companies, putting investors in a better position to contribute to the goals of a greener economy and a more sustainable society.
Fiduciary duty in the 21st century
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