The integration of ESG issues into investment practice and decision making is an increasingly standard part of the regulatory and legal requirements for institutional investors, along with requirements to consider the sustainability-related preferences of their clients and beneficiaries, and to report on how these obligations have been implemented.
Investors that fail to incorporate ESG issues are failing their fiduciary duties and are increasingly likely to be subject to legal challenge.
Fiduciary duties (or equivalent obligations) exist to ensure that those who manage other people’s money act in the interests of beneficiaries, rather than serving their own interests.
The most important of these duties are:
- Act honestly and in good faith in the interests of their beneficiaries or their clients.
- Understand and incorporate into their decision making the sustainability preferences of beneficiaries and/or clients, whether or not these preferences are financially material.
- Impartially balance the conflicting interests of different beneficiaries and clients.
- Avoid conflicts of interest.
- Not act for the benefit of themselves or third parties.
Fiduciaries should act with due care, skill and diligence, investing as an ‘ordinary prudent person’ would. This includes:
- Incorporating financially material ESG factors into their investment decision making, consistent with the timeframe of the obligation.
- Being an active owner, encouraging high standards of ESG performance in the companies or other entities in which they are invested.
- Supporting the stability and resilience of the financial system.
Fiduciaries should disclose their investment approach to clients and/or beneficiaries including information on how preferences are incorporated into the scheme’s investment strategy and the potential risks and benefits of doing so.
Fiduciary duties require ESG incorporation, however capital markets remain unsustainable. As currently defined, the legal and regulatory frameworks within which investors operate require consideration of how ESG issues affect the investment decision, but not how the investment decision affects ESG issues. Changing this will be our next phase of work.
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