Fiduciary duties are imposed upon a person or an organisation who exercises some discretionary power in the interests of another person in circumstances that give rise to a relationship of trust and confidence.

They are of particular importance in asymmetrical relationships; these are situations where there are imbalances in expertise and where the beneficiary has limited ability to monitor or oversee the actions of the entity acting in their interests.

The starting point for our research was the question of whether there is a need to reframe or redefine fiduciary duty in a way that is relevant for 21st century investors. We wanted to explore whether fiduciary duty is a legitimate obstacle to investors taking account of ESG issues in their investment processes. We also wanted to explore the question of whether investors’ fiduciary duties require them to consider the impacts of their investment activities on wider society and on the environment and, if so, what the implications for investment practice might be.

While the core concepts of fiduciary duty remain as relevant to today’s investment markets as they have ever been, investors with fiduciary duties need to address fundamental questions such as:

  • Should investors take account of environmental, social and governance (ESG) issues in their investment processes and decision-making?
  • Should investors encourage higher standards of ESG performance in the companies in which they are invested?
  • Do investors have a responsibility to support the integrity and stability of the financial system?
  • How should investors respond to wider systemic risks – and opportunities – such as those presented by climate change?

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:

Loyalty

  • Fiduciaries should act in good faith in the interests of their beneficiaries, should impartially balance the conflicting interests of different beneficiaries, should avoid conflicts of interest and should not act for the benefit of themselves or a third party.

Prudence:

  • Fiduciaries should act with due care, skill and diligence, investing as an ‘ordinary prudent person’ would do.

In 2005, a group of investment managers organised under the United Nations Environment Programme Finance Initiative (UNEP FI) commissioned the law firm Freshfields Bruckhaus Deringer to publish the ground-breaking report titled A Legal Framework for the Integration of Environmental, Social and Governance Issues into Institutional Investment (commonly referred to as the Freshfields report). The report, in what was seen as a radical conclusion at the time, argued that “integrating ESG considerations into an investment analysis so as to more reliably predict financial performance is clearly permissible and is arguably required in all jurisdictions.”

Despite the conclusions of the Freshfields report, many investors continue to point to their fiduciary duties and to the need to deliver financial returns to their beneficiaries as reasons why they cannot do more on responsible investment.

Legal context

In each of the eight jurisdictions examined in this report, investors have varying degrees of discretion as to how they invest the funds they control; it may be narrow, such as for tailored mutual funds where the beneficiary specifies the asset profile and only the day-to-day stock selection and other management tasks are left to the investor, or it may be wide, as with many occupational pension funds, where very few limits are typically placed on the way the fund may be managed. Some public funds are subject to considerable state control and the discretion afforded to these investors may be further narrowed by parameters set by government.

Within the discretion left to the investors, certain legal rules define their ability to integrate ESG considerations into their decision-making. It is these rules that are the subject of this report.

Common law vs civil law jurisdictions

In all jurisdictions, the rules that affect investment decisionmaking take the form both of specific laws (about the types of assets that are permitted for certain types of investment, and the extent to which the assets of a fund may be invested in specific asset classes or be exposed to specific issuers or categories of issuers, for example) and general duties that must be fulfilled (such as duties to ensure investments are adequately diversified).

Common law

In the common law jurisdictions covered by this report – Australia, Canada, South Africa, the UK, the US – fiduciary duties are the key source limits of the discretion of investment decisionmakers, aside from any specific constraints imposed contractually or by regulation. These duties are articulated in statute and decided in the courts: some rules are open to re-interpretation over time or when applied to new facts. In the US, for example, the decisionmaker’s duty is to exercise reasonable care, skill, and caution in pursuing an overall investment strategy that incorporates risk and return objectives reasonably suitable to the trust.

Civil law

In countries where civil law applies – Brazil, Germany, Japan – any obligations equivalent to ‘fiduciary duties’ will be set-out in statutory provisions regulating the conduct of investment decisionmakers and in the governmental and other guidelines that assist in the interpretation of these provisions. The content of each of these statutory provisions differs slightly between jurisdictions and depending on the type of institutional investor, but common themes include:

  • duty to act conscientiously in the interests of beneficiaries – this duty is expressed in different terms, with jurisdictions using terms such as “good and conscientious manager” (Japan) or “professionally” (Germany);
  • duty to seek profitability;
  • recognition of the portfolio approach to modern investment, either in express terms or implicitly in the form of requirements to ensure adequate diversification;
  • other duties relating to liquidity and limits on the types of assets that may be selected for certain types of funds.

Treatment of ESG issues

In none of the jurisdictions do the rules exhaustively prescribe how investors should go about integrating ESG opportunities and risks in their investment practices and processes, and on the timeframes over which they define their investment goals. In most cases, it is left to investors to determine the approach that will enable them to meet their legal obligations in the particular circumstances.

When evaluating whether or not an institutional investor has delivered on its fiduciary duties, courts will look at the evaluation and integration process of ESG issues into the investment decisionmaking.

Evolution of fiduciary duty

Over the past decade, there has been relatively little change in the law relating to fiduciary duty. However, there has been a significant increase in ESG disclosure requirements for asset owners and investment managers and in the use of soft law instruments such as stewardship codes that encourage investors to engage with the companies in which they are invested. Many of the interviewees for this project commented that while the law may not change quickly, there is likely to be increased use of disclosure requirements and soft law measures to encourage investors to pay greater attention to ESG issues in their investment practices and processes.

In addition, the economic and market environment in which the law is applied has changed dramatically. Factors such as globalisation, population growth and natural resource scarcity, the internet and social media, and changing community and stakeholder norms all contribute to the evolution in the relevance of ESG factors to investment risk and return. This necessarily changes the standards of conduct required of fiduciaries to satisfy their duties under the law.

“The concept of fiduciary duty is organic, not static. It will continue to evolve as society changes, not least in response to the urgent need for us to move towards an environmentally, economically and socially sustainable financial system.”

Paul Watchman (Honorary Professor, School of Law, University of Glasgow)