Fiduciary duty: the global state of play

The topic of fiduciary duties will be familiar to readers of Responsible Investor. The core fiduciary duties are those of loyalty and prudence. Loyalty requires fiduciaries to act in good faith in the interests of their beneficiaries and to impartially balance the conflicting interests of different beneficiaries. Prudence requires fiduciaries to act with due care, skill and diligence, investing as an ordinary prudent person would do. Fiduciary duties exist in common law countries, like the UK and US. The concepts, more broadly known as investor duties, are also codified in civil law countries like Brazil, France and China. 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. Yet, despite the growth in the number of investors that have made commitments to responsible investment, 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. Expressed another way, these investors argue that their fiduciary duty to maximise financial returns precludes them from considering sustainability-related issues in their investment practices and processes.
This is of profound importance. The manner in which fiduciary duty is defined and interpreted affects the entire investment chain, from asset owners through to companies. It informs the manner in which asset owners select, appoint and monitor investment managers. It influences investment decision-making processes and ownership practices. It affects the way in which companies are managed. Ultimately, it affects financial stability and sustainability, and strongly influences our global response to climate change and sustainable development.
However, the argument that fiduciary duty means that investors should not pay attention to sustainability issues can no longer be supported. In fact, neglecting ESG analysis can cause the mispricing of risk and poor asset allocation. Drawing on detailed legal reviews and some 350 interviews with policy makers and investors across 15 countries and jurisdictions, the Fiduciary Dutyin the 21st Century project concludes that failing to consider sustainability issues is a failure of fiduciary duty. The project also acknowledges that the law in many countries is not sufficiently clear, and that more explicit signals from policymakers are required. This is changing. The PRI mapping of responsible investment policy instruments across the world’s 50 largest economies has identified over 300 individual policy tools or initiatives relating to ESG issues and investment. These include pension fund disclosure requirements, stewardship codes and corporate disclosure requirements. Over half of these were created between 2013 and 2016, suggesting that regulatory action is accelerating. Despite this progress, more needs to be done. In each of the 15 countries and jurisdictions covered by The Fiduciary Duty in the 21st Century project, we have conducted a detailed legal assessment (or gap analysis) of the law and policy on fiduciary duty and on the requirements for investors to take account of ESG issues in their investment practices and processes. We have made detailed recommendations to the relevant regulators and government agencies on changes that are required, and are now engaging with these organisations to encourage them to take effective action. In Brazil, to provide just one example, pension fund regulation encourages ESG disclosures, but does not require ESG integration; for example, Resolution 3.792 requires closed pension schemes to disclose whether they take account of environmental and social matters. This falls far short of a requirement to take account of these issues in investment decision-making. We have highlighted the issue with Brazilian regulators and Brazil’s PREVIC has committed to take action to correct this obvious regulatory gap. Our research also points to the importance of analysing the wider regulatory context. Two themes recur in our analysis. The first is the importance of integrating sustainability-related considerations into all aspects of policy. For example, in China, the Guidelines for a Green Financial System include recommendations for banks, but not investors nor pension funds. And the EU’s commitment to sustainable capital markets contrasts with the

Trump administrations deregulatory agenda, including the roll-back of Dodd Frank through the Financial Choice Act. The second is that implementation is important. The effectiveness of responsible investment-related policy the world over is hampered by weak implementation and weak signals. Investors are sceptical of the effectiveness of policy because of weaknesses in policy design and monitoring and because of inconsistency between different government departments and regulators. Added together, these send a signal to investors that sustainability is separate from the core purpose of financial markets. Addressing these barriers – the need for legal clarity, the need for integrated policy, the need for effective policy implementation – is the core objective of the Fiduciary Duty in the 21st Century project.Over the past three years, we have engaged governments – with significant success in many jurisdictions – to clarify the meaning of fiduciary duty and to introduce legislation or other policy measures that make ESG issues an integral part of investment.
In later articles in this series, we reflect on the success of our efforts and identify areas where more work is required. But the core message is clear. The historic approach to fiduciary duty with this exclusive emphasis on financial returns is no longer fit for purpose. We are moving to a world where, driven by the investment case, the reputational case, the societal case and the legal case, investors must take full account of sustainability-related issues in their investment processes. A failure to do so will be seen as a breach of their core fiduciary duties.

Will Martindale is the head of policy at the PRI, Elodie Feller is the Investment Commission Coordinator for the UNEP FI investment work programme, Rory Sullivan is an independent adviser on responsible investment and corporate responsibility

Notes:
1. In January 2016, the Principles for Responsible Investment (PRI), the United Nations Environment Programme Finance Initiative (UNEP FI) and The Generation Foundation launched a three-year project – Fiduciary Duty in the 21st Century – to clarify investors’ obligations and duties in relation to the integration of environmental, social and governance (ESG) issues in investment practice and decision-making. The project involves working with investors, governments and intergovernmental organisations to develop and publish an international statement on investors’ obligations and duties, and to publish and implement roadmaps on the policy changes required to achieve full ESG integration across some fifteen countries and jurisdictions, including Australia, Brazil, China, Germany, Japan, South Korea, the UK and the US.