Fiduciary Duty in the 21st Century: Europe’s leadership

This is the fifth in a series exploring interpretation of fiduciary duties. Earlier articles in this series are available here: Brazil, China and the US. The series kicked off with a look at the global state of play.

On May 24th, the PRI, UNEP FI and The Generation Foundation were pleased to welcome proposed legislative changes from the European Commission to codify ESG integration requirements into investor duties. The legislation is part of a series of proposals to clarify ESG integration and disclosure requirements across the investment chain.
This action underscores the Commission’s longstanding commitment to creating a more sustainable financial system, with ESG factors as an integral part of this process. It followed on the heels of the March release by the Commission of its Action Plan for Financing Sustainable Growth, providing a roadmap to achieve a more sustainable financial system across the European Union, implementing recommendations based on the January 2018 EU High-Level Expert Group (HLEG) final report. The PRI and UN Environment participated in the HLEG and contributed findings from our seminal project, Fiduciary Duty in the 21st Century.
The Fiduciary Duty in the 21st Century project demonstrated that there are already requirements to consider ESG issues in current legislation, they’re just not explicit, which leads to confusion and weak implementation. Duties of loyalty and prudence require consideration of all risk and opportunity factors, over the time-horizon of the obligation: that includes ESG factors.
The recent amendments to the IORP ii directive – a directive that regulates occupational pension funds – will introduce reporting requirements on ESG issues. These new Commission proposals will go further still, and codify ESG duties. This underpins the PRI, UNEP FI and The Generation Foundation work, namely that ESG factors should be incorporated in investment decision-making and that investors should understand and incorporate the sustainability preferences of their clients and beneficiaries.

There are also two important considerations to note:
• Fiduciary duties require a process in place: It is the requirement of a process to integrate ESG issues. The legislation doesn’t seek to be prescriptive of the ESG issues that are relevant to an investor; that is left to the discretion of the investor.
• The mandate agreement with the client drives the investment process, and will continue to do so. These considerations are important to accommodate differences in pension and asset management markets across European Member States.The PRI, UNEP FI and The Generation Foundation believe the proposals are necessary but proportionate and modest. We find that despite significant progress, responsible investment policies are often unclear with weak drafting, positioning ESG issues as voluntary and unaligned with wider policy frameworks. The PRI’s policy programme also finds very little monitoring of responsible investment practice.
We believe that regulatory support in line with what we are seeing from the Commission can help to clarify these issues for investors. In its Global guide to responsible investment regulation, the first global study to analyse the impact of responsible investment-related public policy initiatives, the PRI found evidence that responsible investment policy is driving better ESG performance by companies.
The UNEP FI Positive Impact initiative also finds that improving transparency on the end-impact of investments’ sustainability strategies will help align investment practice with the Sustainable Development Goals, and we believe that the Commission’s proposal provides a first and positive step in that direction. However, as Christine Chow at Hermes noted, “A piece of regulation in isolation is a matter of compliance. We need to look at the ecosystem and how regulations coordinate. In a well-functioning market, there should be positive reinforcement that enables responsible investment.” This is why the Action Plan and recent legislative proposals are welcome.
Over the coming months, the ESG disclosure proposal will go through a political process. The European Commission proposes legislation, but to pass, it must be supported by both European Parliament and Council. The Parliament and Council will scrutinise the proposals and make changes. Agreement is expected in early 2019 and Member States then have two-years to implement.
If the proposals become part of European legislation, there is the potential that they will be significant beyond Europe, with countries such as China, Canada, Brazil, South Africa and Japan.
While Europe is not alone in making progress in codifying ESG duties, European policy makers are demonstrating leadership—both through the HLEG process, the Commission Action Plan, and now through these proposals. We encourage our signatories and members to engage European policy makers to support effective implementation.

By Elodie Feller and Alyssa Heath, on behalf of the Fiduciary Duty in the 21st Century project. Feller is the Investment Commission Coordinator responsible for the investment work programme at the United Nations Environment Programme Finance Initiative (UNEP FI). Heath is Senior Policy Manager at the Principles for Responsible Investment (PRI).