Field Notes: Fiduciary Duty in the 21st Century

The United Nations Environment Programme's new study seeks to end the debate on whether fiduciary duty is a legitimate obstacle to greater ESG integration.

A new study by Principles for Responsible Investing (PRI) and UNEP Finance Initiative, “Fiduciary Duty in the 21st Century”, has sought to examine the prevailing literal interpretation of fiduciary duty, and the active omission of ESG metrics by asset managers. Fiduciary duty, a legal obligation of money managers to act in the interests of beneficiaries rather than their own, has often been cited as a barrier to integrating environmental, social and governance (ESG) considerations into their investment processes.

For the report, the project team interviewed over 50 investors, policymakers, lawyers and regulators from eight countries—including the U.S.—to understand how fiduciary duty affected investment practices in each country:

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 modernize definitions and interpretations of fiduciary duty in a way that ensures these duties are relevant to 21st century investors.

At present, the report found several challenges that hamper the use of ESG metrics in making investment decissions, such as an outdated perception, especially in the U.S., that ESG metrics are not material, as well as lack of clarity around what ESG integration actually means in practice. Limited knowledge about the relationship between ESG issues and investment performance, lack of transparency, inconsistency in corporate reporting and weaknesses in implementation are also cited as serious challenges.

The report makes suggestions for policymakers and regulators to facilitate the integration of ESG metrics. In general, it advocates that they should clarify what fiduciary duty requires, strengthen implementation of legislation and codes and support efforts to harmonize legislation and policy on global responsible investment. The report also makes country-specific recommendations. For the U.S., it recommends the following:

The Department of Labor should:
• Clarify that:

• Fiduciary responsibility requires a long-term, risk-adjusted approach to management of pension assets so as to deliver sustainable retirement benefits to participants and
beneficiaries in an impartial manner.
• Asset owners should pay attention to long-term factors (including ESG issues) in their decision-making, and in the decision-making of their agents.
• Asset owners are expected to proactively engage with the companies and other entities in which they are invested.
• And clarify that these actions are consistent with asset owners’ fiduciary duties.

• Reissue its 2008 bulletins on Economically Targeted Investments and on Shareholder Rights, and:

• Clarify that asset owners’ duty is to impartially serve the interests of participants and beneficiaries.
• Clarify that the assessment of the costs and benefits of risk management measures such as active ownership should explicitly consider the long-term benefits of such measures.
• Clarify that green investments can make important financial and risk mitigation contributions to investment portfolios.

• Require asset owners to say how they integrate ESG issues into their investment decisions. As part of these requirements, the Department of Labor should commit to:

• Review progress annually.
• Explain how asset owners integrate ESG issues into their investment processes;

• Analyse how these commitments have affected the actions taken and the outcomes achieved (where the outcomes relate to both investment performance and to the ESG performance of the entities in which they are invested).

The New York Stock Exchange (NYSE) and Nasdaq, given their scale and influence, should strengthen their ESG disclosure requirements for companies, in accordance with their public
commitment to the Sustainable Stock Exchanges (SSE) initiative to promote long-term sustainable investment and improved ESG disclosure and performance among companies listed on their exchange

This long list of required reforms shows that the U.S. can do a lot more to encourage responsible investing. The IRS recently ruled that mission-related investments do not necessarily jeopardize a foundation’s ability to support their mission and are therefore not subject to a tax penalty. This is a huge step in making impact investing easier and removes a ready excuse for philanthropic investors who continue to resist responsible investing.

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