Fiduciary duties and sustainable finance

Earlier this month, the European Commission launched a public consultation on the need to clarify that the fiduciary duties of institutional investors and asset managers allow (or require) them to take into account environmental, social and governance (ESG) factors when making investment decisions. The consultation is part of a broader EU commitment to align its financial system with the objective of global sustainable development. To this end, in December 2016 the Commission appointed a High-Level Expert Group (HLEG), and mandated it to develop a set of recommendations on how to integrate sustainability into EU financial policy.  In its Interim Report, published in July 2017, the HLEG formulated a series of recommendations for reforming the EU’s rules and financial policies to facilitate green and sustainable investment. They included the need to harmonise the different formulations and standards of fiduciary duties across all relevant EU financial regulation instruments. Specifically, the HLEG recommended the creation of “a single set of principles of fiduciary duty and all its related concepts that can then feed into the respective relevant laws according to the specificities of market participants. The regulatory authorities need to make clear… that managing ESG risks is integral to fulfilling fiduciary duty, acting loyally to beneficiaries and acting in a prudent manner.”[1] In addition, the Interim Report suggested the creation of a set of guidelines that specify in more detail the relevant fiduciary duties and standards. In the HLEG’s view, these duties include:

• a duty to act with due care, skill and diligence
• a duty to act in good faith in the best interests of beneficiaries and clients
• a duty to avoid, or balance the conflicting interests of different classes of beneficiaries
• a duty to avoid acting in the fiduciary’s own interest or in the interest of a third party, without the prior informed consent of the beneficiaries
• duties to include ESG considerations in their investment decision and processes, to encourage high standards of ESG performance in their investee entities, and support the stability and resilience of the financial system.[2]

Some of the main arguments for a uniform approach to fiduciary duties presented in the Interim Report include the following. First, there is a “growing consensus” that institutional investors and financial intermediaries have an obligation to include ESG considerations in their investment decisions, and making such an obligation explicit would bring this approach into the mainstream and remove any remaining doubts or tendencies to focus exclusively on financial returns. Second, duties of loyalty and prudence and other related concepts are partly codified in several directives, but standards are at times unclear or inconsistent. A harmonised approach will allow the application of uniform fiduciary standards across the investment and lending chain and the full array of financial instruments. Moreover, it could serve as the foundation for a broader international articulation of fiduciary duties, such as an OECD convention, and as a model for national regulators to integrate ESG considerations into fiduciary duties.

Establishing a single set of fiduciary principles covering all the key participants in the investment and lending chain would certainly enhance the clarity, predictability and consistency of the relevant EU instruments and the national laws based on them. However, taking into account the multitude of circumstances in which fiduciary duties arise in the investment chain, as well as the different legal traditions coexisting in the EU, attempting to define and apply fiduciary duties uniformly is extremely ambitious. Furthermore, it seems that it is unnecessary to redefine or unify fiduciary duties for the purpose of allowing or requiring ESG considerations to be taken into account in investment decisions and processes.

One reason for this is that many institutional investors in Europe and elsewhere already have in place policies and principles for integrating ESG considerations in their investment. The 2016 study of socially responsible investment in Europe shows significant and consistent growth across all socially responsible investment strategies, with rates ranging from 30% for engagement and voting, up to 385% for impact investing. The study also found that interpreting fiduciary duties as narrowly focused on financial results is becoming a thing of the past: “fund managers have come to see ESG considerations as part of their investment obligations in line with their fiduciary duty.”[3] Another study by Global Sustainable Investment Alliance shows that socially responsible investing has become mainstream in Europe: 52.6% of the total managed assets in 2016 were subject to some form of sustainable and responsible investment strategy.[4]

Another reason is that the legal framework may not be a relevant obstacle to incorporating ESG considerations into the investment decision. A Report drafted by EY for the European Commission in 2014, looking at fiduciary duties in several Member States and comparing their regimes to common law (UK, USA, Canada), found that “no legal framework has been identified in the EU or any of its Member States that limits institutional investors from taking relevant environmental, social and governance (ESG) issues into account in their investment decisions.”[5] An earlier study published in 2005 by the United Nations Environment Programme Finance Initiative (UNEPFI) and Freshfields Bruckhaus Deringer investigated whether the integration of ESG issues in investment decisions was compatible with the fiduciary duties of finance institutions. It concluded that, given the increasingly recognised links between ESG factors and financial performance, “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.”[6] Ten years later, however, a follow-up report published by the UNEPFI, Principles of Responsible Investment, UN Global Compact and UN Inquiry highlighted that, despite the sustained growth of the socially responsible investment, there is a need for the European Commission to clarify “that fiduciary duty requires asset owners to pay attention to long-term factors (including ESG factors) in their decision making and in the decision-making of their agents.”[7] This approach is preferable to a uniform legal definition and regime for fiduciary duties in the investment chain. A guidance document explaining the extent to which taking into account ESG considerations is compatible with fiduciary duties, including examples of best practice of sustainable investment, would be a more practicable solution to the need for clarity and uniformity, and would allow national authorities and regulatory bodies to adapt the EU guidelines to their national needs and conceptual legal framework.

[1] The EU High-Level Expert Group on Sustainable Finance, “Financing a European Economy: Interim Report” (2017) at 25.

[2] Ibid. at 24.

[3] Eurosif, “European SRI Study” (2016) at 7-8.

[4] Global Sustainable Investment Alliance, “Global Sustainable Investment Review” (2016) at 7.

[5] EY, “Resource Efficiency and Fiduciary Duties of Investors: Final Report” (2014) at 8.

[6] UNEPFI and Freshfields Bruckhaus Deringer, “A Legal Framework for the Integration of Environmental, Social and Governance Issues into Institutional Investment” (2005) at 13.

[7] UNEPFI at al, “Fiduciary Duty in the 21st Century” at 44.