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Fiduciary Duty, Climate Change and ESG Considerations

What is Fiduciary Duty?

The concept of fiduciary duty is defined differently, if in fact the specific term is identified at all, in different countries around the globe. However, across numerous jurisdictions, the following duties are among the two most important and frequently referenced that apply to investment decision makers:1

  • Loyalty: Fiduciaries should act honestly and 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, conducting activities such as investing as a ‘prudent person’ would.

From a regulatory framework, the concept of fiduciary duty is most commonly reflected in the duties of corporate directors and officers (including those in not for profit organizations), pension fund regulations, stewardship codes for managers of assets, trusts and estates, as well as in appropriate banking and insurance regulations. For example, the Supreme Court of Canada has stated:

“Every director and officer of a corporation in exercising their powers and discharging their duties must exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.”

(SCC, Peoples, BCE)
Person using calculator and looking at graphs

Why Discuss Fiduciary Duty AND Climate Change?

The understanding of fiduciary duty by corporate directors and officers shapes the very nature of corporate behaviours and investment practices. As such, providing clarity on the proper interpretation of fiduciary duty has the potential to significantly affect current and future investment decisions, thus impacting how our economy will evolve. For example, a redefinition of fiduciary duty for institutional investors during the 1990s changed the face of the investment landscape, transforming large pensions from boring, passive investors in government bonds and treasury bills, to significant players in public equity markets, and eventually in hedge funds, private equity, real estate and infrastructure. Learn more

Until recently, many actions and investments have been based on the premise that environmental, social and governance (ESG) factors, including climate change, are either immaterial or irrelevant and should not detract from other considerations – in summary, they were not viewed as ‘risk factors’ when evaluating an investment. However, incorporating ESG considerations is fast becoming the investment norm. For example, the Principles for Responsible Investment (PRI) has grown to over 2,500 signatories, representing over $90 trillion, and the list continues to grow. One of the motivating factors for the PRI’s growth is the fact that investors have come to realize that ESG matters, including climate change, are financially material. As such, they must be considered when assessing investment opportunities and must be incorporated in risk management processes. Ignoring these considerations has increasingly led to legal risks. The recognition that ESG and climate change are relevant risk factors will create added pressure for companies to provide more comprehensive and standardized ESG and climate–related disclosures. Learn more

In short, clarification regarding the importance of including ESG and climate change within the scope of fiduciary duty will have a direct impact on the amount of the $180 trillion or so of global investable assets that integrates these considerations, as well as improving the quality of the resulting investment and business decisions.

What is Hapenning in the Regulatory Landscape?

Since 2013, Australian rules require that the investment strategies of pensions must demonstrate how ESG factors have been considered, even when they may not be quantifiable. Since 2015, the Korean National Pension Services Act requires pensions to consider ESG issues and provide declarations regarding the extent to which such issues have been taken into account.

The EU issued a directive in 2016 dictating that appropriate governance required that ESG factors be incorporated into investment decisions, while 2019 proposals advocate required disclosures regarding policies related to sustainability. Revisions to UK regulations that were implemented in 2019 clarified that consideration of ESG factors is a component of prudent investment decision making, and is therefore required by pension trustees. The U.S. provided guidance on ESG issues in a 2018 bulletin that essentially says that when ESG considerations are material, they should be treated similarly to other material economic factors that could be expected to affect risk and return levels.

In Canada, as of 2016, Section 78(3) of the Ontario Pension Benefits Act requires: “that a statement of investment policies and procedures include a statement about whether environmental, social, and governance (ESG) factors are incorporated into the plan’s investment policies and procedures, and if so, how they have been incorporated.”

What is the Role for Fiduciary Duty in Promoting Sustainability?

As can be seen from the examples noted above, global policy and regulatory frameworks currently range from strong to weak in terms of the requirements to incorporate ESG and climate change considerations. However, the overall movement is towards further strengthening of the interpretation of the role of these considerations in fiduciary duty. Such integration is a necessary, but not a sufficient, condition to adequately shift the required amount of resources towards sustainable investments and business decisions. In other words, fiduciary duties are evolving to require consideration of how sustainability issues affect the investment decision, but not necessarily how the investment decision affects sustainability.

Other non-regulatory developments are also providing insight as to the direction of expanding the ‘scope’ of fiduciary duty. For example, in August 2019 a statement was released by the Business Roundtable regarding the Purpose of a Corporation. This statement was signed by 181 of the largest U.S. CEOs, who committed to lead their companies for the benefit of all “stakeholders” – i.e., customers, employees, suppliers, communities and shareholders. This represents a significant shift from the pre-existing emphasis on shareholder interests, which is consistent with existing U.S. fiduciary regulations.

The Canadian Expert Panel on Sustainable Finance pointed to the critical role that is played by the definition of fiduciary duty, as well as its interpretation by market participants. In particular, Recommendation #6 of the final report states: “Clarify the scope of fiduciary duty in the context of climate change.” We agree with the Expert Panel that this represents an important step in moving the needle forward for sustainable finance in Canada.

1Source: Page 12, Fiduciary Duty in the 21st Century (UNEP Finance Initiative)

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