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 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, quoting the Canada Business Corporations Act, has stated:

The CBCA requires directors and officers of a corporation to "exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances". ²

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 about climate proofing Canada's economy.

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, by Q4 of 2021, the United Nations’ Principles for Responsible Investment (PRI) had grown to 4,375 signatories, representing $121-trillion US, up from $6-trillion in 2006, 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. For example, the Royal Bank of Canada’s 2020 Responsible Investment Survey of 809 global institutional investors and investment consultants found that 75 per cent of those surveyed integrate ESG factors into their investment decisions, and that 63 per cent did so because they believed it was a component of their fiduciary duty.³ 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 about financial disclosures.

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 $121-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 Happening 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.

In the United States, there is no firm obligation to explicitly consider ESG issues in pensions’ investment policies. However, ESG related investment decisions are clearly deemed to be permissible. Perhaps more accurately they are “not prohibited,” but relegated to a secondary consideration to the financial risk and return characteristics of the overall investment portfolio. If they are to be included, they are deemed to require the same prudent and thorough analysis of appropriateness and impact. There is a relatively clear prohibition against acceptance of lower return or increase in risk in the pursuit of collateral objectives. There are, however, no standards that have been articulated to guide a fiduciary electing to pursue ESG investments.

Similar to the U.S., the EU approach begins with deference to existing laws at the member state (or national) level and then seeks to achieve a degree of “harmonization” by establishing a broad EU-wide set of standards that individual countries are encouraged to fulfill but with provision of considerable latitude to reflect their own particular structure of pension regulation and policy objectives. There remains, however, considerable tension in the implementation of the EU-wide standards and how member state variations are accommodated. Reflecting this tension, in contrast to U.S. law, current and proposed requirements include affirmative requirements for ESG factors to be considered in investment decisions and for plan administrators to report to members on how this obligation is being fulfilled.

The 2020 U.K. Stewardship Code states: “Environmental, particularly climate change, and social factors, in addition to governance, have become material issues for investors to consider when making investment decisions and undertaking stewardship.” Principle 4 of this code identifies climate change as a systemic risk, while Principle 7 requires that signatories “systematically integrate stewardship and investment, including material environmental, social and governance issues, and climate change, to fulfil their responsibilities.” New U.K. regulations which came into effect in October 2021 require trustees to: identify climate-related risks and opportunities and their impact on the scheme’s investment or funding strategy; select metrics for determining the greenhouse gas emissions attributable to the scheme investments and which inform the assessment of climate-related risks; design strategies to mitigate exposure to risks and establish measurable targets in managing these risks; and, undertake scenario analyses which consider the impact of global rises in temperature, including a rise within the range of 1.5 and 2 degrees Celsius above pre-industrial levels, on the resilience of the scheme’s investment or funding strategy, and the scheme’s assets and liabilities.

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.” More recently, the Office of the Superintendent of Financial Institutions (OSFI) released a consultation paper regarding climate-related risks and the financial sector. With respect to its oversight of federally regulated financial institutions (FRFIs) and federally regulated pension plans (FRPPs), the paper notes that while “OSFI’s current guidance does not reference climate-related risks specifically, it includes principles and expectations that are relevant to FRFIs’ [FRPPs’] management of these risks." In other words, while climate-related considerations may not be specifically identified in current legislation, if they are relevant, they should be addressed, as would be the case for any other relevant factors.⁴

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 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.

Carol Hansell of Hansell LLP recently published an important legal opinion⁵ indicating that Canadian directors are obligated to consider climate change risks and opportunities relevant to the companies of which they sit on the board. Her analysis iterates the need for directors to ensure that, where material, management must develop strategies to address both climate change risks and opportunities. A failure to do so could facilitate legal liability, not dissimilar to any other kind of risk.

Another important legal opinion from Randy Bauslaugh of McCarthy Tétrault LLP in May of 2021, concludes that climate change considerations lie squarely under the fiduciary responsibilities of pension plans. Notably, the report arrives at this conclusion based on interpretation of current law, and based on an acceptance of the fact that climate change is a material financial consideration. In fact, the opinion does not really spend much time debating whether the consideration of climate change is the right thing to do for pensions from a social or moral perspective, stating: “The bottom-line is that their management focus must be on value, not values, and that climate change affects value.” ⁶

The Canadian Expert Panel on Sustainable Finance emphasized 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.” A September 2021 ISF report indicates that only moderate progress had been made on this recommendation, while survey results included in that report indicated this was the second most commonly cited “potential need for action in the short-term” among experts that were surveyed for the report.⁷ We agree with the Expert Panel and other experts 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), 2019.
• ²Source: SCC, Peoples, BCE, 2008.
• ³Source: RBC Global Asset Management (“RBC GAM”) Responsible Investment Survey, 2020.
• ⁴Source: Discussion paper: Navigating Uncertainty in Climate Change: Promoting Preparedness and Resilience to Climate-Related Risks, 2021.
• ⁵Source: Hansell LLP Legal Opinion, 2022.
• ⁶Source: Randy Bauslaugh, McCarthy Tétrault LLP, 2021.
• ⁷Source: “Changing Gears: Sustainable Finance Progress in Canada”, ISF, September 2021.