Martin Grosskopf understands why pension plan sponsors might be reluctant to include environmental, social and governance (ESG) issues in their investment decision-making process. But the director of sustainability research and fund manager at Acuity Investment Management strongly believes that ESG adds value to investment returns over the long term. And he agrees with the recommendations of a new UN report, which suggests that plan sponsors who are not willing to assess ESG issues are leaving themselves open to potential legal liability.
Grosskopf may be somewhat biased: he’s been a member of the United Nations Environment Programme Finance Initiative Asset Management Working Group since 2003. This summer, that group released “Fiduciary Responsibility: Legal and Practical Aspects of Integrating Environmental, Social and Governance Issues into Institutional Investment.” The report, Fiduciary II for short, is a follow-up to a UN report on the same topic released in 2005.
Responsible Regulation
Fiduciary II suggests that asset managers or investment consultants who fail to raise ESG issues with their clients and embed those issues in legal contracts run “the very real risk of being sued for negligence”—even if the pension fund had not specified ESG considerations as a material concern. “Institutional investment consultants and asset managers have a professional duty of care to proactively raise ESG considerations with their clients and failure to do so may have serious consequences,” the report warns.
However, pension plan sponsors needn’t push the panic button. Although legal action is a possibility in such cases, it’s a fairly unlikely scenario.
“There is little relevant jurisprudence to indicate a liability, but this can only be established through a case being brought forward,” says Jordan Berger, head of responsible investing with Mercer Canada. “That’s one of the interesting issues about fiduciary obligation; there is very little case law to either support or oppose including responsible investment in the investment process,” Berger adds. “I really don’t think that an absolute legal obligation has been established, but there is a best practice expectation that I think is quite justified.”
Professor Benjamin Richardson of Osgoode Hall Law School in Toronto says the report’s recommendations raise the question of what is “responsible” and whether or not that should be legally regulated.
“To really transform financial markets, we may need some standardization of the notion of being responsible,” he remarks. “Otherwise, it will likely remain only an instrumental business case consideration (i.e., consider ESG issues only when they are financially material to your own portfolio).”
“Canadian courts have hardly considered the relationship between SRI and fiduciary duties, unlike U.S. and U.K. courts,” Richardson adds. “However, there have been some significant Canadian cases concerning the fiduciary duties of company directors, which are indirectly relevant to this debate. Those cases have created a more favourable legal climate for corporate social responsibility in Canada.”
Grosskopf points out that focusing too much on the legal liability aspect misses many important messages in the 101-page report. He says the report highlights some of the inadequacies of the current interpretations of fiduciary duty. For instance, many pension funds retreat to the position that ESG issues cannot—or, at least, should not—be considered in any weighting above financial value to the portfolio.
“I think the main recommendations that are critical in this report are that [ESG] issues are as relevant as financial issues if they are material to the investment returns,” Grosskopf says. “What it really highlights is that investment committees cannot say that ESG is an external issue and cannot be integrated into the investment process.”
As a consultant, Berger supports the report’s recommendation that advisors to institutional investors have a duty to proactively raise ESG issues as part of the advice they provide.
“I think that’s important—it’s a best practice,” he says. “Although one might quibble with the strength of the conclusions, I think they have highlighted a critical issue, which is the responsibility of advisors to be informed of recent trends in dealing with ESG factors and to recognize their responsibility to proactively raise concerns with their clients. So it shifts the focus from, ‘You cannot look at responsible investment’ to ‘You really have an obligation to incorporate responsible investment insights when they can have a material impact on return and risk.’”
Talking Points
Both Grosskopf and Berger note that, if nothing else, the report provides some important points for pension funds and their advisors to consider. “It’s going to take the discussion of [ESG] issues to another level within investment committees,” says Grosskopf.
Rachel Davies, an investment analyst with Acuity, says some corporate pension plans haven’t been actively integrating ESG because they don’t have the appropriate legal language. “That was another goal of this report: to give [pension plans] some tools so they can incorporate ESG issues into investment management contracts,” Davies says.
For example, the report notes that if ESG considerations are relevant and material investment considerations for pension funds, it then becomes necessary for those funds to use ESG language in order to clarify the expectations of all parties to the investment contract. “In particular, it is important that it is made absolutely clear to beneficiaries, pension fund trustees and asset managers that ESG is regarded as a mainstream investment consideration.”
As well as embedding ESG language in contracts, ESG considerations and their application in practice should be included as part of regular portfolio reviews, the report suggests. Pension fund trustees could also adopt—and require their asset managers to adopt—the UN’s Principles for Responsible Investment. And the Investment Policy Statement could be amended to include examples of international laws/treaties and voluntary guidelines or principles that the investment industry has accepted as having a material effect on investment value, such as the Universal Declaration of Human Rights, the Equator Principles and the Carbon Principles.