A new project aims to find answers to some fundamental legal questions about investing, people and planet

Key points 

  • The PRI and two partner organisations have launched a project to develop ‘a legal framework for impact’ 
  • A law firm will delve into questions such as whether investors are legally required to take into account the sustainability impact of their investment activity
  • Potential project outputs include recommendations for policy change

More than a decade ago, the law firm Freshfields published a landmark report on the relationship between fiduciary duty and the integration of environmental, social and corporate governance (ESG) considerations in investment policy.

Published in 2005, it was entitled ‘A legal framework for the integration of environmental, social and governance issues into institutional investment’.

Commissioned by the asset management working group of the UN Environment Programme Finance Initiative (UNEP FI), it concluded that integrating ESG considerations into investment analysis in a bid to better value securities was “clearly permissible and… arguably required in all jurisdictions”.

According to the Principles for Responsible Investment (PRI), whose launch the Freshfields report contributed to, this was a radical conclusion, even though “the first generation” of responsible investors were beginning to see things this way. 

Fast forward to today and the PRI, together with UNEP FI and the Generation Foundation, has developed a project that is aimed at “the third generation” of responsible investment.

This project is also about “a legal framework”, but this time for “the consideration of sustainability impact in investor decision-making”. “Investors are now beginning to consider what in this project we’re calling impact duties,” says Will Martindale, director of policy and research at the PRI. 

These could be decarbonisation targets, or relate to quality of life in retirement or the impact of investments on wider society. “Impact duties are distinct from fiduciary duties in that they focus less on the process investors follow and more on the outcome of the investment decision,” he says. 

Will Martindale

The goal of the project is to try to analyse and clarify those grey areas of the law where impact duties and fiduciary duties do not align. 

Another reason for the project’s launch, according to Martindale, is that regulators are also beginning to consider the outcomes of investment activity.

Arguably the best example, he suggests, is the proposed EU regulation on sustainability-related disclosures in the financial services sector. According to the European Commission, the regulation “requires the disclosure of adverse impact on ESG matters, such as in assets that pollute water or devastate bio-diversity”.

The ‘disclosures’ regulation, as it is known, is one of three legislative proposals the Commission unveiled last May to implement its sustainable finance action plan. The body for EU member states and the European Parliament came to a political agreement about it in March, so it is close to being completed.

Martindale says the PRI expects consideration of regulation in relation to the impacts or outcomes of investment activity to be the “regulatory trajectory”.

“There are valid legal questions that need to be resolved as part of that and we think this project is going to be a cornerstone of better understanding,” he says. 

The project will involve a “reference group” of investment experts to work with a large law firm to publish analysis of the legal framework for investors to consider sustainability impact in five substantial economies. 

According to Martindale, the five jurisdictions are likely to include the UK, France and the EU, and possibly the US or a US state. Depending on the capabilities of the law firm, the analysis could also take in China. 

The project team plans to publish a request for proposal for the recruitment of the law firm in May, and to appoint the firm in the summer. 

‘Fundamental’ questions
According to a description of the project, fiduciary duties – as currently defined – require a fiduciary to consider “how sustainability issues affect the investment decision, but not how the investment decision affects sustainability issues”.

It says there are “emerging ‘pockets of excellence’ in technical understanding” of integrating impact in investment decision-making, but that “fundamental legal questions remain”.

The project organisers identify three such questions:
● Are investors legally required to integrate the sustainability impact of their investment activity in their decision-making processes?
● Are there any legal impediments to investors adopting “impact targets”?
● On what positive legal grounds could or should investors integrate the realisation of the UN Sustainable Development Goals in their investment decision-making?

The project is fuelled by a clear ambition – to help “assessing and accounting for” sustainability impact become a core part of investment activity over the next decade. 

In that sense, the project is not confined to impact investing as an asset class or a sub-section of responsible investing. “We’re looking at understanding the regulation, the legislative and legal requirements for all investors in terms of the impact they have,” says Martindale. 

Piet Klop, senior adviser for responsible investment at PGGM, shares the vision outlined by the PRI and its project partners. “Definitely,” he says when asked whether impact should become a core part of investment activity. 

He refers to an idea espoused by others, too, namely of impact as the “third dimension” alongside risk and return. “Increasingly, we just want to know from our investments what that impact, negative or positive, has been,” he says. 

According to the project overview, if the commissioned legal analysis uncovers legal impediments to incorporating sustainability impact, “the project will recommend policy change”.

In addition to targeting policy-makers, the project organisers would like it to yield practical recommendations about how investment practice could evolve to achieve the goal of “systematic integration of sustainability impact in investment decision-making”.

The investors on the reference group are supposed to help support the research, test the legal analysis and implement the final recommendations.

Representatives from Swedish buffer fund AP2, Aviva Investors, and Generation will be among the members of the group, according to Martindale. 

He says the PRI and its project partners are hoping to have investors from different geographies involved, as well as investors’ legal counsel. The project team also says there is much to learn from impact investors, in particular with regard to impact measurement, and hopes to have one or two involved with the project, too. 

The 2005 Freshfields report about ESG and fiduciary duty has been variously described as seminal and ground-breaking. But in 2015 the PRI and the Generation Foundation followed it up with another report because, as they wrote at the time, “many investors continue to point to their fiduciary duties and to the need to deliver financial returns to their beneficiaries as reasons why they cannot do more on responsible investment”.

Today, as Lisa Beauvilian, head of sustainability and ESG at Impax Asset Management, says, the “ESG question still isn’t fully understood or solved yet in the current fiduciary duty discourse”. 

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Approaching fiduciary duty from an ‘impact’ angle could be better or more meaningful, she adds. It should be interesting to see what the legal analysis turns up.