Fiduciary Duties
Introduction
Decisions made by fiduciaries cascade through the intermediation chain and in turn through the investment decision-making process, ownership practices, and ultimately, the way in which companies are managed.
Where their exists agency, where one party has agency over another, the relationship is often governed by fiduciary duties: A duty of care, loyalty and prudence, whereby the agent makes decisions in good faith and judgment and in the best interests of the principal.
Investment decision-makers have a duty of care to their savers and to act in their savers’ best interests. In the relationships between asset manager and asset owner and between asset owner and saver, fiduciary duties tend to be interpreted as, “in the best financial interests”.
Fiduciary duties exist in common law countries, such as the UK or US, which is based on case law and judicial precedent. In civil law countries, such as
France or Germany, while more prescriptive, there exists similar duties.
Fiduciaries are sensitive to retrospective legal action where they have (or are seen to have) imposed their own personal views (say, on sustainability) on their investment decisions.
In the case of a dispute – as a 2022 UK Department for Work and Pensions (DWP) guidance says – “Neither DWP nor TPR [The UK Pensions Regulator] can provide a definitive interpretation of the legislation which is a matter for the courts”. A pecuniary (financial only) interpretation of fiduciary duties is particularly prevalent in the US.
Case law is thin, and therefore application can be ambigious. Lawyers often cite Cowan v Scargill, an English trusts law case from 1984. A follow up memorandum, issued in 1985 said, “Trustees … may be held liable for investing in assets which yield a poor return or for disinvesting in stock at inappropriate times for non-financial criteria”.
Increasingly, however, the argument that fiduciary duties preclude sustainability has been turned on its head. Rather, fiduciary duties require sustainability.
In 2014, the UK Law Commission concluded: “Whilst it is clear that trustees may take into account environmental, social and governance factors in making investment decisions where they are financially material, we think the law goes further: trustees should take into account financially material factors.”
In 2019, the PRI concluded: “Investors that fail to incorporate ESG issues are failing their fiduciary duties and are increasingly likely to be subject to legal challenge.”
However, ambiguity can lead asset owners (and their advisors) towards a narrow interpretation of duties; one that may not adequately consider sustainability risks and may miss out on the upside of effective sustainability implementation.
Financial materiality
That ESG issues are financially material is largely undisputed.
Financial materiality is the often cited counter-argument to the recent politicisation of ‘ESG’, that neglecting analysis of ESG issues leads to the mispricing of risks, and is therefore not in savers’ best interests (and as such, a failure of fiduciary duties).
‘Proof’, however, can be challenging for a number of reasons.
- The inability to isolate ESG issues and attribute to financial performance
- The divergent, and potentially conflicting, approaches to responsible investment.
- Sustainability is rarely a singular construct. Determining whether a company is sustainable is subjective.
There are of course scenarios where a sustainable company underperforms or a non-sustainable company over-performs and for investors,
proving materiality is a two-step process: 1) whether the ESG issue affects company performance, 2) whether it’s priced by the market.
There is however more evidence than not that ESG issues are financially material, supported by a range of practitioner and academic studies.
It is also ‘common sense’ (or in the language of fiduciary duties, ‘acting as a prudent person’) that issues such as climate change, human rights, biodiversity and inequality affect company, and therefore portfolio, valuations.
“Incompleteness theorems” developed in the 1900s can have application here; because financial outperformance cannot be proven in every instance, does not mean it is untrue.
For investors, it comes back to governance, process, time horizon, and reporting. Ignoring sustainability risks is self-evidently imprudent.
Impact and outcomes
One of the challenges for investors is marrying together fiduciary responsibilities with real-world sustainability impact.
The terms ‘impact’ and ‘outcomes’ are increasingly associated with sustainable investment – not as an asset class, but characteristics of the investment strategy.
“Double materiality” considers dual objectives: the investment’s financial performance and the investment’s real-world sustainability impact.
When it comes to fiduciary duties, the lens is typically one of ‘systemic risk’.
There may be investors that are comfortable pursuing impact in its own right (what law firm Freshfields badges as “ultimate ends” investing for sustainability impact).
But for other investors, while the strategy may be the same, the pursuit of impact is for financial reasons, such as to address systemic risks (or “instrumental” investing for sustainability impact).
How Canbury can help
Asset managers are typically subject to mandates (or contracts) as service providers to asset owners. Asset managers are therefore governed by contract law, and as long as asset managers meet requirements set out in contracts, they are unlikely to be in breach of fiduciary duties.
Fiduciary duties are more commonly discussed by asset owners, which is often a less resourced part of the intermediation chain, and reliant on advisors -typically, an investment consultant or lawyer.
This can lead to status-quo bias, where stale advice can impede decision-making.
Canbury was created with a vision to make sustainability meaningful.
We draw on a unique blend of experience across sustainability, investment, policy and regulation and technology.
We can provide you with:
- Training on a range of sustainability issues, bespoke to you, so you have access to the latest insights.
- Building the evidence base on issues such as financial materiality, through our use of technology.
- Thematic research projects, our team has expertise on a range of sustainability themes.
- Policy development, so you have the right policies in place to meet your sustainability objectives.
- Advice and consultancy, we focus on implementation.
Navigating fiduciary duties is a shared challenge – and one we can support you to solve.