Fiduciary duty in the 21st century final report

In January 2016, the PRI and UNEP FI launched a four-year project to clarify investor obligations and duties (known in common law markets as fiduciary duties) in relation to the integration of environmental, social and governance (ESG) issues in investment practice and decision making. The project involved working with investors, governments and intergovernmental organisations: 

1. To develop and publish an international statement on investor obligations and duties.
2. To prepare policy analysis and research into investor duties across a range of markets, published in country roadmaps.
3. To engage with policy makers and encourage them to adopt policy measures that clarify and formalise that investor duties and obligations incorporate ESG issues in their markets.

This is the final report from that project. It replaces the original 2015 report which found that the “failure to consider all longterm investment value drivers, including ESG issues, is a failure of fiduciary duty”. Despite significant progress, many investors were not fully integrating ESG issues into their investment decisionmaking processes, necessitating regulatory clarification.

The origins of the modern interpretation of fiduciary duty date back to the landmark 2005 Freshfields Report, commissioned by the United Nations Environment Programme Finance Initiative (UNEP FI) Asset Management Working Group. Whereas there was relatively little change in the law relating to fiduciary duty between 2005 and 2015, there has been a great deal of development in the past few years.

This report describes how the integration of ESG issues into investment practice and decision making is an increasingly standard part of the regulatory and legal requirements for institutional investors, along with requirements to consider the sustainability-related preferences of their clients and beneficiaries, and to report on how these obligations have been implemented. It also identifies areas where further work is required and reflects on how investors’ duties and obligations may further evolve over time.

Executive summary

The fiduciary duties of investors require them to:

• Incorporate environmental, social and governance (ESG) issues into investment analysis and decision-making processes, consistent with their investment time horizons.
• Encourage high standards of ESG performance in the companies or other entities in which they invest.
• Understand and incorporate beneficiaries’ and savers’ sustainability-related preferences, regardless of whether these preferences are financially material.
• Support the stability and resilience of the financial system.
• Report on how they have implemented these commitments.

There are three main reasons why the fiduciary duties of loyalty and prudence require the incorporation of ESG issues.

1. ESG incorporation is an investment norm.

There is now such momentum behind the idea of responsible investment that the PRI has grown to over 2500 signatories, investing $90 trillion; and it is still growing.

In 2018, the PRI introduced minimum requirements for signatories including an investment policy that covers the investor’s responsible investment approach, which must account for more than 50% of assets under management, as well as senior-level commitment and accountability mechanisms for implementation. Ongoing annual disclosures by signatories demonstrate further progress towards the implementation of the Principles by signatories, including disclosure requirements which map to the TCFD.

This tells us that there is convergence between the ideas and motivations of responsible investment and investment. The incorporation of ESG issues into investment analysis and decision-making processes has become a necessary part of investment.

2. ESG issues are financially material.

Empirical and academic evidence demonstrates that incorporating ESG issues is a source of investment value. ESG analysis assists investors to identify value-relevant issues. Neglecting ESG analysis may cause the mispricing of risk and poor asset allocation decisions and is therefore a failure of fiduciary duty.

Systemic issues, like climate change, may significantly alter the investment rationale for particular sectors, industries and geographies and may have generalised negative impacts on economic output. Ultimately, the consideration of ESG issues has become one of the core characteristics of a prudent investment process.

3. Policy and regulatory frameworks are changing to require ESG incorporation.

Globally, there are over 730 hard and soft-law policy revisions, across some 500 policy instruments, that support, encourage or require investors to consider long-term value drivers, including ESG issues. Policy change has clarified that ESG incorporation and active ownership are part of investors’ fiduciary duties to their clients and beneficiaries.

Investors that fail to incorporate ESG issues are failing their fiduciary duties and are increasingly likely to be subject to legal challenge.