Fiduciary responsibility has been reinvented to include environmental, social and governance (ESG) considerations – this was the clear message to pension funds and their trustees, as well as the consultants and asset managers who work with them that emerged from the 2005 United Nations Environment Programme Finance Initiative (UNEP FI) global roundtable.
More than 450 participants from the financial services industry, as well as government agencies, NGOs, and academia, attended the two-day conference at the United Nations headquarters in New York City, under the theme of ‘A World of Risk: A World of Opportunities?’
The conference opened with the release of a study conducted on behalf of UNEP FI by leading international law firm Freshfields Bruckhaus Deringer. Entitled ‘A legal framework for the integration of environmental, social and governance issues into institutional investment,’ the study evaluated the laws regarding fiduciary responsibility in nine jurisdictions (Australia, Canada, France, Germany, Italy, Japan, Spain, UK, and US), from both civil law and common law traditions. Freshfields did the work out of its network of offices on a pro bono basis.
The question posed by the study was: “Is the integration of environmental, social, and governance issues into investment policy (including asset allocation, portfolio construction, and stock-picking or bond-picking) voluntarily permitted, legally required, or hampered by law and regulation; primarily as regards public and private pension funds, secondarily as regards insurance company reserves and mutual funds?”
The findings were unambiguous.
“It is not only lawful to take into account ESG considerations, but it is also mandatory to do so in certain circumstances,” announced Paul Watchman, a partner at Freshfields Bruckhaus Deringer and senior author of the study.
“There is a view in the industry that investment decision-making is dominated by the need to make profits. But investment decision-makers have broad discretion, and in fact they have a duty in certain circumstances to take ESG considerations into account,” Watchman explained at the conference. He pointed out that it would be mandatory to take ESG considerations into account if they are expected to have a material impact on the value of the investment, or if they are believed to be a subject of consensus among the beneficiaries. “Conventional investment analysis focuses on value, in the sense of financial performance…the links between ESG factors and financial performance are increasingly being recognised. On that basis, integrating ESG considerations into an investment analysis so as to more reliably predict financial performance is clearly permissible and is arguably required in all jurisdictions,” the report states.
The fact that there are links between ESG factors and financial performance arose frequently during the conference. For example, Mike Musuraca, a trustee of the New York City Employees Retirement System, asserted that, in his experience, “taking ESG into consideration reduces volatility”. UNEP FI’s own studies on materiality have also produced interesting results covering a variety of equity sectors, and various speakers pointed out the same.
Watchman stressed that the weighting given to ESG considerations is up to the decision-makers, pointing out that there is a distinction between relevance and weight. As the report states: “In none of the jurisdictions do the rules exhaustively prescribe how decision-makers should go about integrating ESG considerations into their decisions; in most cases, it is left to decision-makers to determine the approach that will enable them to meet their legal obligations in the particular circumstances”.
The Freshfields report is a serious call to pension fund trustees, maintains Matthew Kiernan, founder and chief executive of Innovest Strategic Value Advisors. He told IPE that this report “gives permission to fiduciaries, if not strong encouragement, to oversee their funds with ESG in mind”.
There is a “crushingly dominant ideology” that sees ESG considerations “as a waste of time at best, and at the worst as a profit killer,” said Kiernan. “It is that ethos that sees sustainability factors as incompatible with profit and prudence.” And he continued: “Remind me how you are more prudent, and more risk-averse, in blinding yourself to potentially useful information”.
But Kiernan noted several signs of change, such as the Freshfields study, and recent work by consultants Mercer. When one of the leading international law firms, and one of the leading consulting firms, take the issue seriously enough to invest significant research resources, boardroom sentiment must be shifting.
While many corporations are beginning to incorporate ESG considerations into their business strategies, having been pressured by shareholders, NGOs, and public opinion, their pension funds do not reflect this sea change, pointed out Kiernan. This is true for many of the organisations that are taking the lead in promoting sustainability issues, such as the Ford Foundation, the Nature Conservancy, the World Bank, even the UN itself.
“Many of the NGOs should look in the mirror, too,” Kiernan commented.
This makes pension funds the next - and quite obvious target - for advocates of sustainability strategies.
In the wake of the conference, the press leaped to investigate the UN’s own pension fund. It was revealed that its holdings do not reflect the organisation’s commitment to ESG considerations, focusing unwelcome attention on the fund’s in-house managers.
A spokesman for the UN Joint Staff Pension Fund had addressed the conference, and the lack of a clear ESG protocol in the investment decision-making process was apparent in his speech.
This kind of scrutiny may signal the start of a trend, an uncomfortable one for pension funds, their trustees and their managers. As Kiernan warned: “If you do not want to think in terms of investment risk, think about career risk.”
In his address to the UNEP FI conference, Kiernan stressed that change does not have to - and in fact should not - happen overnight. “There are incremental steps that can be taken. It does not have to be either/or.” Examples are trialing small tranches or doing simulations – or simply investing in making the research into sustainability issues available.”
James Hawley of St Mary’s College, California, pointed out, as things stand at the moment, pension funds are restricted to experimenting with their small, active components. And he admitted that “a massive amount of education for trustees as well as administrators” will be required.
While several pension funds have been very influential as active shareholders - CalPERS is the obvious example, and South Africa is notable for its burgeoning trustee activism movement – it is unlikely that many pension funds will follow that route.
They face a risk in pointing out bad governance, because it can lead to a fall in their investments, noted Thomas Schneeweis, the director of the Center for International Securities and Derivatives Markets at the University of Massachusetts. He noted that this may be a more suitable role for hedge funds, since they can protect themselves against falls in value by offsetting them.
During the conference, delegates frequently raised the issue of non-financial reporting, mentioning in particular the lack of consistent reporting.
For large companies, non-financial reporting is becoming commonplace – a survey in June by KPMG found that more than 50% of the top 250 companies in the Fortune 500 provide sustainability reports. (Interestingly enough, fewer than 50% of UNEP FI members issue CSR reports.)
In fact, demand for non-financial information is running wild – during the conference, Lynn Patterson of the RBC Financial Group in Canada admitted to completing four separate CSR reports for different readerships. At the moment, there are several competing standards for non-financial reporting. UNEP FI has thrown its weight behind the GRI standards.
As Watchman pointed out, the lack of reporting is less of an issue. The real question is incorporating ESG information into investment decision-making.

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