ESG and Fiduciary Duties: A Roadmap for the US Capital Market

Brian Tomlinson is Associate Director of Fiduciary Duty at Principles for Responsible Investment (PRI) and the United Nations Environment Programme Finance Initiative (UNEP FI). This post is based on a recent publication authored by PRI, The Generation Foundation, and UNEP FI.

Some investors have defined their fiduciary duties in narrow terms, arguing that they preclude consideration of Environmental, Social and Governance (ESG) factors. This misunderstands the nature of a prudent investment decision—which changes over time.

Over recent decades corporate disclosures to investors have expanded to include reporting on a corporation’s liquidity, capital structure, credit risk instruments and off-balance sheet transactions [1]. This reflects the evolving tools and techniques of prudent investment analysis. In that context, the incorporation of ESG factors into investment processes and research is a critical addition to the analytical tool-kit available to investors in making informed voting and investment decisions, constructing portfolios [2] and identifying enhanced operational performance and financial prospects in investee companies. [3]

Our work is part of a three-year project to end any remaining debate about whether fiduciary duty is a barrier to the integration of ESG factors in investment processes.

The Principles for Responsible Investment (PRI) defines ESG integration as “the systematic and explicit inclusion of material ESG factors into investment analysis and investment decisions.” A recent PRI report indicates that investors can treat ESG factors in the same way as any other financial factors using existing quantitative methodologies. [4] It is worth clarifying that, in our view, ESG integration does not necessarily involve a narrowing of the available investment universe (unlike negative screening). [5] Neither does it involve subordinating the pursuit of a financial return to unrelated objectives (social or ethical).

The relevance of an ESG factor won’t be symmetrical across sectors. What is material for understanding the operational performance and financial prospects of a bank (risk management, cyber security), won’t be the same for an extractives firm (water use, GHG emissions). But ESG factors may be some of the most consequential that an investor has to consider in relation to investee companies. Neglecting ESG factors may cause the mispricing of risk and poor asset allocation decisions—making it a fundamental component of financial analysis. [6] As such, ESG integration is less a product than it is part of the broader process and technology of investment analysis.

Regulators across mature markets have sought to clarify the extent to which ESG factors can be considered by investors in a manner consistent with their fiduciary duties (prudence and loyalty pre-eminent among them). The Department of Labor clarified that ESG factors can be part of the “primary analysis” of prudent investment decision-making by ERISA fiduciaries (the ESG Bulletin). [7] The UK Law Commission stated that “there is no impediment to trustees taking account of environmental, social or governance factors where they are, or may be, financially material”. [8] It is not the origin of the factor, but rather its financial materiality which is of relevance. There are also over 300 policy instruments across the world’s 50 largest economies focused on responsible investment approaches.

The report Fiduciary Duty in the 21st Century concluded that fiduciary duty requires investors to consider long-term value drivers in prudent investment practice. [9] ESG factors are a core part of such an assessment and should be integrated into investment decision-making processes, engagement with investee companies and interventions in public policy and regulation.

We also note that within the core fiduciary duties of prudence and loyalty are the duty of impartiality [10] and the duty to monitor. [11] These duties are the subject of renewed focus causing fiduciaries to consider long-term sustainable value in investment decisions and to diligently oversee the appropriateness of investments in the light of known trends and uncertainties.

Stakeholder Feedback: Our project seeks to ensure that this interpretation of fiduciary duty is broadly reflected in investment practice. Drawing on over 30 interviews with key stakeholders at different points in the US capital market (see full report for list), we make a series of recommendations for policy and investment practice. Our stakeholders identified common themes in their feedback:

  • The proportion of assets under management in the US subject to ESG integration was growing rapidly responding to a rising tide of client demand for ESG services.
  • For ESG to become an operational reality, two broad developments were required: the reporting of comparable, decision-relevant material ESG information by investee companies; and the incorporation of ESG factors into the organizational processes of institutional investors (and interactions with their service providers).
  • Shareholder engagement was identified as a core element of prudent investment practice. Many stakeholders indicated that ESG analysis was a tool for focusing engagement with investee companies on value-relevant subjects.
  • Changes to underlying statute were not required to enable the broad adoption of the stated interpretation of fiduciary duty. Well-framed regulatory guidance could be a catalyst for plan fiduciaries to revisit governance structures and investment processes.

Analysis & Recommendations

Enhanced disclosure of material ESG information: The lack of standardization of the reporting of material ESG factors creates inconsistent reporting practices, raises the cost of production of such information and limits its usefulness to investors. Existing SEC guidance, such as the 2010 interpretive guidance on climate risks, has not been sufficient to create a perceived industry requirement to disclose against material ESG factors. We recommend that the SEC update Regulation S-K to ensure high quality disclosure of ESG factors.

Framework for shareholder engagement: Shareholder engagement has moved from the margins to the mainstream [12]—a year-round activity, not one simply precipitated by an annual general meeting or corporate crisis. ESG themes have proved a dominant topic for shareholder resolutions in recent years, attracting an increasing proportion of voting returns. Engagement is increasingly seen as an instrument for creating long-term value. The role of shareholder oversight should be affirmed and procedural obstacles removed wherever they exist. In this context, we make recommendations relating to the use of the shareholder rights of ERISA fiduciaries, collaborative engagements and universal proxy ballots.

Enhanced scheme governance and disclosure regarding ESG: Fiduciaries would benefit from guidance as to best practice in their interactions with service providers, such as in the selection, appointment and monitoring of investment managers. Investment Policy Statements are a critical tool in enabling the adoption of ESG methodologies within scheme practice. Their development can be a powerful tool for organizational learning and an opportunity to engage with the requirements fiduciary duty imposes on their institution. Consistent with regulatory developments in the UK and Canada, we welcome the Department of Labor’s proposed extensions to the reporting of scheme practices by ERISA governed plans.

Litigation analysis: PRI released guidance in February 2016 by Morgan, Lewis and Bockius and Groom Law Group on fiduciary duty in the US reflecting the content of the ESG Bulletin. We consider that a lack of integration of ESG factors into investment processes is emerging as a source of significant legal and financial risk. We seek further engagement with the US legal community on this issue.

Fiduciary Training: Knowledge of ESG integration needs to be broadly available to trustees and scheme fiduciaries. As such, they should be part of on-boarding procedures and core competencies in fiduciary education. In that context, investment consultants should advise their clients as to ESG risks and analysis.

The Principles for Responsible Investment, the United Nations Environment Program Finance Initiative and The Generation Foundation, as co-sponsors of this work, will be prioritizing our work program on these issues seeking to collaborate with and support the many initiatives working in this space in the US.

The full roadmap is available here.


1Securities and Exchange Commission, Business and Financial Disclosure Required by Regulation S-K: (go back)

2SBA Florida, Valuing the Vote: & “Calpers Effect” Continues to Improve Company Performance: back)

3Robert Eccles, Ioannis Ioannou and George Serafeim. (2012) the Impact of Corporate Sustainability on Organization Processes and Performance\_6791edac-7daa-4603-a220-4a0c6c7a3f7a.pdf(go back)

4PRI Reporting Framework 2016 Main Definitions: back)

5For some investors, ESG integration is pursued in concert with negative screens.(go back)

6ESG Research Works: back)

7Interpretive Bulletin Relating to the Fiduciary Standard under ERISA in Considering Economically Targeted Investments—also known as the ETI Bulletin(go back)

8Fiduciary Duties of Investment Intermediaries, UK Law Commission 2014(go back)

9Fiduciary Duty in the 21st Century: back)

10Varity Corp v Howe et al., 516 U.S. 489 (1996)(go back)

11Glenn Tibble, et al., Petitioners v Edison International, et al., 13-550 (2015)(go back)

12Four takeaways from proxy season 2015:\#company-investor-engagement (discussed on the Forum here).(go back)

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