The Sustainability of Fiduciary Duties

THE SUSTAINABILITY OF THE SUSTAINABILITY OF FIDUCIARY DUTIESFIDUCIARY DUTIES

Triple Bottom Line Investing (TBLI) Conference Paris November 9 – 10, 2006

Paul Watchman

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UNEP FI ReportUNEP FI Report

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“A legal framework for the integration of environment, social and governance issues into institutional investment”

“Significant landmark in the discussion and evolution of initiatives related to the complex interaction of capital markets and responsible companies.”

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UNEP FI Report UNEP FI Report

“Critical supplement to the PRI (Principles of Responsible Investment) work and takes an important step to further embed environmental, social and governance issues into investment thinking”

“[The Report] has contributed in a most significant way to the advancement of the debate around responsible corporate behaviour and the role of the investment community and for this you should be congratulated.”

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“This is not an advocacy paper but a 150 page boring legal opinion which does not seek to justify the position of the UNEP FI or any other interested parties”

“The Report states the bleeding obvious” “More important than the Turner report on pension

reform” “Brings ESG [Environmental Social and Governance

issues] into the mainstream of investment decision-making”

“Empowers pension fund trustees to do the right thing”

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“Institutional investors who hide behind profit maximisation and the limits supposedly placed by their legal duties as fiduciaries do so at their own peril. There is no legal bar to the integration of ESG considerations into investment decision-making (provided the focus is always on the beneficiaries best interests) and indeed failure to have regard for such considerations where there is a proven link between an ESG consideration and investment value may itself amount to a breach of fiduciary duties by the pension fund trustee or on his behalf by an asset manager.”

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Background to the UNEP FI Background to the UNEP FI ReportReport

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Background to the UNEP FI ReportBackground to the UNEP FI Report

The legacy of Milton Friedman: “Business of business is

business”

The legacy of the Chicago School of Law and Economics: Richard Posner and John

Langbein create new legal tests for fiduciaries not required by US courts or other distinguished trust law and pension fund commentators

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A legacy of the miners strike:

Cowan v. Scargill

The vanity of the NUM leader

Judgment of Mr. Justice Megarry according to Mr. Justice Megarry was misinterpreted by lawyers and the pension fund industry to place unnecessary restrictions on investment powers of pension fund trustees

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Goldman Sachs, UBS, ABN Amro and others: Research for UNEP FI shows link between environment,

social and governance (ESG) and financial health and vitality of companies

Pension funds resist UNEP FI findings and cite fiduciary duties restrictions

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Remit by UNEP FI “If and, if so to what extent, it was consistent with the

fiduciary duties of pension funds and the responsibilities of mutual funds and insurance companies to have regard to environmental, social and governance decisions in making decisions whether to acquire, retain or divest investments.”

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UNEP FI Fiduciary Duties StudyUNEP FI Fiduciary Duties Study

Approached because of work done on CSR, human rights and the equator principles

Pro bono project for Freshfields 40 plus lawyers worldwide led by Paul Watchman, Lucas

Shipway and Jane Anstee-Wedderburn

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UNEP FI Report StudyUNEP FI Report Study

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Common law countries, states, provinces and other legal jurisdictions: United States United Kingdom Canada Australia

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Civil law countries: France Spain Japan Germany

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Countries or regional governments which recognise ESG explicitly in primary or secondary legislation as relevant and material investment considerations: United Kingdom France Germany Canada (Manitoba) Australia “Italy”

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What is the nature of the duties of a fiduciary trustee? Fiduciary duties are organic and respond to changes in

society Examples:

Equal pay for women for equal work held to be an unlawful breach of fiduciary duties

Encouraging provision for disabled people on public transport held to be unlawful breach of fiduciary duties

Pricing public transport fares to discourage the use of cars in city centres held to be an unlawful breach of fiduciary duties

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What are the fiduciary duties of a pension fund trustee? Duty of loyalty Duty of prudence Duty to act fairly Duty to act in the interests of all beneficiary classes and

balance interest between beneficiary classes, including present and future contributors and beneficiaries

Duty to spread risk according to modern portfolio theory Duty not to crusade unless a bona fide crusader Duty to take a long term not short term or medium view

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Approach of the courts to fiduciary duties of pension fund trustees Courts recognise that valuation and investment,

notwithstanding the use of mathematical and scientific and economic modelling, is an art not a science.

Courts concerned with process, not whether the decision is the best decision

Courts expect that pension funds will diversify investments and that modern portfolio theory will be applied to spread risk

Courts will not second guess business decisions

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Courts will not accept blanket policies or political pursuits based on political zeal rather than investment principles

Courts give wide discretion to pension fund trustees and asset managers within the penumbra of fiduciary duties

Courts do not expect pension fund trustees to be experts but do expect them to seek expert advice

Courts do not regard prudence as a strict mistress but someway short of a fun time girl

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Conclusions of the StudyConclusions of the Study

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The view associated with Friedman and the Chicago school that investment profits must be maximised and ESG considerations rejected as an unlawful breach of fiduciary duties is wrong and is not based on an analysis of case law or legislation.

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ESG considerations are mainstream investment considerations not SRI niche

Where there is evidence that there is a relationship between value and a consideration it should be taken into account

For example: Climate change and the insurance &

reinsurance, oil & gas, automobile manufacturers and real estate industries

Child labour and the clothing and food & drink industries

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Human rights and the clothing, food, retail and electrical and electronic industries

Good governance and all industries Where a decision is made on political or ethical values

rather than value there is a danger that fiduciary duties may be breached There is an exception for moral and other crusaders, such as

churches, charities and political funds Otherwise no crusading: decisions should be based on

investment value not moral values

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Principles of Responsible Principles of Responsible Investment (PRI)Investment (PRI)(UNEP F1 & UN Global (UNEP F1 & UN Global Compact)Compact)

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Principles of Responsible Investment (PRI)Principles of Responsible Investment (PRI)

Pension fund, mutual fund and insurance industries valued at $47 trillion

Value of signatories to PRI $4.5 trillion signed up for PRI in first 18 months

First three principles of PRI: Insofar as is consistent with fiduciary duties

Incorporate ESG issues into investment analysis and decision-making

Be active owners and incorporate ESG issues into our ownership policies and procedures

Seek appropriate disclosure of ESG issues by entities we invest in.

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Principles of Responsible Investment (PRI)Principles of Responsible Investment (PRI)

Who has signed up so far? Asset owners Investment managers Professional services providers

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Where do we go from here?Where do we go from here?

Ask your pension fund if it takes account of ESG and if not why not

If it does ask how it does and to see pension fund mandate given to asset managers

Issues remain: Darfur Sudan Norweigan pension fund Calpers and Calsters Reluctance of US pension funds to accept ESG as lawful and

material investment considerations

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Final ThoughtsFinal Thoughts

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“You can either sit with a hood over your head and pretend things won’t change or you can get ready for it.”

Jeff Immelt, CEO, GE. “Climate change and its impact on key industries is the

greatest challenge facing us in the 21st century.”Just about anyone and everyone from Al Gore to Tony Blair to Sir David King, Chief Scientific Adviser to the UK Government and from Arnold Schwarzenegger, the Governor of California, to Gordon Brown and Margaret Beckett.

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ESG not a substitute for existing valuation tools but an additional one

Opportunities as much as risks Examples:

GE ecomagination BP renewables investment Emerging climate change insurance products and services

Forget Friedman and his Chicago acolytes. Their response was based on corporate America getting on board the Marrakech Express with Crosby, Stills and Nash

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If my pension fund is wedded to profit maximisation how come my return on investment is so poor?

Do the right thing is consistent with fiduciary duties


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The sustainability of fiduciary duties

The Sustainability of Fiduciary Duties

Economy & Finance

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