The anti-ESG (environment, social and governance) movement, traditionally associated with “anti-woke” right-wing politicians and business leaders, gained prominence in Europe when they alleged that European companies were suffering financially as a consequence of not focusing on maximising returns.[1] Amidst geoeconomic uncertainty and challenges, the UK administration openly stated that it is contemplating rolling back some of its key climate targets[2]. In contrast, a group of Vanguard investors took a different stance by expressing serious concerns and criticising Vanguard’s failure to account for the risk of climate change into their portfolio[3].

Central to both sets of arguments is the concept of fiduciary duty, seen as a legal and ethical obligation to act in the best interests of their clients. The anti-ESG movement argues focusing on ESG matters and social agendas unrelated to the clients’ long-term financial interests is a breach of fiduciary duty as they should focus on profit maximisation[4]. On the other hand, socially and environmentally conscious investors, seen in the case of investors’ letter to Vanguard, believes that investors are violating their duty of care if they do not use their voice and influence to drive positive climate action[5]. As the debate between pro and anti-ESG sentiments intensifies, questions about the interpretation and application of fiduciary duty become more prominent. To what extent should investment managers consider ESG factors while upholding their fiduciary duty of prudence and loyalty?

Has the dial shifted? Yes, but not without some apprehension  

Fiduciary duty, at its core, refers to the obligation that individuals or entities bear when entrusted with managing others’ money or asset, which involves acting in the best interests of the beneficiaries. According to the United Nations Environment Programme Finance Initiative (UNEPFI), fiduciary duty comprises of two components: i) loyalty - where fiduciaries should act in good faith in the interests of their beneficiaries and ii) prudence - where fiduciaries exercise sound judgement and diligence in managing assets.[6] The UN Principles for Responsible Investment states that the fiduciary duty of investors should incorporate all value drivers, including ESG in their investment decision making.[7]

Nevertheless, several investors highlight fiduciary responsibility as a limiting factor in their participation in such practices, as they are concerned that incorporating ESG factors could compromise their ability to maximise their returns for their clients.[8] In a highly competitive market, the fear of losing a competitive advantage against peers becomes a compelling reason for hesitancy. In our research report, Investing for a better world: navigating 6 paradoxes, we identify three key messages that shed light on how this tension is perceived and navigated by investors in the current landscape.

Rule number one: Sustainable investments need to be financially-material

Investment managers often face the challenge of ensuring both profitability and societal impact. The fiduciary duty of loyalty underscores the imperative for institutional investors to act in a manner that benefits their clients financially while acknowledging such benefits may extend beyond immediate financial returns. Consequently, a fundamental guiding principle for many investment managers is to ensure sustainable investing make commercial sense and be rooted in financial materiality. Rather than exclusively focusing on groundbreaking technologies, risk mitigation and identification of new opportunities that align with sustainable practices, and integrating them into traditional investment frameworks.[9]

There are nuanced variances in fiduciary duty across jurisdictions

The complexity of the matter is exacerbated by the fact that many regulatory regimes afford a degree of discretion to integrate ESG considerations, owing to differences in legal systems and cultural contexts.[10] In numerous jurisdictions ESG rules and guidelines can be vague. Operating under the premise of “prudence”, some jurisdictions insist investment managers should only consider financial interests. In contrast, other jurisdictions allow flexibility for investment managers to consider non-factors in parallel with financial factors. [11]

A notable distinction is the definition of fiduciary duty between common law and civil law jurisdictions. In common law jurisdictions, such as Australia, the UK and US, fiduciary duties are key constraints on the discretion of investment decision, although these rules could be reinterpreted over time. In civil law jurisdictions like Germany and Japan, any obligations equivalent to “fiduciary duties” are explicitly outlined in statutory provisions that regulate the conduct of investment decision-makers For instance, in the US, the Employeee Retirement Income Security Act of 1974 (ERISA) imposes a strict duty of loyalty, requiring fiduciaries to act solely in the interest of beneficiaries for the exclusive purpose of providing financial benefits to them (a new rule which permits ERISA fiduciaries to consider ESG factors was released, although this has received backlash from opponents, who felt that it contravenes the conventional fiduciary duty of maximising financial returns for fiduciaries).[12] In Germany, pension funds may integrate in ESG factors if they inform their beneficiaries in writing if and how it takes ethical, social and ecological aspects into account in its investment policies.[13]

Fiduciary duty goes beyond financial returns

There is also a common myth that sustainable investing, or impact investing—investments with the intent to generate positive, measurable social and environmental impact alongside a financial return[14] —is incompatible with the fiduciary duties of private and public fund managers, and could have detrimental impact on the financial returns generated. Contrary to this misconception, there is growing realisation by many investors that sustainable investing and the pursuit of risk-adjusted returns are not mutually exclusive. This is evident in the increasing number of institutional investors that incorporate social and environmental factors into their investment framework, recognising the long-term value they add to their assets. One example is the expectations outlined by a commission set up the Norwegian government on Norges Bank Investment Management (NBIM), highlighting the paramount importance of NBIM to pursue good financial returns and responsible investment. This dual approach is deemed essential for maintain the fund’s legitimacy, both nationally and internationally.[15] Similarly, Khazanah, Malaysia’s sovereign wealth fund and a signatory to the Principles for Responsible Investment, in their governance and accountability framework, states that they would incorporate ESG issues into their decision-making processes and ownership policies that is consistent with their fiduciary duties.[16]

Conclusion

Amidst an ongoing anti-ESG movement, the investment industry remains unfazed and undeterred to double down their efforts in sustainable investments. A 2022 Cambridge Associates survey found that there was significant uptick on engagements in sustainable and impact investing among asset owners and asset managers, with an overwhelming proportion of respondents expressing their intentions to further increase their allocation to sustainable and impacting investing over the next five years.[17]

Simultaneously, regulators are intensifying their efforts to impose more ESG disclosure and requirements on the industry. For instance, the Sustainable Finance Disclosure Disclosures Regulation Level 1 and 2 have gone into force in 2023, where financial institutions are accountable to disclose to reduce adverse sustainability impacts and greenwashing.[18] In Singapore, the Monetary Authority of Singapore published the country’s Sustainable Finance taxonomy, aimed at promoting the development of an environmentally sustainable economy for Singapore and ASEAN.[19] Additionally, the emergence of stewardship codes, with growing emphasis for investors to actively engage with investee companies on ESG issues,[20] collectively reflect a noticeable trend towards aligning fiduciary duty with societal responsibilities.

While interpretations of fiduciary duty may continue to persist and vary, the overall trend signals a more encompassing view of the fiduciary’s obligations of institutional investors, and how the industry collectively is shaping a more environmentally and socially responsible future. As the investment landscape and expectations of beneficiaries continue to evolve, finding innovative ways (while ensuring profitability) to integrate sustainable practices within fiduciary duty will be essential for investors seeking to navigate this intricate terrain successfully.