Fiduciary duty through the long-term lens
Milton Friedman and Adam Smith are lions of economic theory. Their influence on organisational responsibility to shareholders, the division of labour and the meaning of fiduciary duty is powerful – but is it out of date?
The financial sector has slowly begun to transform its understanding of fiduciary duty, especially since the Global Financial Crisis. While Friedman’s traditional investment lens perceives the sole purpose of a company to be maximising profits to shareholders, modern thought1 says ignoring ESG principles may compromise future risk-adjusted returns and could fall short of our fiduciary duty.
Examples of this are clear when one looks: climate change means investment in old technology (where a new green economy is on the rise) results in poor long-term return prospects; companies that support modern slavery in their supply chains risk their social licence to operate.
The notion of embedding social and environmental good is no longer restricted to advocacy groups. The financial sector is beginning to understand that for a company to perform well over the long term, it must be sustainable.
The long term-lens
ESG risks can start small and compound over time. This means managers who only apply a financial lens today are vulnerable to ‘ESG shocks’ down the track.
It is the Sustainable Investment Team’s view that the financial system will be greatly and progressively impacted by global sustainability challenges. We believe investors in the future will eschew traditional financial practices and norms and wonder why the integration of ESG principles – the consideration of non-monetary risks and opportunities – was not always embedded within investment processes.
But this mindset is not fully developed across the globe. In some regions, there is a highly outdated perception that ESG compromises returns and therefore fiduciary duty. Fiduciary duty is thus often used as an excuse for inaction. This tends to occur in locations where the investment community is still very much at the ‘compliance’ stage of their ESG journey, or perhaps have a more short-term mindset.
Europe is the most advanced region, with some of the most innovative and sophisticated ESG reporting and investment practices. Australia, Canada and the UK follow closely behind, while others are in the earlier development and awareness-building stages2.
In Asia, the dominant assumption remains that a trade-off exists between sustainability and financial performance, although studies in the last five years find no significant differences between risk-adjusted returns of sustainable investment and conventional indices or funds3 . The challenge is that Asian markets tend to be higher turnover on average, and ESG considerations beyond legal and regulatory minimums are often deemed less relevant to these short-term horizons.
We are witnessing some ad-hoc efforts to move this crucial question forward, which began in 2015 with the UNEP Finance Initiative's Fiduciary Duty in the 21st Century report, followed up with another focused on Asian markets in 20164.
But while there are pockets of activity, these efforts are somewhat fragmented across the globe, and include independent legal opinions, changes to company reporting requirements, and even legislative change. They have been particularly focused on climate change but are also applicable to more general questions around corporate sustainability.
In Australia, a 2016 legal opinion on climate change risks5 was followed up by ASIC's 2017 statement6 that directors who fail to consider them might be liable for breaches of the Corporations Act.
In the UK, a 2018 paper by law firm Pinsent Masons7 summarised the fiduciary duty debate in the absence of legislation or case law and concluded that pension scheme trustees have a fiduciary duty to consider climate change risk in their investment decisions.
Across Europe, new laws require investors to consider and disclose management of climate change-related risks. Recent pension fund guidance and legislation also recognises at least the potential for financial materiality and requires climate change to be considered in investment decision-making processes.
Meanwhile in Canada, the Ontario provincial government requires pensions to disclose whether and how ESG factors are considered.
In some markets, regulators or stock exchanges are also trying to advance ESG principles through corporate reporting. The Hong Kong Stock Exchange is an example of this.
We believe that financial capital has a critical role to play in addressing some of the world’s most pressing challenges. Global changes mean society thinks more broadly about not just profit but what impact companies are having on the world. Investors are seeking investment solutions that both align with their values as well as provide competitive financial returns. It could therefore present a significant catalyst for sustainable investment practices if regulators took decisive action to clarify and standardise responsibilities when it comes to ESG and stewardship.
1UNEP Finance Initiative on Fiduciary Duty in the 21st Century, link
2Global Sustainable Investment Review 2018 http://www.gsi-alliance.org/wp-content/uploads/2019/03/GSIR_Review2018.3.28.pdf
3Ur Rehman et al (2016), Lean et al (2014) and Ang & Lean (2013)
4Sullivan, R., Feller, E., Martindale, W., & Robinson, J. (2016), Fiduciary Duty in the 21st
Century: Investor Obligations and Duties in Six Asian Markets
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