How to balance fiduciary duties with environmental goals

The importance of fiduciary duty over environmental responsibilities was raised when the Financial Times recently reported that several US banks had threatened to leave the Glasgow Financial Alliance for Net Zero (GFANZ) due to the threat that membership could lead to legal liabilities for shareholders.

Lars Hagenbuch, investment consultant at global investment firm RisCura, says threatened departures by US banks stemmed from concerns that GFANZ could bind them to tougher rules under Securities and Exchange Commission (SEC) proposals.

“We have a situation where asset owners need to carefully consider what downstream risks they might face by joining a body like GFANZ,” he says. “If that risk is deemed too high, and the companies don’t join the alliance, that is likely to be negative overall for meeting net-zero targets as some institutions may then decide not to dedicate the same time and resources to decarbonisation as otherwise.

“It’s perhaps worth noting that the issue is not so much about the alliance itself but rather because of proposed penalties the SEC is considering for companies not keeping to environmental commitments.”

Facing legal action

Nevertheless, the issue of potential legal liability has raised the question of asset managers' and owners’ fiduciary responsibilities to investors and how they consider their environmental goals.

The issue has become particularly relevant since the introduction of new MiFID (Markets in Financial Instruments Directive) requirements that investment advisers and portfolio managers incorporate their clients’ sustainability preferences into their suitability assessments.

“Perhaps the biggest challenge comes when an asset manager pursues an environmentally responsible strategy, which happen to result in lower returns than otherwise, and because the environmental elements were not explicitly listed in their mandate they are later accused of fiduciary lapses,” says RisCura’s Hagenbuch.

“This problem can be addressed by making sure that mandates stipulate environmental goals alongside traditional ones like return generation or capital preservation.”

In parts of the US and Australia that are more resource- or oil-dependent, funds have faced legal action for following environmental objectives that compromise investment returns or economic prospects for residents of those regions, says Hagenbuch.

More recently, in the US, there has been greater political involvement in the ESG debate as some Republican governors and states have sought to prioritise the economy over environmental concerns.

In August, for example, Florida governor Ron DeSantis banned state pension schemes from ESG considerations that prioritise “the financial security of the people of Florida over whimsical notions of a utopian tomorrow”.

Meanwhile, Texas comptroller Glenn Hegar declared that the world’s largest asset manager BlackRock and nine European financial groups had deliberately boycotted the fossil fuel industry and decried a lack of transparency over ESG practices.

Tackling the climate Prisoner’s Dilemma

The prospect of high-profile departures from industry initiatives such as GFANZ has raised questions over whether asset owners might also join any potential exodus over liability concerns.

Resourcing issues were understood to be behind the recent departures of the first institutions from GFANZ – Australia’s Cbus Super and Austria’s Bundespensionsklasse – as onerous reporting requirements put greater pressure on the pension funds.

But asset owners and managers are likely to benefit from membership of such alliances when tackling issues such as climate change and transitioning to a net-zero economy.

“All investment decisions are made with a range of scenarios in mind, and whether actions today can be judged in line with fiduciary duty hinges crucially on the assumptions and beliefs about those future states," says Venetia Bell, head of strategy at global asset manager GIB Asset Management.

“By committing to joint climate action, alliances make it more likely that we achieve the better aggregate financial outcomes of a climate-safe world.”

She adds: “Although collective action is the way out of the climate Prisoner’s Dilemma, we need to reframe the climate challenge as an opportunity.

“If you believe, as we do, that the greatest profits will accrue to those who are solving the world’s greatest challenges – which includes climate – then the alignment between net zero and fiduciary duty is clear.”

Membership of groups can also help give asset managers and owners a voice in shaping goals and policy, says RisCura’s Hagenbuch, but there is a need for a smaller group of larger organisations, such as GFANZ.

“As it is, the environmental space is still quite fragmented with many smaller alliances having slightly different objectives, measurement standards and so on,” he says. “New ones seem to pop up quite regularly. The more this can be standardised, the more comparable the reporting will be, and the more widespread acceptance is likely to become.

He adds: “Losing members from alliances is a step backwards in that process – depending on where they go afterwards, of course – if it increases fragmentation.”