In a new report which overturns the previously held belief that fund managers are legally required to chase profit above all, a United Nations grouping has found institutional investors must take into consideration ‘green’ issues when making investment decisions and could be sued for not doing so.

The study, which goes under the wordy title of ‘A legal framework for the integration of environmental, social and governance issues into institutional investment’ was commissioned by Asset Management Working Group of The United Nations Environment Programme Finance Initiative (UNEP FI) and was prepared by international law firm, Freshfields Bruckhaus Deringer. The UNEP FI is described in a statement as “… a unique global partnership between UNEP and the private financial sector” and is said to represent trillions of dollars (the US variety) of institutional investment funds. Last week some of those involved in the Freshfields report were in Australia to discuss its implications for local investment funds, and local supporters of the ethical investment message such as Bob Welsh, CEO VicSuper and Erik Mather, head of BT Financial Group Governance Advisory Service, attended. One of the principal intentions of the UNEP study was to refute the widely-held assumption by institutional investors and super fund trustees that environmental, social and governance (ESG) issues were outweighed by a primary duty to make a profit for their beneficiaries. And according to senior author of the report, Paul Watchman, Partner at Freshfields Bruckhaus Deringer, its findings clearly indicate the ‘profit comes first’ argument is legally flawed. “;The report confirms that a number of the perceived limitations on the integration of ESG issues into investment decision-making are illusory,” Watchman says. “Far from preventing the integration of ESG considerations, the law clearly permits and, in certain circumstances, requires that this be done. This legal interpretation has far-reaching implications for the institutional investment community worldwide.”; A key plank in the UNEP argument was that the landmark UK case concerning the proper investments of a pension fund, known as Cowan v Scargill, has been misinterpreted. Cowan v Scargill, which is frequently cited by institutional investors as the legal precedent for putting profit-making above any ESG considerations, was in fact only a limited ruling that revolved around adherence to a specific trust deed, according to the Freshfields study. Indeed the judge, Justice Megarry, in the Cowan v Scargill case downplayed its significance some years after the initial judgment. “He [Megarry] stated it was ‘a dull case’ that would not have been given any attention but for the lack of authority and added that in his opinion it decided nothing new. He explained that Cowan v Scargill did not support the thesis that profit maximisation alone was consistent with the fiduciary duties of a pension fund trustee. However, he has been ignored or misrepresented by those who wish to shun ESG,” the UNEP report says. With the legal underpinnings of the anti-ESG brigade highly questionable, the Freshfields authors suggest fund managers and super fund trustees should incorporate ethical and social elements into their decision-making in a number of ways. Firstly, institutional investors should examine how ESG factors affect the value of their investments. The Freshfields study says: “… there is a body of credible evidence demonstrating that such considerations often have a role to play in the proper analysis of investment value. As such they cannot be ignored, because doing so may result in investments being given an inappropriate value.” It also disputes the argument that ESG factors are too hard to quantify and points out that fund managers seem to have no trouble quantifying goodwill and other intangibles. As well, the Freshfields report notes that a number of jurisdictions, including Australia, already require fund managers to disclose how or if ESG factors are used in their investment decision-making process. Secondly, the study concludes that institutional investors should reflect the values of their funds’ beneficiaries above and beyond pure financial gain. For instance, it suggests profit-maximisation doesn’t have to be pursued on an “investment by investment” basis but should be viewed across the entire portfolio – meaning the portfolio can and should include investments with an ESG bent. Funds could also avoid certain investments, despite their likely high return, with the express agreement of their beneficiaries, the Freshfields study says. “… it can also be argued that even in the absence of such express consensus, there will be a class of investments that a decision-maker is entitled to avoid on the grounds that their ESG characteristics are likely to make them so repugnant to beneficiaries that they should not be invested in, regardless of the financial return that they are expected to bring.” The Freshfields report does not mark the extent or the end of the UN’s involvement in pushing such ethical issues to the fore in financial markets. As well as the UN Global Compact, a project started in 2004 to bring ESG issues into mainstream financial markets with its ‘Who cares wins’ papers, the world body has another initiative underway. Early this year the UN Secretary-General convened a group of 20 of the world’s largest institutional investors, representing $US1.7 trillion in assets owned, to negotiate a set of Principles for Responsible Investment (PRI). The PRI were finalised in October but will not be revealed by the UN until early next year.

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