Asset owners’ duties involve rectifying inconsistencies in impact mandates

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Jesica Andrews, Investment Lead at UNEP FI © Pedro Ramirez

| By Elena Johansson

As the law on impact investing evolves, so are the related duties of asset owners to pursue impact investing and ensure that external managers reflect their goals.

“Asset owners delegating to investment managers need to satisfy themselves that the activities of the manager are aligned — or at least not inconsistent — with their own goals and duties to beneficiaries,” a new report by global law firm Freshfields Bruckhaus Deringer has said.

Commenting on one finding, Jesica Andrews, Investment Lead at UNEP FI, said: “The report authors surveyed the landscape and found that the time periods of such mandates do not typically align with the long-term time horizons required to invest for sustainability impact.”

Freshfields Bruckhaus Deringer released the report titled A Legal Framework for Impact last week. It was commissioned by UK charity Generation Foundation, UN Environment Programme Finance Initiative (UNEP FI) and the Principles for Responsible Investment (PRI).

Impact duties emerge from financial goals

The report aims to establish the legal scope under which investors are currently required or permitted to ‘invest for sustainability impact’ (IFSI), while also identifying options policymakers have to facilitate IFSI.

The report defines IFSI as any investment approach where investors intentionally seek to influence investee companies and third parties regarding sustainability challenges.

When assessing 11 jurisdictions, including the US, China and the EU, the report found that legal obligations of investors could result from their duties to pursue financial goals.

The authors conclude that “there is no doubt that asset owners and investment managers have a duty to understand sustainability risks relevant to their ability to achieve the financial goals they are required to pursue, and to take these into account as appropriate in their investment process”.

David Rouch, Partner at Freshfields Bruckhaus Deringer, explained at the launch event of the report: “The situation is most clear where sustainability risk bears on an investor’s duty to pursue financial goals.

“Here, where sustainability impact approaches can be an effective way of achieving investors’ goals, the investor will likely be required to consider using them and to act accordingly.”

Potential legal requirements for asset owners to apply IFSI depend however on their goals.

Investors are likely more required to consider impact investing when they pursue sustainability impact goals as a means to pursue financial return goals, so-called “Instrumental IFSI”.

But the requirements are more limited when investors pursue these goals for their own sake, alongside financial return goals, so-called “Ultimate ends IFSI”.

Yet, whether legal rules require or permit IFSI in practice still depends on the regional law and relevant circumstances, such as costs, the authors explain.

Inger Andersen, Executive Director of the UN Environment Programme, said: “At present, many leading responsible investors feel constrained by current financial and legal frameworks that were not originally designed to facilitate today’s sustainability goals.

“This revelatory report offers a new path forward, identifying the current law and modification options to support a transition from predominantly environmental, social and governance-integration to widespread investment for sustainability impact.”

Andrews continued: “The report should enable and empower, in clear terms, investors on ESG, portfolio management, and legal teams alike to better understand the interaction between investing for sustainability impact and legal frameworks.”

Alignment of mandates to impact goals

“As the report puts it, there is a legal ‘cascade effect’ from asset owners to all those who directly or indirectly provide services to them,” she told investESG.eu.

Asset owners could be required to consider options to achieve sustainability impact goals, in particular stewardship of publicly traded investee firms and public policy engagement, the report says.

Asset owners need to take oversight that their own goals and duties are reflected in the activities of their third-party asset managers.

This includes for example to supervise that third parties “have the necessary experience and capacity to deliver an effective sustainability solution”.

Asset owners need to consider a manager’s expertise in their selection process, and its stewardship and policy engagement capacity to pursue delegated investment objectives.

Given that asset managers are unlikely “to be naturally focused on the longer term”, asset owners need to take “extra care” to ensure that their financial objectives and legal duties are aligned with the terms of the manager’s appointment and involved incentives.

“Asset owners should recognise that the mismatch in time horizons between them and their investment managers has the potential to create a structural obstacle (which asset owners need to work to overcome) to effectively addressing systemic risks of a sort that could impact portfolio performance in the long term,” according to the authors.

Eva Halvarsson, CEO of AP2, explained at the launch event: “This is a totally new way to invest. It’s a new way to think for most of us, even if some have been doing this for 20 or 30 years.”

Andrews said that it will be crucial that a real shift happens, “towards an asset owner determining its own sustainability preferences and being able to express these in metrics that can be incorporated in their mandates to asset managers”.

Guidelines on how this can be done are increasing, including those by the UN-convened Net-Zero Asset Owner Alliance, she added.

The PRI, UNEP FI and the Generation Foundation plan to use the report as the start of a three-year programme, initially with five key jurisdictions, to enable regulatory environments that meet global sustainability needs.

 

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