A Legal Framework for Impact is a long report, running to more than 560 pages, but it seeks to answer a complicated question: whether investing to achieve a positive sustainability impact is legal. Even at this length, the report is a “relatively high-level view” of the various considerations, says David Rouch, one of the authors.
At the heart of the issue is whether an institutional investor can or should take into account anything other than financial considerations when making an investment decision. And if they do, do they leave themselves legally exposed?
This continues to be a major area of concern for asset owners, in particular those whose beneficiaries have disparate views of the state of the world and their pension. Just look at the caution with which the Teacher Retirement System of Texas is taking steps towards including ESG language in its investment policy documents. “The key part that I’ll point out here is that any investing will be done with our fiduciary duty in mind seeking good risk and return,” said Katy Hoffman in discussion about the proposed 73-word statement.
Kudos to Rouch and his colleagues from Freshfields Bruckhaus Deringer: they have sought to answer the question and created a document of epic proportions. The report considers the legal framework for “investing for sustainability impact” (or IFSI) for different types of institution in 11 major jurisdictions across the world.
What’s the answer? Unsurprisingly, it’s complicated.
“There is no single or simple answer to the question of how far IFSI is legally required or permitted across the jurisdictions covered, or in any single jurisdiction,” write the authors. Even within a jurisdiction, there are different rules for different categories of investor.
That said, the primary purpose of asset owners’ investment activity is “generally regarded (by legislators, regulators, courts and the asset owners themselves) as generating a financial return for beneficiaries within acceptable risk parameters,” the report notes.
Thus: “applicable legal duties have generally been interpreted to require financial investment objectives to be prioritised, and in some cases a financial return is the only goal that an asset owner should pursue.”
However, if an investor decides that an issue of sustainability poses a material risk to its financial goals, then it will generally “have a legal obligation to consider what, if anything, it can do to mitigate that risk”.
In other words: if my portfolio is going to be eroded by climate change, then I should be doing something to mitigate it.
It is worth noting that legal risk doesn’t just come from investment decision making. If an investor with exclusively financial investment objectives ploughs any resource into, for example, lobbying for regulatory change, it could find themselves exposed if that expenditure is not easily linked to better investment performance.
Time horizons matter a great deal here. A pension beneficiary retiring tomorrow could have a very different view of what is material to their investment performance to one retiring in 40 years’ time.
The scope to land in legal hot water based on sustainable investment issues seems, when confronted with the nuances of various legal frameworks, mind-boggling. The advice of Freshfields’ Rouch? This document is a starting point, but the unique nature of each investors’ circumstance means, if in doubt, you are best off talking to your advisers.