Fiduciary standards evolving toward including new investing factors
Corporate, fiduciary trust and securities laws are emerging as critical drivers of action on climate change by asset owners and other institutional investors.
The evolving relevance of climate change to valuation, risk assessment and disclosure obligations has recently been reinforced by a group of experts in international law, human rights law, environmental law and other legal fields, with the group's adoption in March of the Oslo Principles on Global Climate Change Obligations.
The voluntary principles set out the legal imperative for both governments and private businesses to proactively manage climate risks under prevailing laws — including corporation, securities and tort laws — regardless of the presence or absence of international agreements to limit greenhouse gas emissions.
While the principles are not themselves law, their sentiment is consistent with, and is increasingly reflected in, international legal developments on trustees' fiduciary duties. For example:
nThe U.S. Supreme Court's May 18 decision in the Tibble et al. vs. Edison International et al. case confirmed that trustees have a continuing duty to monitor their investments to ensure that none of them is imprudent, even if they were prudent investments when purchased. Climate risks, including issues such as stranded assets and climate change mitigation, are likely to have large effects on the profitability of many companies and impact the value of institutional investments.
nIn the U.K., the Climate and Pensions Legal Initiative — a collaboration of environmental law organization ClientEarth and independent not-for-profit Asset Owners Disclosure Project — is examining whether pension funds are meeting their legal obligations to manage the investment risks associated with climate change. It could lead to legal challenges against funds deemed to be in breach of those obligations.
nIn April, 60 large institutional investors, representing a combined $1.9 trillion in assets, sent a letter to Securities and Exchange Commission, expressing concern that oil and gas companies are not disclosing in their financial statements sufficient information about carbon asset risks and the possibility of reduced global demand for oil.
As climate change investment risk is incorporated into mainstream market analysis, it is likely that the Oslo principles and other legal and fiduciary developments will be viewed by many courts as an uncontroversial reflection of international corporation and securities laws, and as influential in determining standards of “prudent conduct” on investor climate risk management. Given the speed at which this evolution is occurring, this might be far sooner than many trustees and investment advisers expect.
In June, the Group of Seven governmental forum reaffirmed its commitment to keep global warming under 2 degrees Celsius and decarbonize the global economy — starting with the removal of inefficient fossil-fuel subsidies and a transformation of the energy sector.
Some of the world's largest and most influential pension funds have announced in the past year new investment exclusions for similarly high-risk, carbon-intensive assets on financial, rather than ethical, grounds. During this year's annual general meeting season, some of the largest companies have faced calls from pension funds and other institutional investors to step up stress-testing of operational plans against potential climate scenarios, as well as to restrict capital spending on assets most likely to be-
come stranded because of climate concerns and to improve financial disclosure on such issues.
These developments add further weight to the conclusion that portfolio carbon exposures are becoming a material financial risk issue for institutional investors. Trustees of these assets will simply not fulfill their fiduciary duties to beneficiaries if they ignore the portfolio risks and opportunities posed by accelerating climate change, and its political, regulatory and technological responses.
In short, trustees must now fundamentally reconsider whether an inactive, reactive or passive approach to climate change risk assessment and strategy is sufficient to discharge their obligations to act with due care and diligence, as they pursue beneficiaries' best financial interests.
This is not to say that, overnight, funds should adopt a herd mentality to divest or exclude assets in carbon-intensive industries. Any such knee-jerk reaction would itself be inconsistent with trustees' fiduciary duties. But it does mean that trustees must consider the impact of these financial risks and opportunities on their portfolios. It is the process of information gathering and deliberation with which the law is primarily concerned, rather than a bare examination of the relevant outcome.
In practice, there is simply no substitute for trustee evaluation of strategic issues that might materially affect the performance of their fund.
Sarah Barker is a Melbourne, Australia-based special counsel at international law firm Minter Ellison; a director of NRCL Ltd., which supports projects focused on the ecosystem; and an academic visitor at the Smith School of Enterprise and the Environment at Oxford University. Jay Youngdahl is a partner at The Youngdahl Law Firm PC, a Houston-based law firm; an independent trustee of the $650 million Middletown Works Hourly and Salaried Union Health Care Fund, a voluntary employees beneficiary association based in Middletown, Ohio; and a senior fellow at the Initiative for Responsible Investment, Hauser Institute for Civil Society, Harvard Kennedy School, Cambridge, Mass. The views expressed in this article are the authors' own and should not be taken to reflect those of their institutions.
This article originally appeared in the August 24, 2015 print issue as, "Momentum building on climate risk".