The Department of Labor's revised guidance on economically targeted investments is a major breakthrough for asset owners and other institutional investment fiduciaries, as well as responsible investment and the future of sustainable markets.
The action is particularly welcome because fiduciary duty as well as environmental, social and governance factors have been a sticking point for many pension funds, other asset owners and institutional investment managers, especially, but not limited to the U.S. market.
Thomas Perez, U.S. Secretary of Labor, announced Oct. 22 the department is rescinding its 2008 Bulletin on Economically Targeted Investments and replacing it with Interpretive Bulletin 2015-01 that reinstates wording of its Interpretive Bulletin 94-01, its 1994 guidance on ETIs with a revised preamble that contains an assurance, saying, “Fiduciaries need not treat commercially reasonable investments as inherently suspect or in need of special scrutiny merely because they take into consideration environmental, social or other factors.”
Fiduciary duty has been cited as a reason by many asset owners, especially corporate-sponsored pension funds, institutional investment managers and investment consultants, for not incorporating ESG factors into the investment decision-making process. They claim that looking at non-financial indicators was not consistent with their fiduciary duty.
While some large pension funds in the United States, such as California Public Employees' Retirement System and California State Teachers' Retirement System, have led the way in looking at ESG factors, many smaller funds, that lack in-house resources, have relied on third parties e.g., investment consultants, for guidance. Smaller asset owners depend more on investment consultants and lawyers, both of which groups have thrown up the issue of fiduciary duty as being inconsistent with ESG. CalPERS and CalSTRS are examples of pension funds that have said they don't see ESG and fiduciary duty in conflict.
The Labor Department's bulletin on ETIs, 29 CFR 25 09.08-1, issued in 2008, arbitrarily disfavored the consideration of environmental and social risks and opportunities in assessing potential investments. While the 2008 guidelines did not specifically prevent investment managers and others from incorporating ESG factors, a narrow interpretation of the guidelines, particularly by lawyers and investment consultants, meant that many managers felt deterred from looking at these considerations. As a result, this has been a major obstacle to responsible investment moving into mainstream investment practices.
The announcement recognizes that the world has changed dramatically in recent years and that ESG factors, which once stood on the periphery, are now relevant for investors and can even enhance portfolio returns, according to recent studies. A good example of this is climate change, with Mark Carney, Bank of England governor, recently noting the potentially catastrophic risks to investors that fossil fuel holdings present.
The Principles of Responsible Investment Association, along with many other organizations, has been pushing hard for change in interpretation of fiduciary duty because they know that ESG factors are material to the investment decision-making process, both with regard to identifying risks as well as opportunities. Across our signatory base, both asset owners and investment managers are increasingly looking at ESG considerations because they see that these factors can offer long-term investment advantages. In the last year, we have seen studies — including a joint study by the Smith School of Enterprise and the Environment at Oxford University and Arabesque Asset Management, released September 2014 — all citing the financial benefits of looking at ESG factors over the long term.
Our recent report, “Fiduciary Duty in the 21st Century,” concluded that not looking at ESG factors in terms of the risk they present to portfolios is actually a breach of fiduciary duty.
The report found that many investors have yet to fully integrate ESG issues into their investment decision-making processes. The Labor Department's announcement has now swept away previous obstacles and paved the way for ESG and responsible investment to truly move forward. It also positions the United States as a potential world leader in responsible investment.
Fiona Reynolds is managing director of London-based Principles for Responsible Investment Association, which oversees the United Nations-supported principles for responsible investment, a voluntary set of principles for the investment management companies incorporating environmental, social and governance factors into investment decision-making.