ESG Investing and Fiduciaries—A Forced Marriage?

The Biden Administration is working on a regulation which will reverse a Trump regulation which restricted the ESG program.

The forthcoming Biden regulation is a pacesetter because:

  • It is a formal rulemaking issued by the Department of Labor
  • Virtually  every major player will submit comments, and
  • Most importantly there is a private sector enforcement mechanism which could keep the participants honest.
Private Sector Enforcement Mechanism

Here is the textbook definition of an ESG Investment Fund:

“ESG funds are portfolios of equities and/or bonds for which environmental, social and governance factors have been integrated into the investment process. This means the equities and bonds contained in the fund have passed stringent tests over how sustainable the company or government is regarding its ESG criteria.”

Regarding stringent tests, CRE was instrumental in passing the Information [Data] Quality Act which sets standards that all data issued by federal agencies must meet and contains a process for the public to file petitions for incorrect data disseminated by federal agencies, see this press article.  The IQA could be heart of a public  enforcement mechanism.

 A Challenging Issue: A Pecuniary Responsibility for ESG Fund Managers?

 “A fiduciary is legally bound to put their client’s best interests ahead of their own. Registered investment advisors have a fiduciary duty to clients; broker-dealers just have to meet the less-stringent suitability standard, which doesn’t require putting the client’s interests ahead of their own.

In the EU and the UK  It has been the subject of extensive debate whether investment managers and other institutional investors are permitted and/or required to consider ESG issues when discharging duties to their clients or beneficiaries. Institutional investors have traditionally viewed their duties as being defined exclusively by the pursuit of financial returns, causing them necessarily to dismiss ESG issues as being non-financial, ethical or moral considerations which should not be taken into account. However, there has been a shift in thinking among industry stakeholders, policymakers and regulators alike toward viewing ESG issues as being financial risks which impact investment performance. This has resulted in legislative and regulatory change in the UK and EU seeking to clarify that ESG issues are financially material, which may in turn impact the interpretation of investment managers’ fiduciary duties, tortious and contractual duties, in addition to their regulatory duties.

There are important questions around whether the consideration of ESG factors is consistent with the fiduciary duties of investment managers and other institutional investors. There has been a series of research papers, coordinated by the United Nations Environment Programme Finance Initiative (UNEP FI), analysing fiduciary duties and the consideration of ESG factors on a cross-jurisdictional basis. Three reports have been published so far: the Freshfields Report (2005);  Fiduciary II (2009);  and Fiduciary Duty in the 21st Century (2015).  The central argument of the UNEP FI is that the integration of ESG considerations into investment decision making is consistent with the fiduciary duties of institutional investors as these are long-term investment value drivers.  As such, UNEP FI concludes that investment approaches which take into account ESG factors are clearly permissible and arguably required.”

We believe the aforementioned concern will be central to the forthcoming rulemaking.

The OMB Comment Period: The Ultimate Resolution Forum

OIRA (Office of Information and Regulatory Affairs) could have a major impact on the substance of the rule.

 CRE will be filing comments on the proposed rule when OMB releases it for public comments.

 

 

 

 

 

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