July this year marked one year since the publication of ground-breaking legal analysis that is supporting investors as they advance their practice towards investing for sustainability impact. A Legal Framework for Impact (LFI), a report authored by Freshfields Bruckhaus Deringer and commissioned by the Principles for Responsible Investment (PRI), the Generation Foundation and the United Nations Environment Programme Finance Initiative (UNEP FI) has paved the way for a programme of work which is helping investors engage with policymakers to transform global financial systems. Read about the report and get the key findings from the project’s first year of work in five legal jurisdictions.
What is A Legal Framework for Impact? The report presents an extensive legal analysis carried out by Freshfields to determine to what extent mainstream investors can pursue positive environmental or social impacts or avoid negative impacts. The authors call this investment approach “investing for sustainability impact (IFSI)”. Freshfields examined international and national legislation, regulation, guidance and case law.
The result is an in-depth study that sheds light on investors’ legal obligations and freedoms to invest for sustainability impact in 11 major markets across the globe. The report also details the legal position on investors’ use of investment powers, stewardship activities and engagement with policymakers to pursue sustainability goals.
Why does the report matter? Currently, many investors consider environmental and social issues only when they are likely to affect the financial return on an investment. Ultimately, this mode of operating will fail to substantially contribute to the realisation of environmental and social goals, such as those in the Paris Agreement and hence, risks undermining capital markets themselves, as well as long-term financial returns for investors. Aligning investor behaviour and capital markets with global sustainability goals calls for a new model of investing whereby decisions are made according to three key considerations: sustainability impact, risk and return.
What does the report conclude? Across all jurisdictions examined, the report’s authors found that investors can and often should be doing more:
- In most cases investors have a legal obligation to consider improving their impacts on sustainability outcomes where this is relevant (“instrumental”) in achieving financial return goals.
- In certain cases, investors are legally permitted to pursue sustainability goals that are distinct from financial return goals, subject to the investor’s individual circumstances. The report calls this “ultimate ends IFSI”.
The report shows that, while investors generally have a duty to prioritise financial objectives, this is not the end of the story. Investors’ fiduciary duties allow – and in many cases – require them to manage their sustainability impacts. However, this is not always widely understood or practised by the investment community. Inertia is a significant barrier to change.
What’s next? The LFI report sets out recommendations for legal reforms that would enable the investment community to pursue sustainability goals. The project partners are now working in five jurisdictions to help investors meet their existing obligations as well as take the growing opportunities to improve their sustainability impacts. The project partners are also developing roadmaps for policymakers in those jurisdictions to facilitate the necessary shift towards sustainable, responsible investment practices.
This update on the LFI project outlines key findings, relevant developments and next steps across the five jurisdictions – Australia, Canada, the EU, Japan and the UK.
In August, Australia’s new climate change and energy minister declared “a new era of climate and energy certainty” as a landmark climate change bill passed in the House of Representatives. In the future, this shift could empower investors to address the impact of their activities on climate.
Existing fiduciary duties permit the consideration of sustainability outcomes. However, outside of certain circumstances (e.g., when sustainability outcomes negatively affect investors’ ability to meet their objectives set by law), there is no legal obligation for investors to do so.
Australia’s current legal framework also limits investors’ ability to pursue desired sustainability outcomes as a distinct objective (not linked to financial objectives).
What’s next? A forthcoming LFI report focusing on Australia will make policy recommendations aimed at helping investors pursue positive sustainability outcomes and mitigate system-level, sustainability-related risks. The recommendations will build on the Australian Sustainable Finance Roadmap by the Australian Sustainable Finance Institute.
- Canada’s legal framework permits and in certain circumstances likely requires investors to invest for sustainability impact where it is financially beneficial.
- Yet, investors seeking to invest for sustainability impact are uncertain as to their legal duties and face impediments such as a lack of decision-useful sustainability data from investee companies.
- The formation of the Canadian Sustainability Standards Board, announced in June, should accelerate progress towards sustainability disclosures by businesses, investors and agencies providing environmental, social and governance (ESG) ratings.
What’s next? The forthcoming LFI report on Canada will explore options for policy reform and provide recommendations for, inter alia, necessary disclosure mechanismsand measures to remove legal impediments to IFSI. The report will also recommend clarifying existing duties with regard to the pursuit of sustainability impact goals.
- EU policy makers have introduced a number of sustainable finance policies in recent years, showing a clear ambition to ensure that investments in the bloc support their climate and other sustainability goals.
- The 2019 regulation on sustainability-related disclosures in the financial services sector or SFDR requires disclosure of actions taken or planned to avoid or reduce adverse sustainability impacts.
- Many investors remain unsure about how IFSI fits with their legal duties.
- The LFI report on the EU published in April 2022 proposes reforms to investors’ duties, processes and disclosures to foster IFSI in the EU.
What’s next? The PRI is engaging with policymakers and investors on measures to clarify that IFSI is consistent with the “prudent person” principle and with the concept of beneficiary “best interest” for pension funds and insurers.
- Existing investor duties generally permit the pursuit of desired sustainability impacts where that is instrumental to securing better investment returns. However, investors seeking such impacts still face practical impediments and, in some cases, a lack of legal clarity and guidance.
- In December 2020, the Financial Services Agency (FSA) established its Expert Panel on Sustainable Finance and has since been developing measures to enhance corporate disclosures on sustainability issues, improve underlying market infrastructure and clarify the role of financial institutions in addressing significant sustainability risks.
- The FSA is considering revisions to Japan’s Stewardship Code and its supervisory guidelines regarding ESG funds. This could present further opportunities to integrate the consideration of sustainability impacts into Japan’s financial regulations.
What’s next? A forthcoming LFI report on Japan will include recommendations for reforms to fiduciary duties, stewardship, corporate disclosures, market infrastructure, and disclosures and product labelling by investors to facilitate IFSI.
- The law is not explicit on UK investors’ freedoms and obligations to invest for sustainability impact, and there is no clear guidance on when and how to engage in this practice.
- The government’s actions, such as the launch of the Green Finance Strategy in 2019 among others, underscore the critical role private investments can play in helping the country deliver on its climate pledges, as well as the need for investors to address climate-related financial risks.
- To achieve both those goals, policy makers need to clarify why IFSI is consistent with UK investors’ fiduciary duties and how investors can assess and address their sustainability impacts.
What’s next? A LFI report focused on the UK (due to be published in autumn 2022) will set out the policy reforms required. It will also inform the PRI’s engagement with UK policy makers on sustainable finance measures such as the Green Finance Strategy, sustainability disclosure requirements (including those aligned with the recommendations by the Task Force on Climate-Related Financial Disclosures) and transition plans for financial institutions and listed companies.
The Legal Framework for Impact can be downloaded here.