July 22, 2009
UNEP Hones Legal Argument for ESG Incorporation in Investments in New Study
by Robert Kropp
Report by the United Nations Environment Program Finance Initiative's Asset Management Working
Group serves as a sequel to landmark Freshfields study, which established legal case for ESG
criteria in investing. First in a two-part series.
Whether asset managers have a fiduciary, and even legal, responsibility to incorporate
environmental, social, and governance (ESG) issues into the investment decisions they make on
behalf of their clients has long been a matter of debate. If the purpose of investing is to secure
a financial return, can ESG criteria be said to be material? When seeking financial returns on
behalf of their clients, what investment horizon should asset managers consider? Do asset managers
place themselves at risk of being sued if failure to incorporate ESG criteria in investment
decisions leads to losses due to such factors as climate change?
A report recently
issued by the United Nations Environment Program
Finance Initiative (UNEP FI) seeks to provide updated information on the legal ramifications of
ESG criteria in investment management, as well as describe the growing support for such ESG
initiatives as the Principles for Responsible
Investment (PRI) among both asset owners and managers.
Entitled Fiduciary Responsibility: Legal
and Practical Aspects of Integrating Environmental, Social and Governance Issue into Institutional
Investment (Fiduciary II), the report argues that consultants may well have a legal duty to
proactively raise ESG issues with their clients. The report also recommends that ESG issues be
embedded into legal contracts between asset owners and asset managers.
Fiduciary II is but
the latest stage of an ongoing effort by UNEP FI to make the case for incorporating ESG criteria
into investment decision-making. In 2002, it formed the Asset Management Working Group
(AMWG), which now includes 15 members and represents approximately $3 trillion of assets under
Dr. Julie Fox Gorte, who in addition to serving as Senior Vice President of
PAX World Funds, is Co-Chair of the AMWG,
said, "UNEP FI exists because over 170 banks, insurance companies, and asset managers believe that
integrating ESG analysis in financial decision-making is crucial, for the proper functioning of
financial markets and for the continued health of the planet and its societies."
continued, "Since 2002, the AMWG has issued a stream of reports that helped catalyze the
incorporation of ESG issues into both buy-side and sell-side financial analysis, introduced the
idea of integration into private equity management, and helped to launch the PRI."
the most important early reports, issues in June, 2004, sought to determine the business case for
incorporating ESG issues into investment decision-making. Entitled Th
e Materiality of Social, Environmental and Corporate Governance Issues to Equity Pricing
(Materiality 1), the report found that "environmental, social and corporate governance criteria
impact both positively and negatively on long-term shareholder value. In some cases these effects
may be profound."
The report derived two far-reaching conclusions from the finding that
ESG criteria do impact shareowner value. The first, that "research to determine the financial
materiality of these criteria should use longer time spans than is currently the norm for financial
analysis", is one of the central tenets of sustainability investing.
conclusion, that "Governments can reduce barriers to environmental, social and corporate governance
analysis by mandating and standardizing the inclusion of these criteria in national and
international financial disclosure frameworks", anticipates the growing call for mandatory
reporting that we now see in the adoption of carbon pricing schemes in most developed countries.
While Materiality 1 conclusively established a business case for the incorporation of ESG
criteria into investing, it did not address the legal ramifications of ESG incorporation to be
considered by asset managers. In response to legal interpretations that in some cases suggested
that investors were prevented from incorporating ESG criteria into investments, the AMWG
commissioned the law firm of Freshfields Bruckhaus Deringer, which in 2005 produced a landmark
report entitled A Legal
Framework for the Integration of Environmental, Social and Governance Issues into Institutional
The authors of the report concluded that "decision-makers are required to
have regard (at some level) to ESG considerations in every decision they make. This is because
there is a body of credible evidence demonstrating that such considerations often have a role to
play in the proper analysis of investment value." Therefore, according to the authors, the
consideration of ESG criteria falls within the bounds of fiduciary duty.
Dr. Gorte said of
the Freshfields report, "The report looked at the infrastructure of institutional investing in nine
countries, and concluded that there were not only no legal impediments to integrating
sustainability into institutional investments, but there were arguably and in some cases assuredly
a requirement to do so. Institutional investors that failed to do so could be breaching their
The business and legal cases for ESG incorporation that were
supported by these early reports helped lead to the formation by UNEP FI and the United Nations Global Compact of the PRI, which was
launched in 2006. Today, the PRI includes 560 signatories, representing over $18 trillion in assets
According to UNEP, the Freshfields report has been "considered by key
opinion formers in the investment industry as the single most effective document for promoting the
integration of ESG issues into institutional investment."
Fiduciary II, the report
produced by the AMWG in June, serves as a sequel to the Freshfields report, and is intended by the
AMWG to "provide a roadmap for fiduciaries looking for concrete steps to operationalize their
commitment to responsible investment." The findings of Fiduciary II will be explored in the second
of this series of articles.