July 23, 2009
ESG Issues Should be Embedded in Legal Agreements Between Investors and Advisors, Report Finds
by Robert Kropp
A new report by the Asset Management Working Group of the United Nations Environment Program
Finance Initiative argues that advisors who fail to raise ESG issues with clients face the risk of
lawsuits. Second in a two-part series.
In 2005, the Asset
Management Working Group (AMWG) of the United
Nations Environment Program Finance Initiative (UNEP FI) commissioned the law firm of
Freshfields Bruckhaus Deringer to author a landmark report entitled A Legal
Framework for the Integration of Environmental, Social and Governance Issues into Institutional
Investment. The report broke important new ground in its finding that the consideration of
environmental, social, and governance (ESG) criteria falls within the bounds of the fiduciary duty
of asset owners.
According to Paul Watchman, the senior author of the Freshfields report,
"Far from preventing the integration of ESG considerations, the law clearly permits and, in certain
circumstances, requires that this be done."
In July, the AMWG published a follow-up
to the Freshfields report, entitled Fiduciary Responsibility: Legal
and Practical Aspects of Integrating Environmental, Social and Governance Issue into Institutional
Investment (Fiduciary II). The new report builds upon its predecessor by arguing that "Advisors
to institutional investors have a duty to proactively raise ESG issues within the advice that they
provide, and that a responsible investment option should be the default position."
Furthermore, according to the report, investment advisors that fail to incorporate ESG issues
into their investment services face "a very real risk that they will be sued for negligence." In
order to avoid such a scenario, "ESG issues should be embedded in the legal contract between asset
owners and asset managers, with the implementation of this framework being governed by trustees via
Fiduciary II consists of three major sections. The first of these
examines the legal perspective on the incorporation of ESG criteria into the investment process,
and concludes with several recommendations. In addition to recommending that the incorporation of
ESG issues become a routine part of the investment process, the report recommends that asset
managers that are signatories to the Principles for
Responsible Investment (PRI) should commit to proactively raising ESG issues within their
Referring to the findings in the legal section of Fiduciary II, Paul
Hilton, who is the Director of Advanced Equities Research at Calvert Investments and served as Co-Project Lead for Fiduciary II,
said, "Pension fund trustees and other institutional investors should consider having their asset
managers adopt the PRI, and ask that their asset managers demonstrate active participation in the
development of the PRI."
"This report specifies how institutional asset owners should
begin to operationalize their responsibility to integrate ESG considerations into their investment
analysis," Hilton continued. "It also highlights the related responsibilities of investment
advisors to be more proactive in raising such issues."
The second section of the report
analyzes the responses by investment management consulting firms to a survey from the AMWG. While
the report notes an increase in demand for ESG services since the advent of the PRI in 2006, it
also finds that the industry has not yet developed ways to measure the competence of asset managers
relating to ESG integration and engagement.
Furthermore, the report finds that in some
cases, the responses of investment advisors conflict with the legal advice contained in the report.
While the report states that it is "the professional duty of institutional investment consultants
and asset managers to proactively raise ESG considerations with their clients", respondents to the
survey indicated that they generally wait for their clients to raise ESG issues. Respondents also
differed with the report's finding that ESG considerations should be embedded in investment
Mary Jane McQuillen, the Director and Portfolio Manager of Socially
Aware Investments at ClearBridge
Advisors and a Fiduciary II Co-Project Lead, said, "To wait for trustees or managers to raise
this issue may be a breach of consultants' professional duty to their clients."
example of good practice by investment consultants, McQuillen referred to the answer provided by Mercer to the question, "Do you consider that
integration of ESG matters is a requisite aspect of investment management as part of fiduciary
Mercer's response was, "Yes. An increasing body of evidence exists to show that ESG
factors can impact investment performance. Therefore, fiduciaries concerned with long-term
preservation and growth of capital should have some understanding of how ESG factors may affect
The third section of the report finds that while laws regarding
fiduciary duty have changed little since the Freshfields report, "many institutional investors are
beginning to see their fiduciary duty as allowing for, or even requiring, a more sustainable
investment approach." The section examines several initiatives among pension plans and
institutional investors that explicitly incorporate ESG issues into their processes, and cites
numerous studies that provide guidance for institutional investors wishing to do so.
third section of Fiduciary II also describes the integration of ESG criteria into new asset
classes, such as private equity and property investment, and financial sectors such as insurance.
Butch Bucani, Program Officer for Insurance and Investment at UNEP, and the Fiduciary II
Project Manager and Chief Editor, said, "Many leading institutional investors are adopting
longer-term and more responsible and sustainable investment strategies, and in fact are moving
toward greater integration of ESG issues into overall investment philosophy and practice."
Bucani continued, "In order to achieve the original vision of the Freshfields report, ESG
issues should be embedded into the legal contracts between asset owners and asset managers. The
report makes the case that asset managers have a duty to proactively raise ESG issues with their
He concluded, "Taking ESG issues into account will align institutional investors
with the interests of society."