Features

Fiduciary responsibility in the context of a global emergency

Published

11 years ago

October 18, 2013

Sam Gill

Fiduciary responsibility, in investment parlance, means acting in the best interests of the person whose money is being managed.

Since we are typically talking about a person’s retirement savings, this is usually understood to mean the fiduciary doing their best to achieve a reasonable rate of return on investment. This interpretation sounds reasonable, especially considering we are normally talking about someone’s nest egg for later life. We certainly wouldn’t want our money to be invested with someone else’s best interests at heart, that’s for sure.

Let’s use an example to illustrate just why this interpretation might not be so clear cut in our current climate.

Your pension fund manager – the fiduciary in this case – can invest your money in a company manufacturing a new type of vaccination drug which, due to demand, is proving extremely profitable. The company’s financials look good and the general consensus is that the company will be around to stay for at least another 30 years. So far, so good.

There is just one small detail. There is some controversy surrounding the company’s most profitable vaccination drug. A peer reviewed report – highly contested by Big Pharma – has recently been published by an independent panel of eminent scientists claiming with 95% certainty that the vaccination is also causing premature deaths among the population.

You are due to be vaccinated in a few months…

An example such as this, however farfetched as it might sound, highlights that acting in the best interests of the person whose money is being managed does not solely mean acting in their best financial interests. Indeed, what good is money to us if we are dead?

Funnily enough, a paper was recently published by the world’s leading climate scientists on the topic of climate change. To the surprise of no one, it reaffirmed that we are currently on course for a true global emergency in the form of a climate crisis. This will see human civilisation grappling to cope with temperature rises of 4-6C by around 2080 (within the lifetime of many alive today).

Once we surpass 2C of warming, figures such as 4-6C are only likely to be interim stops on our way to far higher temperature rises as various feedback loops kick in.

Arguably, at least one of the barriers preventing the investment world from being able to see the bigger picture has been the misguided notion that fiduciary responsibility is exclusively about maximising investor returns.

If it wasn’t such a big deal, it’s unlikely the Asset Owners Disclosure Project would have gone as far as to commission Baker & McKenzie to produce a report on the topic, and ShareAction wouldn’t have produced a 140-page report entitled Protecting Our Best Interests – Rediscovering Fiduciary Obligation.

The ShareAction report establishes through previous case law that there is no hard and fast rule stating that fiduciary obligation amounts to a blanket ban on considering non-financial issues.

This is highlighted by the Cowan v Scargill court case in which the judge ruled, “’Benefit’ is a word with a very wide meaning, and there are circumstances in which arrangements which work to the financial disadvantage of a beneficiary may yet be for his benefit.”

Of particular pertinence, the Baker & McKenzie report notes that a failure to consider climate change risk would be negligent and a breach of a pension trustee’s duties.

Let’s consider this in more detail. What is the purpose of a pension? It is to provide the beneficiaries with a decent standard of living in retirement.

It is debatable if a world ravaged by climate change – where a beneficiary has to deal with more extreme weather events, rising food and energy bills exacerbated by increased resource scarcity – would be considered a decent standard of living.

The journey to arriving at such a sorry state of affairs is also likely to have damaged the financial position of the pension fund, since as universal investors, most pension funds will suffer from any problem that wreaks havoc with the global economy.

ShareAction also picks up on another barrier, whereby funds may not be large enough to influence something such as climate change on their own, and therefore struggle to justify the benefit of trying to take action to their beneficiaries.

Scale has always been an issue, and it could also be argued that thus far there hasn’t been a collective investment vehicle presented to pension funds which would allow them to pool their money to confront the climate crisis head on. Until now.

Next month the Environmental Investment Organisation (EIO) will be launching Project One Percent. Project One Percent is a global movement of people calling on the largest asset owners in the world to move 1% of their funds into a market mechanism to tackle climate change.

Environmental Tracking, as it is known, involves tracking a mainstream broad market index (as many pension funds already do) but re-weighting companies according to their position in a series of public carbon rankings.

The scheme is designed to drive lower emissions and greater transparency by shifting demand for company shares, and ultimately share price, in line with emissions and transparency.

But what about the financial implications from a fiduciary point of view?

The literature from case law involving responsible investment is clear in stressing fiduciary responsibility is about the process of assessing all available information and making informed decisions, rather than trying to second guess the eventual financial return.

A UN Environment Programme initiative commissioned report on the topic adds, “The courts accept, despite the widespread use of mathematical modelling, that investment is an art rather than a science and there is a wide spectrum of opinion.”

Examining this line of argument suggests that there is a guaranteed financial loss associated with investing ethically, which is by no means an assured outcome. Legally speaking, what if no sacrifice of financial return is involved? As the judge from Cowan v Scargill case put it, “If the investment in fact made is equally beneficial to the beneficiaries, then criticism would be difficult to sustain in practice, whatever the position in theory.”

This is precisely why the EIO has spent the last four years developing its Environmental Tracking mechanism to ensure it offers the same performance as traditional indexes, but a very difference outcome. One which could help us avoid the worst effects of catastrophic climate change.

Imagine a world in which asset owners unite to support Project One Percent, in turn resulting in the creation of a share price incentive mechanism that drives companies to shift to low-carbon business models. Surely that would be in the best interests of everyone?

Sam Gill is chief executive of the Environmental Investment Organisation, which co-ordinates Project One Percent.