21st Century Fiduciary Duties: A New Day and a New Dawn for Investors?


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A presentation by Paul Watchman at TBLI CONFERENCE EUROPE 2008.

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  • 21st Century Fiduciary Duties: A New Day and a New Dawn for Investors?

    1. 1. 21st Century Fiduciary Duties: A New Day and a New Dawn for Investors? 13 November 2008 Paul Q Watchman QWC Quayle Watchman Consulting
    2. 2. Agenda <ul><li>The UNEP FI Report on ESG and investment decisions </li></ul><ul><li>Overview of fiduciary duties </li></ul><ul><li>Conclusions of the UNEP FI Report </li></ul><ul><li>How these conclusions relate to fiduciary duties and climate change </li></ul><ul><li>Recent developments </li></ul><ul><li>Final thoughts </li></ul>
    3. 3. The focus of today’s discussions <ul><li>“ The business of business is business” </li></ul><ul><li>(Milton Friedman) </li></ul><ul><li>“ If we are to build a more successful, vibrant, modern economy we can no longer afford to view economic success as being in conflict with social and environmental goals. On the contrary these goals must be seen as integral to economic success and the very essence of sustainable development” </li></ul><ul><li>(Rt Hon Mike O'Brien MP, Minister of State for Pensions Reform, 21 May 2008) </li></ul>
    4. 4. UNEP FI Report Primary Conclusion <ul><li>“ Institutional investors who hide behind profit maximisation and the limits supposedly placed by their legal duties as fiduciaries do so at their own peril. There is no legal bar to the integration of ESG considerations into investment decision-making (provided the focus is always on the beneficiaries best interests) and indeed failure to have regard for such considerations where there is a proven link between an ESG consideration and investment value may itself amount to a breach of fiduciary duties by the pension fund trustee or on his behalf by an asset manager.” </li></ul><ul><ul><li>(UNEP FI Report, October 2005 ) </li></ul></ul>
    5. 5. More recent conclusions <ul><li>Some are very positive: </li></ul><ul><ul><li>“ There is no reason in law why trustees cannot consider social and moral criteria in addition to their usual criteria of financial returns, security and diversifications. This applies to trustees of all pension funds.”   (Lord McKensie, House of Lords, Pensions Bill, Hansard, 7 October 2008) </li></ul></ul><ul><ul><li>This may go further than judicial interpretation </li></ul></ul><ul><ul><ul><li>Gives greater latitude to church and charity pension funds </li></ul></ul></ul><ul><ul><li>Indicative of the government's position to encourage RI </li></ul></ul>
    6. 6. More recent conclusions <ul><ul><li>“ It is an obligation on pension fund trustees not simply a right or option to state in their Statement of Investment Principles what the fund's guidelines are on responsible investment and to what extent social, environmental or ethical considerations are taken into account. ”   (Lord McKensie, House of Lords, Pensions Bill, Hansard, 7 October 2008) </li></ul></ul>
    7. 7. More recent conclusions <ul><li>Some are more negative </li></ul><ul><ul><li>US Department of Labor interpretive bulletin on &quot;economically targeted investments”, 23 October 2008 </li></ul></ul><ul><ul><ul><li>If ERISA plan fiduciaries choose investments for reasons other than the economic interests of the plan, then they only can choose investments that are economically equal to available alternative investments. </li></ul></ul></ul><ul><ul><ul><li>Contrast to: </li></ul></ul></ul><ul><ul><li>“ Calvert Letter”, US Dept. Of Labor PWBA Advisory Opinion 98-04A, 28 May 1998) </li></ul></ul><ul><ul><ul><li>If properly made, the selection of a Calvert socially responsible mutual fund for plan investment would not be inconsistent with the ERISA fiduciary standards </li></ul></ul></ul>
    8. 8. Background to the UNEP FI Report <ul><li>The legacy of Milton Friedman and the Chicago School of Law and Economics </li></ul><ul><li>Goldman Sachs, UBS, ABN Amro and others </li></ul><ul><li>A legacy of the miners strike </li></ul>
    9. 9. UNEP FI Report Study <ul><li>Common law countries, states, provinces and other legal jurisdictions </li></ul><ul><ul><li>United States </li></ul></ul><ul><ul><li>United Kingdom </li></ul></ul><ul><ul><li>Canada </li></ul></ul><ul><ul><li>Australia </li></ul></ul><ul><li>Civil law jurisdictions </li></ul><ul><ul><li>France </li></ul></ul><ul><ul><li>Spain </li></ul></ul><ul><ul><li>Japan </li></ul></ul><ul><ul><li>Germany </li></ul></ul>
    10. 10. UNEP FI Report Study <ul><li>Countries or regional governments which recognise ESG explicitly in primary or secondary legislation as relevant and material investment considerations </li></ul><ul><ul><li>United Kingdom </li></ul></ul><ul><ul><li>France </li></ul></ul><ul><ul><li>Germany </li></ul></ul><ul><ul><li>Canada (Manitoba) </li></ul></ul><ul><ul><li>Australia </li></ul></ul><ul><ul><li>“ Italy” </li></ul></ul>
    11. 11. Where do fiduciary duties come from? <ul><li>Open to debate – conflicting theories </li></ul><ul><li>From fiduciarius &quot;(holding) in trust,&quot; from fidere &quot;to trust&quot; </li></ul><ul><li>Have been traced back to Roman law </li></ul><ul><li>One scholar on trusts and fiduciary duties found a breach of “fiduciary duty” by a steward in the Bible </li></ul>
    12. 13. Fiduciary duties change over time <ul><li>Fiduciary duties are organic and respond to changes in society </li></ul><ul><li>Examples </li></ul><ul><ul><li>Equal pay for women for equal work held to be an unlawful breach of fiduciary duties </li></ul></ul><ul><ul><li>Encouraging provision for disabled people on public transport held to be unlawful breach of fiduciary duties </li></ul></ul><ul><ul><li>Pricing public transport fares to discourage the use of cars in city centres held to be an unlawful breach of fiduciary duties </li></ul></ul>
    13. 14. What are the modern fiduciary duties of a pension fund trustee? <ul><li>Duty of loyalty </li></ul><ul><li>Duty of prudence </li></ul><ul><li>Duty to act fairly </li></ul><ul><li>Duty to act in the interests of all beneficiary classes and balance interest between beneficiary classes, including present and future contributors and beneficiaries </li></ul><ul><li>Duty to spread risk according to modern portfolio theory </li></ul><ul><li>Duty not to crusade unless a bona fide crusader </li></ul><ul><li>Duty to take a long term not short term or medium view </li></ul>
    14. 15. Conclusions of the UNEP FI Report <ul><li>The view associated with Friedman and the Chicago school that investment profits must be maximised and ESG considerations rejected as an unlawful breach of fiduciary duties is wrong and is not based on an analysis of case law or legislation </li></ul><ul><li>ESG considerations are mainstream investment considerations not SRI niche </li></ul>
    15. 16. Conclusions of the UNEP FI Report <ul><li>Where there is evidence that there is a relationship between value and an ESG consideration it should be taken into account. For example </li></ul><ul><ul><li>Climate change in the insurance & reinsurance, oil & gas, automobile manufacturers and real estate industries </li></ul></ul><ul><ul><li>Child labour in the clothing and food & drink industries </li></ul></ul><ul><ul><li>Human rights in the clothing, food, retail and electrical and electronic industries </li></ul></ul><ul><ul><li>Biofuels (food v. fuel) </li></ul></ul><ul><ul><li>Good governance in all industries </li></ul></ul>
    16. 17. Conclusions of the UNEP FI Report <ul><li>Where a decision is made on political or ethical values rather than value there is a danger that fiduciary duties may be breached </li></ul><ul><ul><li>There is an exception for moral and other crusaders, such as churches, charities and political funds </li></ul></ul><ul><ul><li>Otherwise no crusading: decisions should be based on investment value not moral values </li></ul></ul>
    17. 18. UNEP FI Report Part II <ul><li>Commenced last month </li></ul><ul><li>Review of changes in policy, practice and law since 2005 </li></ul>
    18. 19. How does this relate to climate change? <ul><li>Investors are increasingly aware of the relevance of many other ESG issues such as human rights, health issues and supply chain management to companies’ financial performance </li></ul><ul><li>Climate change is just one example of an ESG issue </li></ul><ul><ul><li>Perhaps more accepted than other EGS issues? </li></ul></ul><ul><ul><li>Already recognised by mainstream investors as a material financial issue? </li></ul></ul><ul><ul><li>E.g. “cost of carbon” to power companies </li></ul></ul>
    19. 20. Principles for Responsible Investment (PRI) <ul><li>Assets under management now in excess of US$14 trillion </li></ul><ul><li>Now approximately 360 signatories </li></ul><ul><li>First three principles of PRI </li></ul><ul><ul><li>Insofar as is consistent with fiduciary duties </li></ul></ul><ul><ul><ul><li>Incorporate ESG issues into investment analysis and decision-making </li></ul></ul></ul><ul><ul><ul><li>Be active owners and incorporate ESG issues into our ownership policies and procedures </li></ul></ul></ul><ul><ul><ul><li>Seek appropriate disclosure of ESG issues by entities we invest in </li></ul></ul></ul>
    20. 21. Principles for Responsible Investment (PRI) <ul><li>Who has signed up so far? </li></ul><ul><ul><li>Asset owners </li></ul></ul><ul><ul><li>Investment managers </li></ul></ul><ul><ul><li>Professional services providers </li></ul></ul><ul><li>Very difficult to adhere to PRI values without taking climate change seriously </li></ul>
    21. 22. OECD Developments <ul><li>The OECD have issued draft Guidelines on Pension Governance for consultation </li></ul><ul><li>The Network for Sustainable Financial Markets has encouraged the &quot;OECD to also examine the role that pension funds played in fostering a market environment that produced the current economic crisis.&quot; (1 October 2008) </li></ul>
    22. 23. Rethinking incentives? <ul><li>“ The [pension fund] industry's 'incentive structure' is flawed - the rewards and sanctions facing industry participants are not appropriate and so participants are incentivised to act in ways that will ensure the system remains prone to periodic crisis.” </li></ul><ul><li>(Watson/Wyatt/Financial Times, Defining Moments: The pension and investment industry of the future (2008)) </li></ul><ul><li>Are short term incentives contrary to the duty of prudence and the duty of loyalty to all beneficiaries and hence breach fiduciary duties of pension fund trustees? </li></ul><ul><li>Government in the era of credit crunch sympathetic to reforming incentives for financial industry in general? </li></ul>
    23. 24. Final Thoughts <ul><li>RI is not a substitute for existing valuation tools but an additional one </li></ul><ul><li>Opportunities as much as risks </li></ul><ul><li>Examples: </li></ul><ul><ul><li>GE Ecomagination </li></ul></ul><ul><ul><li>BP renewables investment </li></ul></ul><ul><ul><li>Emerging climate change insurance products and services </li></ul></ul><ul><li>Forget Friedman and his Chicago acolytes. Their response was based on corporate America getting on board the Marrakech Express with Crosby, Stills and Nash </li></ul>
    24. 25. 21st Century Fiduciary Duties: A New Day and a New Dawn for Investors? 13 November 2008 Paul Q Watchman QWC Quayle Watchman Consulting