Investors have both a profound responsibility and a huge stake in the maintenance of a sound financial system. That stability relies upon the health of our environmental and social systems – which are currently under threat. International frameworks like the Sustainable Development Goals and the Paris Agreement set out the plan to preserve and enhance those systems but the global investment sector is currently not holding up its end of the deal. We explain how our joint project is clarifying the legal responsibilities of investors to consider the sustainability impact of their decision-making and provide examples from jurisdictions around the world. We also explain how we are targeting policymakers to deliver legal frameworks that can support sustainable economies that are fit for purpose.

The IPCC unequivocally attributes climate change to human influence. Economic activity, and the financial decisions that underpin it, are one of the primary drivers of that influence. The financial sector has to manage risks linked to climate change, biodiversity loss, social and economic inequalities and human rights – but that alone is not enough.

To address these issues, investors need to increase positive (and decrease negative) outcomes arising from their actions. Investment practice is evolving to this end and policymakers and regulators need to ensure that legal frameworks evolve too – to ensure that investors’ duties and discretions facilitate investing for sustainability impact.

Investors’ duties are moving from a consideration of ESG risk to an obligation to consider sustainability impact

Beneficiaries are increasingly demanding that their investments are managed sustainably, and investors are enhancing their efforts to deliver solutions. However, despite significant industry advances in recent years, investment activity continues to generate negative impacts on a scale that our planet and society cannot sustain. It is also not yet sufficiently funding activities that can deliver on global goals, including those set out in international treaties like the Paris Agreement. The issue however is not a shortage of capital but rather the inadequate deployment of capital. Whilst common practices in sustainable investing address some of society’s most pressing challenges such as climate change, we need to place stronger emphasis on the core issue which is to fundamentally change the behaviour of investee enterprises towards a more sustainable mode of operating.

Until now sustainability factors have been taken into account by investors predominantly from a risk and return perspective. The 2005 Freshfields Report and a subsequent project, Fiduciary Duty in the 21st Century, moved the dial in this respect and argued that ‘investors that fail to incorporate environmental, social and governance (ESG) issues are failing their fiduciary duties’. But if the financial system is to play its part in achieving major societal goals, mainstream investors need to consider the impact from all their activities and legal frameworks, and financial systems need to adapt to facilitate this.

The joint project ‘A Legal Framework for Impact’ led by PRI, the Generation Foundation and UNEP FI explores how the global investment sector could strengthen its response to ESG issues by pursuing positive sustainability impact in the real economy. It looks at sustainability factors not merely from a risk-return perspective but rather emphasizes the need to utilize capital allocation, stewardship and policy engagement to steer investee enterprises towards increasing positive sustainability outcomes and decreasing activities that have a negative impact on our environment and society. For investors this means a shift in their thinking in favour of impact, and it requires goal setting, taking action accordingly and measuring that impact on a regular basis.

The report ‘A Legal Framework for Impact’, written by the law firm Freshfields Bruckhaus Deringer, was published in July 2021 and provides an in-depth analysis of laws governing the investment sector with regards to investing for sustainability impact, covering 11 jurisdictions. With the publication of the report, the project team, PRI, UNEP FI and the Generation Foundation, entered Phase II which concentrates on the implementation of policy reform options outlined in the report with a predominant focus on five key jurisdictions including Australia, Canada, the EU, Japan and the UK, as well as supporting investors to carry out their existing impact duties.

What is ‘Investing for Sustainability Impact’?

A Legal Framework for Impact sets out what is meant by ‘investing for sustainability impact’ (IFSI), a conceptual net that captures any approach whereby an investor intentionally seeks to pursue assessable positive sustainability outcomes (including the reduction of negative sustainability outcomes).

IFSI differs from ESG-integration: where the latter focuses purely on management of risk, the former is about actively pursuing an impact goal. These impact objectives might be targeted as a means to meet financial objectives, or in some cases, as an end in themselves alongside financial returns.

Such forms of stewardship and collective action are already visible and include examples such as the UN-convened Net-Zero Asset Owner Alliance, which has committed to transition investment portfolios to net-zero greenhouse gas emissions by 2050.

What does the law say?

In most jurisdictions, the primary goal of investors is generating a financial return for beneficiaries. But this is far from the end of the story. There are obligations and opportunities for investors to seek improved sustainability impacts, and a process to assess the possible materiality of those is required in all jurisdictions. Accordingly, where sustainability impacts pose a material risk or opportunity, investors will likely be required to take account of those sustainability impacts and in most contexts, there will be at least some sustainability impact they would be obliged to take action on. The report also sheds light on cases where investors could pursue sustainability goals in their own right, in parallel to financial return goals, acknowledging that these cases are more limited.

For example, the guidelines for Japan’s largest asset owner the Government Pension Investment Fund (GPIF) provide scope for investing for sustainability impact if GPIF reasonably believes it will improve investment returns in the long term.

In Canada, financial regulators allow mutual funds to be set up for sustainability impact objectives, and likewise the EU and UK regimes allow this for the establishment of Undertakings for Collective Investment in Transferable Securities (UCITS). Canadian legislation explicitly allows for pension funds to incorporate non-financial criteria ‘to formulate an investment policy or to make an investment decision’ according to the Trustee Act and a similar provision is provided in the Pension Benefits Act (Manitoba).

Such powers are not limited to pension funds and mutual funds. In the Netherlands and the UK, for example, life insurers may create products with an objective to invest for sustainability impact.

Why we need policy reform and what options are available

Despite the significant requirements and opportunities for investors to address real-world impacts, impediments to investing for sustainability impact remain. These challenges are multi-layered and, in some cases, interdependent, covering areas of regulation, policy and market practice. The Legal Framework for Impact report therefore considers a range of policy reform options to expedite the process to a more sustainable and inclusive investment sector which accounts for outcomes and meets 21st century needs. These policy options broadly envisage a) adjustments to investors’ core legal duties and discretions and the way these are understood and b) changing the circumstances in which these are applied to create an enabling environment and adjust underlying market features so that investors can recognize and discharge their existing legal duties.

Phase II of the Legal Framework for Impact project focuses on developing ideas and options for reform into policy proposals specific for the jurisdictions selected for further work. This will entail engagement with the investment community, legal professionals, policymakers and regulators. Especially in light of the ongoing COVID-19 pandemic, building back better needs to be sustainable and inclusive with concrete and coordinated policy reform options.

‘The Sustainable Development Goals and the Paris Climate Agreement are our best chance for not only a livable but also a brighter future. Reaching these goals requires an updated financial system that is fit for purpose – one in which assessing and accounting for the sustainability impact of investment decision-making is a core part of investment activity.’ Inger Andersen, Executive Director, United Nations Environment Programme

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