European Overhaul Needed to Support Investor Impact

PRI calls for greater alignment between sustainability impact and fiduciary duties.

Legal changes are required in the European Union to enable investors to work towards sustainability impact goals, according to the Principles for Responsible Investment (PRI). In a new paper, the PRI said EU law currently limits the ability of investors to invest or exercise stewardship in alignment with social and environmental goals, “except where it is also financially beneficial to do so”.

The paper builds on the findings of an earlier report commissioned by PRI on the legal barriers to investing for sustainability impact in 11 jurisdictions including the EU, the UK and the US. The report concluded that policymakers could act to “better align” sustainability-driven goals with fiduciary duty.

The PRI identifies “potential inconsistency” between EU financial regulation and wider EU sustainability goals, citing existing rules on occupational retirement provision, personal pension products, insurance distribution, UCITS and markets in financial instruments.

For greater alignment between financial regulation and the EU’s support for sustainability impact goals for investors, the PRI suggested that EU lawmakers should clarify that existing duties may require or permit the pursuit of positive sustainability impacts by investors, especially in the case of instrumental investing for sustainability impact, where it can investors help pursue their financial objectives.

Further, legal barriers that impede investors from pursuing positive sustainability impacts more broadly should be removed and lawmakers should provide clarity on the appropriate mechanisms for investors to consider pursuing such impacts.

While much of the focus of the EU sustainable finance regulatory framework has been on disclosure requirements, the PRI said disclosure “has its limits”, pointing out that the Sustainable Finance Disclosure Regulation (SFDR) does not cover “the full range of ways in which investors may achieve positive sustainability impacts”. Nor does it fully distinguish between the sustainability impact of an investee and the investors positive influence on that impact.

“Moreover, several EU member states have developed minimum requirements for sustainable or ESG investment funds in the absence of EU requirements, which creates a risk of fragmentation,” said the PRI.

To provide the appropriate regulatory framework for pursuing sustainability impact goals, the current focus on disclosures needs to be balanced with other obligations, such as those related to investors’ duties and processes.

Mutually reinforcing policy interventions in the areas of investors’ fiduciary duties, processes and disclosure requirements would help align capital markets with sustainability goals. The PRI’s suggested policy reforms are designed to “better embed” investors’ rights to pursue positive sustainability impacts in fiduciary duties and give them “greater confidence” to do so.

The PRI makes four recommendations for policymakers to embed sustainability impact goals in fiduciary duties. The first is to clarify, within the prudent person principle (PPP), when sustainability impact goals must or can be considered and develop implementation guidance. This means that in applying PPP, insurers and occupational pension funds are obliged to consider pursuing social and environmental impact goals where this would help achieve their financial objectives, and may in some cases pursue environmental and social impact goals as a distinct goal alongside financial objectives.

The second recommendation is to take into account sustainability impact goals when defining beneficiaries’ ‘best interest’. To date, many lawyers and investors have interpreted best interest as financial interest. Further work is needed to embed sustainability impact goals in the concept of best interest where they are relevant to achieving financial goals, and where they are relevant to serving beneficiaries’ wider interests.

A third recommendation is to clarify that beneficiaries’ and clients’ preferences can be taken into account and that such investment behaviour is encouraged. In tandem, investment strategies that involve pursuing positive sustainability impacts as one of the default options for clients should be established.

Finally, the PRI recommended that the relationship between financial and sustainability objectives should be clarified. “The extent to which investors can work towards sustainability impact goals in practice will depend on the relationship between financial and sustainability objectives: in particular, whether sustainability impact goals are pursued in support of financial objectives or, rather, sustainability objectives are pursued as ends in themselves, in parallel to any financial objectives.”

Other areas that could be examined, said the PRI, include directors’ duties, barriers to stewardship sustainability-impact focused investment products, and due diligence.


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