The ESG Interview: Tougher Membership Rules in PRI’s ‘Big Tent’

CEO Fiona Reynolds says growing size will not diminish ambition, as PRI intensifies focus on impact.

The title of the UN-supported Principles for Responsible Investment’s new 2021-2024 strategy – ‘Building a bridge between financial risk, opportunities and real-world outcomes’ – reflects the pace and scale of change since the organisation set out its 10-year blueprint in 2016.

From the investor perspective, it acknowledges a shift in emphasis from recognising and managing ESG risks in the investment portfolio to actively tackling the causes of those risks on the ground. PRI CEO Fiona Reynolds says the past five years has had a profound impact on investor priorities, noting the influence of the Paris Climate Agreement and the UN Sustainable Development Goals (SDGs).

“Impact is becoming the new frontier in the investment space,” she says. “More investors aren’t just thinking about, ‘What are the ESG risks to my portfolio?’ They’re also thinking about, ‘What are the risks of my portfolio for the real world? What is my carbon footprint? How am I treating the environment and people.’ These provide a feedback loop to each other. Understanding outcomes helps investors understand their portfolios.”

The new strategy places emphasis on the scalability of the PRI’s activities and the need for diversity among its signatory base. Alongside this ‘big tent’ approach, it recognises also the “critical” importance of accountability among signatories.

As investors’ priorities have evolved, the PRI has regularly developed tools to support them, such as a framework to help investors understand and measure outcomes in terms of contribution to the UN SDGs, issued last year. This will continue, says Reynolds, with support for “assessing financial risks / opportunities and links to real-world outcomes” the first of 22 key initiatives over the next three years.

“It’s more than thinking about impact investing as such. It’s about thinking about the impact of your investments in the real world,” says Reynolds.

Increased legal certainty for investors

To further facilitate this focus on impact, the PRI is examining legal frameworks in key jurisdictions, with the aim of providing investors with the legal certainty to invest for outcome while remaining within the boundaries of fiduciary duty.

The work follows on from a four-year project, completed last year, to clarify the fiduciary duties of investors in relation to integration of ESG factors into investment decisions. The final report noted the need for “fundamental changes” to structures, duties and incentives “if the financial sector is to enable economic activities and societies to prosper in a sustainable manner”.

The shift from integration to impact partly reflects the challenges of rising expectations. With the private sector obliged to support government-level commitments, investors are squeezed between the pressure to decarbonise portfolios, for example, and a fiduciary duty which requires them only to consider sustainability in terms of risks to their portfolio.

“There are much greater expectations on investors, from beneficiaries, governments and the NGO sector, all of which now have a much greater understanding of the leverage investors have with the corporations they invest in. Their role as shareholders is under much more scrutiny,” Reynolds adds.

As such the PRI is working with international law firm Freshfields Bruckhaus Deringer to examine 11 jurisdictions to identify whether their regulations have evolved to accommodate investors’ desire to more fully consider impact.

“When we look at these jurisdictions, where necessary we will recommend regulation be changed to provide investors with more certainty,” she said.

The report is now expected to be published in June.

Slowed by size?

This support for asset owners’ rising ambitions to drive real-world change can only go so far without the full cooperation and support of their asset manager partners. The ranks of the PRI’s membership – which include asset owners, managers and other service providers – have swollen over the past five years as managers have sought to improve their skills and demonstrate their ESG credentials in line with clients’ expectations.

More than 3,800 signatories tells its own story, but success also brings new challenges. Some observers have warned that greater size can slow down or dilute the sense of purpose of an organisation which as rarely minced its words on the urgency of the issues facing investors.

Earlier this year, a study by Robeco and Erasmus School of Economics in Rotterdam found that US-based PRI signatories performed worse than non-signatories in terms of supporting environmental and social shareholder proposals. The PRI pointed out that the study used data only up to 2018, but nevertheless acknowledged that some firms sought membership to win mandates rather than integrate ESG factors into their investment processes.

Reynolds is convinced the PRI should remain inclusive and diverse, accommodating parties at different levels of development in their ESG investing journey. But it is raising its membership standards, toughening its reporting requirements and will increasingly look to eject those that don’t respect the club’s rules.

“In our ‘theory of change’, we take the view that investment is global, and we need to move everyone,” she says. Working with a small niche group is not going to bring about the necessary broad-based shift toward responsible investment principles.

Raising the reporting bar

The desire to ‘raise the bar’ to support asset owners in their greater scrutiny and monitoring of manager performance can be seen in changes to the PRI’s reporting framework, which are currently being piloted and will be finalised following feedback.

These include a voluntary element for reporting outcomes, alongside core mandatory information on policies and processes. The voluntary reporting will be used, says Reynolds, to showcase leadership and best practice by forward-thinking firms, as well as shaping guidance to others.

The new reporting requirements will also reflect the priorities of the new 2021-24 strategy, enabling even greater focus on climate and human rights, as well as responding to improvements in performance and scores by the majority of asset managers.

“in some of the modules, huge numbers of our signatories were all getting ‘A’s. Practice has changed, so some of our questions needed to continue to change with practice,” says Reynolds, asserting that the new system will make it easier to distinguish between managers.

Whether and what asset managers report on outcomes will also be available for scrutiny by their clients. Often highly dependant on asset managers in managing the ESG risks and opportunities across their portfolios, as well as representing their views to investee companies, many asset owners use the PRI’s reporting processes as part of their due diligence.

Different stages, same direction

This relationship is not without its tensions, in part because perceptions and priorities differ when interpreting ESG factors within portfolios. Client expectations of asset managers continue to intensify, with high levels of active engagement now becoming the norm, even for large passive investment houses. Reynolds is under no illusions and admits it can be hard to keep all parties on the same page.

“It’s completely fine that people are at different stages – after all, they work in different regulatory environments and they’re different sizes and scale to be able to do things – as long as everyone’s moving in the right direction,” she says.

But the PRI stands fully behind the desire of asset owners to hold managers to account, insists Reynolds, noting the guidance the organisation published last year on selection and monitoring of manager relationships.

Long gone are the days when membership of the PRI was sufficient evidence for a manager attempting to assert its responsible investment bona fides. Reynolds says asset owners have to constantly up their game in terms of due diligence, by embedding sustainability principles and targets into their mandates, and putting rigorous monitoring processes

To support them in selecting appropriate partners for responsible investment, the PRI has removed signatories before and is willing to do so again.

In addition, the PRI plans to change its minimum requirements of member managers. These were first put in place a few years ago, and new ones will be put in place over the course of the new strategy. Reynolds says it’s necessary to “ratchet things up” even while remaining a big tent.

“We’re saying: ‘It’s okay if you’re at different stages, but you all need to be moving, and you need to be demonstrating that you’re moving’.”

New era of responsibility and accountability

A key mechanism for pushing signatories to new levels of best practice is the PRI Leaders’ Group, a small band of asset managers and owners selected and highlighted for their strong performance in the PRI’s annual reporting cycle on a specific theme. This year’s theme is stewardship, in line with the growing importance of constructive engagement to better influence real-world outcomes.

Assessment will be based on the PRI’s Active Ownership 2.0 framework, which prioritises achieving real-world outcomes, addressing systemic sustainability issues, and commitment to collaboration.

“I see responsible investment now as really mainstreaming and maturing. It’s moved a lot in the almost 15 years that the PRI has been in operation. As industries mature and professionalize, their practices change and regulation follows,” says Reynolds.

Both asset owners and managers need to continually evolve, she suggests. To this end, the PRI is providing new guidance to asset owners on how to incorporate beneficiaries’ ESG preferences into their investment decisions.

“I think we’re getting into a new era of responsibility and accountability about responsible investment. We’re trying to provide guidance,” adds Reynolds.

Emerging best practice is also demonstrated through the actions of the UN-convened Net Zero Asset Owner Alliance, consisting a coalition of firms ready to implement portfolio decarbonisation, effectively clearing a path for a wider range of investors to follow. The Alliance, a 35-strong sub-group of the PRI with US$5.5 trillion AUM, recently made its contribution to the art of stewardship through the release of a guide to help asset owners assess the ‘climate-voting’ credentials of managers.

Reynolds acknowledges the complexities involved and the need to treat votes on a case-by-case basis. “We’re trying to do more around how to make voting count, how to make engagement meaningful, not tick-boxing. That will be a very important part of the work we’re doing in the next three years. So we’re trying to move the needle, move the dial, constantly,” she says.

Everyone playing their role

As asset owners and managers grapple with the operational realities of sustainable investing, they inevitably have half an eye on political developments, such as this week’s Earth Day summit, and COP26 in Glasgow.

“The whole focus of COP 26 is about net-zero commitments from governments, investors and business,” says Reynolds. “The investment community needs to show that we are playing our role, because that increases what businesses are prepared to do. At the same time, we need governments which might make net-zero commitments to then bring in the policy changes that are going to enable the transition to happen, so that we know with some certainty the direction in which we’re going.”

Reynolds credits the UK government, for example, for building on its net-zero 2050 commitment with actions which stimulate change in key sectors, such as announcing a ban new sales of vehicles with internal combustion engines by 2030. More detail is required, she notes, across multiple sectors.

“Governments need to play their role. Hopefully, we will see more clarity about what governments are doing to drive their commitments forward. You can’t just announce a commitment to net zero by 2050 and think it’s all going to magically happen. Investors want certainty about what government policy is going to be so they can invest, deploy capital, and make changes.”



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